Financial Accounting 2

LESSON THREE
INTRODUCTION TO ACCOUNTING EQUATION AND DOUBLE ENTRY SYSTEM
Learning objectives
A study of this chapter should enable students to:
 Explain what is meant by the Accounting Equation
 Have a clear perspective of the double entry system
 Understand how the double entry system follows the rules of the accounting equation
 Describe the debit and credit entries with corresponding transactions
 Account for Assets, Liabilities and Capital
 Account for Sales, Purchases, Incomes and Expenses
 Understand the Asset of Stock
Introduction
This chapter introduces the application of the Accounting Equation that forms the basis of the
double entry in accounting. Debit and credit entries are used in accordance to a particular
transaction and for the double entry to be observed, every debit entry must be corresponded with
a credit entry or a set of credit entries and vice versa.
3.1 The Accounting Equation

Initially when a business enterprise starts operating, it owns property inform of assets that are
equivalent to the start up capital. Later on after continuance in the business, obligations inform of
liabilities are incurred hence the equation changes. The total assets are now equivalent to the capital
plus the liabilities in the business.
ASSETS = LIABILITIES + CAPITAL
The accounting equation is summarized in the balance sheet as illustrated below;
(Horizontal Format) Balance sheet as at 31.12.20x3

ASSETS CAPITAL AND LIABILITIES
Non Current Assets Capital xxx
Land and buildings xxx
Furniture and fittings xxx Long term liabilities
Less Acc Depreciation (xx) 5 year loan from ABC ltd xxx
xxx
Motor vehicles xxx
Less Acc Depreciation (xx)
xxx
Current Assets Current Liabilities
Debtors (A/c Receivable) xxx Creditors (A/c Payable) xxx
Stock (Closing Inventory) xxx Bank overdraft xxx
Prepaid Expenses xxx Accrued expenses xxx
Bank xxx xxx
Cash xxx
xxx
XXX XXX
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(Vertical Format I) Balance sheet as at 31.12.20x3
Non Current Assets Cost Depreciation Net Book Value
Land and Buildings xxx ----- xxx
Furniture and fittings xxx (xx) xxx
Motor vehicles xxx (xx) xxx
xxx xxx xxx
Current Assets
Stock xx
Debtors xx
Prepaid expenses xx
Bank xx
Cash xx xx
Total Assets XXX
FINANCED BY:
Capital xxx
Long term Liabilities (5 year loan) xxx
Current Liabilities
Creditors xx
Accrued expenses xx
Bank overdraft xx xxx
XXX
(Vertical Format II) Balance sheet as at 31.12.20x3

xxx xxx xxx
Current Assets
Stock xx
Debtors xx
Prepaid expenses xx
Bank xx
Cash xx
Total current assets xx
Current Liabilities
Creditors xx
Accrued expenses xx
Bank overdraft xx
Total current liabilities (xx)
Working Capital xxx
NET WORTH XXX
FINANCED BY:
Capital xxx
XXX
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Activity 3.1
The following transactions demonstrate the application of the accounting equation in a balance
sheet.
1.) Introduction of Capital for a New Business

01/01/20x3; XYZ traders started business by depositing Ksh 90,000 in a business bank account
Balance sheet as at 01/01/20x3

ASSETS Kshs CAPITAL Kshs
Cash at bank 90,000 Capital 90,000
90,000 90,000
2.) Purchase of a Non Current Asset via Cheque

04/01/20x3; XYZ bought a motor vehicle for the business worth Ksh 40,000 paying by cheque

ASSETS Kshs CAPITAL Kshs
Motor vehicle 40,000 Capital 90,000
Cash at bank 50,000
90,000 90,000
3.) Purchase of a Current Asset on Credit

07/01/20x3; XYZ purchased goods for Ksh 13,000 on credit terms.

ASSETS Kshs CAPITAL & LIABILITIES Kshs
Stock 13,000 Liability
Cash at bank 50,000 Creditor 13,000
103,000 103,000
4.) Sale of a Current Asset on Credit Terms

11/01/20x3; XYZ made credit sales costing Ksh 5,000 to ABC enterprises.

Stock 8,000
Debtor 5,000 Liability
103,000 103,000
5.) Sale of a Current Asset on Cash Terms

14/01/20x3; XYZ made cash sales costing Ksh 7,000 to KK enterprises
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Stock 1,000
103,000 103,000
6.) Payment of a liability

16/01/20x3; XYZ paid Ksh 11,000 for the goods bought on credit.

Stock 1,000
92,000 92,000
7.) Collection of a current asset

30/01/20x3; ABC enterprises paid XYZ traders Ksh 3,500 being part settlement of the account.

Stock 1,000
92,000 92,000
Illustration 3.1
The following information relates to Alpha traders as at 31st December 20x3. You are required to
prepare a balance sheet as at that date.
Ksh
Land & Buildings 450,000
Furniture & Fittings 75,500
Motor Vehicles 95,800
Stocks 57,000
Debtor 17,600
Cash a bank 21,500
Cash in hand 9,000
Creditors 97,700
Capital 224,200
Loan 400,000
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Solution using horizontal format
Alpha Traders
Balance Sheet as at 31 December 20x3
Non Current Assets Ksh Capital & Liabilities
Land & Buildings 450,000 Capital 224,200
Motor Vehicles 95,800 Long term Liability
621,300 Loan 400,000
Current Assets
Stock 57,000 Current Liability
Debtors 17,600 Creditors 97,700
Cash at bank 21,500 Accrued Electricity bill 4,500
Cash in hand 9,000
105,100
726,400 726,400
Solution using vertical format
Alpha Traders
Balance Sheet as at 31 December 20x3
Non Current Assets Ksh Ksh Ksh
Land & Buildings 450,000
621,300
Current Assets
Stock 57,000
Debtors 17,600
Cash at bank 21,500
Cash in hand 9,000
105,100
Current Liabilities
Creditors 97,700
Accrued Electricity bill 4,500
(102,200)
Working Capital 2,900
NET WORTH 624,200
Financed By:
Capital 224,200
Long term liability – Loan 400,000
624,200
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Illustration 3.2
The following assets and liabilities are owned by Jacob a sole trader as at 01/01/20x3.
Ksh
Accounts payable 56,500
Machinery 150,000
Motor Vehicle 260,600
Stock 105,000
Accounts receivable 155,700
Bank 90,000
Cash 34,000
The following transactions were also captured during the financial period that ended 31/12/20x3.
a) A new machine was purchased on credit worth Ksh 21,500.
b) Additional stock for Ksh 64,000 was purchased via bank.
c) Creditors were partly settled by payment of Ksh 20,000 by cheque.
d) The current debtors paid their account by Ksh 72,000 on cash.
e) Jacob deposited Ksh 5,000 into the bank account as capital.
Required:
i. Determine the capital amount for the business at the beginning of the financial period.
ii. Extract a trial balance that captures all the transactions reported.
Solution:
i. Capital can be derived using the accounting equation.
ASSETS = LIABILITIES + CAPITAL Therefore;

CAPITAL = ASSETS – CAPITAL
ASSETS Ksh LIABILITIES Ksh

Accounts receivable 155,700 Accounts payable 56,500
Machinery 150,000
Motor Vehicle 260,600
Stock 105,000
Bank 90,000
Cash 34,000
795,300
Capital = Assets – Liabilities
Capital = 795,300 – 56,500 = Ksh 738,800
ii. To Extract a balance sheet we need to consider the reported transactions

 Credit purchase of new machine will Increase both machinery and accounts payable by
Ksh 21,500
 Purchase of stock via bank will Increase stock and Reduce bank by Ksh 64,000.
 Payment of Creditors by cheque will Reduce accounts payable and bank by Ksh 20,000.
 Debtors cash payment will Reduce accounts receivable and Increase cash by Ksh 72,000.
 Bank deposit of Ksh 5,000 (as capital) by Jacob will Increase both capital and bank.
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This can be summarized as follows:
Assets Ksh Capital & Liabilities Ksh
Accounts receivable 155,700 – 72,000 Capital 738,800 + 5,000
Machinery 150,000 + 21,500 Liabilities
Motor Vehicle 260,600 Accounts payable 56,500 + 21,500 – 20,000
Stock 105,000 + 64,000
Bank 90,000 – 64,000 – 20,000 + 5,000
Cash 34,000 + 72,000
With the above adjustments the balance sheet will now appear to be as follows:
Jacob Sole Trader
Machinery 171,500
Motor vehicle 260,600
432,100
Current Assets
Stock 169,000
Accounts receivable 83,700
Bank 11,000
Cash 106,000
369,700
Current Liabilities
Accounts payable 58,000
(58,000)
Net Worth 743,800
Financed By:
Capital 743,800
3.2 The Double Entry System
Accounting equation forms the basis of the double entry system. Change in a business involving
Assets, Liabilities or Capital MUST have an effect that is interrelated to the three components of
the accounting equation. This is known as a double effect such that assets will always be equal to
liabilities plus capital. For Example if the owners of a business enterprise put in additional capital
into the business via bank, this will increase the cash at bank and the capital amount will also
increase hence the equation is still maintained.
According to the accounting equation if all assets are represented by liabilities and capital then all
debit entries should be the same as credit entries.
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3.3 The Debit and Credit Entries
The Debit Entry is shown on the left hand side of an account (Commonly referred to as a “T –
Account) while the Credit Entry is shown on the right hand side of an account (Commonly
referred to as a “T – Account). Assets are recorded on the debit side while all the liabilities and
capital are recorded on the credit side.
Assets and Liabilities are classified into various categories as covered in lesson two and every type
of asset or liability must have its own account whereby all transactions affecting them are recorded
in that particular account.
This means that there should be individual accounts for Buildings, Equipment, Machinery, Motor
vehicles, Furniture & fittings, Debtors, Creditors, etc. For the double entry to be reflected in the
accounts, every debit entry must have a corresponding credit entry or a set of credit entries and
vice versa. The transactions affecting these accounts are posted in the account as debit entry and
credit entry to complete the double entry.
The following is a layout of accounts with a debit and credit side:
Title of Account
Left-hand side Right-hand side
This side represents the ‘debit’ side This side represents the ‘credit’ side.
These accounts are commonly referred to as T – Accounts because the lines separating the two
sides form a ‘T’. This is simply illustrated as:
Dr. Title of Account Cr.
3.4 Double Entry System for the Various Elements of Financial Statements
As covered in lesson two, we now have an idea of elements used in financial statements.
Remember we have elements for the income statement as well as those for the balance sheet. The
double entry system that is based on the Accounting Equation has interconnectivity with the
discussed elements of financial statements.
3.4.1 Accounting for Assets, Liabilities and Capital.

Assets, Liabilities and Capital comprise of the elements in the Balance Sheet. Activity 3.1,
illustrations 3.1 and 3.2 have been revolving with these elements. The following summary
indicates the double entries relevant to account for them.
Increase in ASSET = DEBIT entry

Decrease in ASSET = CREDIT entry
Increase in LIABILITY = CREDIT entry
Decrease in LIABILITY = DEBIT entry
Increase in CAPITAL = CREDIT entry
Decrease in CAPITAL = DEBIT entry
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Summary table for Balance Sheet Elements
ASSETS INCREASE Debit
DECREASE Credit
LIABILITIES INCREASE Credit
DECREASE Debit
CAPITAL INCREASE Credit
DECREASE Debit
Illustration 3.3
Prepare Asset, Liability and Capital Accounts for Michael who had the following transactions for
the month of January, 20x3.
01/01/20x3: Started business by depositing Ksh 500,000 in the bank.
02/01/20x3: Purchased a Motor Vehicle paying by cheque Ksh 120,000.
05/01/20x3: Purchased Fixtures & Fittings Ksh 40,000 on credit from ABC Ltd.
08/01/20x3: Purchased another Motor Vehicle on credit from XYZ Ltd for Ksh 80,000.
12/01/20x3: Withdrew Ksh 10,000 from the bank and put it into the cash till.
15/01/20x3: Purchased extra Fixtures & Fittings paying by cash Ksh 6,000.
19/01/20x3: Paid XYZ Ltd by cheque Ksh 80,000.
21/01/20x3: Received a loan of Ksh 100,000 in cash from KK financers.
25/01/20x3: Deposited cash amount of Ksh 80,000 into the bank account.
30/01/20x3: Purchased more Fixtures & Fittings by cheque worth Ksh 30,000.
Capital A/c Bank A/c
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.

30/1 Bal c/f 500,0001/1 Bank 500,000 1/1 Capital 500,0002/1 M/vehicle120,000
25/1 Cash 80,000 12/1Cash 10,000
19/1 XYZ Ltd 80,000
500,000 500,000 30/1 Fixtures 30,000
30/1 Bal c/f 340,000
580,000 580,000
Motor Vehicle A/c

20x3 Sh. 20x3 Sh.
2/1 Bank 120,000
8/1 XYZ Ltd 80,000 30/1 Bal c/f 200,000
200,000 200,000
Fixtures & Fittings A/c

20x3 Sh. 20x3 Sh.
5/1 ABC Ltd 40,000
15/1 Cash 6,000
30/1 Bank 30,000 30/1 Bal c/f 76,000
76,000 76,000
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XYZ Ltd A/c – Creditors
20x3 Sh. 20x3 Sh.
19/1 Bank 80,000 8/1 M/vehicle 80,000
80,000 80,000
ABC Ltd A/c – Creditor
20x3 Sh. 20x3 Sh.
30/1 Bal c\f 40,000 8/1 Fixtures & Fittings 40,000
40,000 40,000
Cash A/c
20x3 Sh. 20x3 Sh.
12/1 Bank 10,000 15/1 Fixtures 6,000
25/1 Bank 80,000
21/1 KK Financers 100,000 30/1 Bal c/f 24,000
110,000 110,000
KK Financers A/c
20x3 Sh. 20x3 Sh.
30/1 Bal c\f 100,000 21/1 Cash 100,000
Points to Note:
 The difference between the debit and credit side is the balancing figure shown in the form
of ‘Bal c/f’ meaning balance carried forward as at the end of that financial period.
 Most Assets have a balance on the credit side while most Liabilities and capital accounts
will have a balance on the debit side. This is not always the case because for example a
bank account (asset account) can have a balance on the debit side meaning its overdrawn
that is it has a bank overdraft hence converting the account into becoming a liability.
A balance sheet from the above accounts will be as follows:

Michael
Balance Sheet as at 30/01/20x3
Fixtures & Fittings 76,000
276,000
Current Assets
Bank 340,000
Cash 24,000
364,000
Current Liabilities
Creditors (ABC Ltd) 40,000
(40,000)
Net Worth 600,000
Financed by:
Capital 500,000
Long term Liability – Loan KK Financers 100,000
600,000
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3.4.2 Accounting for Sales, Purchases, Incomes and Expenses
The above comprise the Income statement elements. Sale and purchases might appear to be new
but Sales form part of Revenue while purchases indicate increase in stock or inventory for a
particular business.
These elements will be later discussed into details.
Double Entry System for Elements in the Income Statement
Increase in EXPENSES = DEBIT entry

Decrease in EXPENSES = CREDIT entry
Increase in INCOME/ REVENUE = CREDIT entry
Decrease in INCOME/ REVENUE = DEBIT entry
Summary table Income Statement Elements

EXPENSES INCREASE Debit
DECREASE Credit
INCOME/ REVENUE INCREASE Credit
DECREASE Debit
Summary table All elements

ASSETS INCREASE Debit
DECREASE Credit
EXPENSES INCREASE Debit
DECREASE Credit
LIABILITIES INCREASE Credit
DECREASE Debit
CAPITAL INCREASE Credit
DECREASE Debit
INCOME/ REVENUE INCREASE Credit
DECREASE Debit
3.4.2.1 Accounting for Sales:

Sales are realized after selling goods that were initially bought or purchased by a business with the
purpose of resale. Sales generate revenue for a particular business and can be sub-divided into
either Cash Sales or Credit Sales.
 Accounting Treatment for Cash Sales

Debit : Cash/ Bank Account
Credit : Sales Account
 Accounting Treatment for Cash Sales

Debit : Debtors Account/ Accounts receivable Account
Credit : Sales Account
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3.4.2.2 Accounting for Purchases:
Purchases involve buying of goods meant for resale by a business firm. Purchases can also be sub-
divided into either for Cash Purchases or Credit Purchases.
 Accounting Treatment for Cash Purchases
Debit : Purchases Account
Credit : Cash/ Bank Account
 Accounting Treatment for Credit Purchases

Debit : Purchases Account
Credit : Creditors Account/ Accounts Payable Account
3.4.2.3 Accounting for Income:

A business firm may generate other income apart from that generated from trading (sales). These
other incomes can include e.g. Rent, Bank interest received, Discounts received etc.
 Accounting Treatment for Income received

Debit : Cash/ Bank Account or Account receivable
Credit : Income Account
NB:
 Each Income should have an individual account.
 Incomes increase the capital of a business thus this being the reason as to why they are
posted on the credit side of their respective accounts.
3.4.2.4 Accounting for Expenses:

Expenses involve amounts incurred in furtherance of generating revenue for a business. Expenses
are paid out for services rendered other than those paid for purchases. Expenses may include;
Electricity bill, Salaries and wages, Bank charges, Motor vehicle expenses, Rent and rates,
Telephone bills, Advertising etc.
 Accounting Treatment for Expenses

Debit : Expenses Account
Credit : Cash/ Bank Account or Account Payable
NB:
 Each expense should have an individual account.
 Expenses decrease the capital of a business thus this being the reason as to why they are
posted on the debit side of their respective accounts.
3.5 The Asset of Stock (Inventory)

A Stock Account is NEVER maintained because sales are not priced at cost hence sales figures
include elements of profit and loss, and do not represent cost of stock of goods. Stock is therefore
subdivided into several accounts each showing the movement of stock.
3.5.1 Accounts to record increase of stock

Accounts that record any increase in stock are:
 Purchases Account
 Return Inwards Account
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3.5.1.1 Purchases Account
Records purchases of additional goods either on credit or cash as discussed earlier.
3.5.1.2 Returns Inwards Account (Sales Returns Account)

Records return of goods previously sold by a business its customers or debtors. Goods may be
returned for various reasons like being; faulty, wrong type of goods or oversupply.
Return inwards may relate to cash sales or credit sales. Goods returned in relation to a cash sale
that was initially made, cash is refunded to the customer.
Return inwards in relation to a credit sale that was initially made, cash is not refunded to the debtor.
 Accounting Treatment for Return inwards relating to Cash Sales:
Debit : Return inwards Account
Credit : Cash/ Bank Account or Cashbook
 Accounting Treatment for Return inwards relating to Credit Sales:

Debit : Return inwards Account
Credit : Debtors Account
 Accounting treatment for Return inwards in the trading account:
Return inwards is deducted from SALES AMOUNT
3.5.2 Accounts to record decrease of stock

Accounts that record any decrease in stock are:
 Sales Account
 Return Outwards Account
 Good Drawings Account
3.5.2.1 Sales Account

Records sale of goods either on credit or cash as discussed earlier.
3.5.2.2 Returns Outwards Account (Purchases Returns Account)

Records return of goods previously bought by a business. The goods are returned to the suppliers
or creditors.
Return outwards may relate to cash purchases or credit purchases. Goods returned in relation to a
cash purchase that was initially made, cash is refunded to the business firm by the supplier.
Return outwards in relation to a credit purchase that was initially made, cash is not refunded to the
business firm by the creditor.
 Accounting Treatment for Return Outwards relating to Cash Purchases:
Debit : Cash/ Bank Account or Cashbook
Credit : Return Outwards Account
 Accounting Treatment for Return Outwards relating to Credit Purchases:

Debit : Creditors Account
Credit : Return Outwards Account
 Accounting treatment for Return Outwards in the trading account:

Return outwards is deducted from PURCHASES AMOUNT
3.5.2.3 Drawings Account (Goods Drawing)
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Drawings in the form of Goods arises when the owner(s) of the business takes out some of the
business goods out of the stock or purchases made for his own use.
 Accounting Treatment for Goods Drawing:
Debit : Drawings Account
Credit : Purchases Account
Illustration 3.4
The following transactions relate to Kencom Enterprises. You are required to complete the double
entry in the relevant accounts for the month of May, 20x3.
01/05/20x3: Started business by depositing Ksh 200,000 in the bank.

02/05/20x3: Purchased goods worth Ksh 17,500 on credit from MM Wholesalers.
03/05/20x3: Bought Equipment for Ksh 15,000 paying by cheque.
05/05/20x3: Sold goods for cash worth Ksh 27,500.
06/05/20x3: Bought goods on credit worth Ksh 11,400 from Pp Shah.
10/05/20x3: Paid rent by cash Ksh 1,500.
12/05/20x3: Bought stationery for Ksh 2,700, paying in cash.
18/05/20x3: Goods returned to MM Wholesalers were amounting to Ksh 2,300.
21/05/20x3: Received rent by cheque for Ksh 500.
23/05/20x3: Sold goods on credit to Unity for Ksh 7,700.
24/05/20x3: Bought a motor vehicle paying by cheque Ksh 30,000.
30/05/20x3: Paid the wages by cash amounting to Ksh 11,700.
31/05/20x3: The owner made cash drawings for personal use worth Ksh 4,400.
Solution:
Bank A/c
20x3 Sh. 20x3 Sh.
1/5 Capital 200,000 3/5 Equipment 15,000
24/5 Motor vehicle 30,000
21/5 Rent 5 31/5 Bal c/f 1,555
2,005 2,005
Capital A/c
20x3 Sh. 20x3 Sh.
31/5 Bal c/f 200,000 1/5 Bank 200,000
Purchases A/c
20x3 Sh. 20x3 Sh.
2/5 MM Wholesalers 17,500
6/5 Pp Shah 11,400 31/5 Bal c/f 28,900
28,900 28,900
MM Wholesalers A/c (Creditor)
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20x3 Sh. 20x3 Sh.
18/5 Returns outward 2,300 2/5 Purchases 17,500
31/5 Bal c/f 152
17,500 17,500
Equipment A/c Sales A/c

20x3 Sh 20x3 Sh 20x3 Sh 20x3 Sh
3/5 Bank 15,000 31/5 Bal c/f 15,000 31/5 Bal c/f 35,200 5/5 Cash 27,500
23/5 Unity 7.700
15,000 15,000 35,200 35,200
Cash A/c Pp Shah a/c

20x3 Sh 20x3 Sh 20x3 Sh 20x3 Sh
5/5 Sales 27,500 10/5 Rent 1,500 31/5 Bal c/f 11,400 6/5Purchases 11,400
12/5 Stationery 2,700 11,400 11,400
30/5 Wages 11,700
31/5 Drawings 4,400
31/5 Bal c/f 7,200
27,500 27,500
Rent A/c (Expenses) Stationery A/c (Expenses)

20x3 Sh 20x3 Sh 20x3 Sh 20x3 Sh
11/5 Bal c/f 1,500 10/5 Cash 1,500 12/5 Cash 2,700 31/5Bal c/f 2,700
2,700 2,700
Returns – Out A/c Rent A/c (Income)

20x3 Sh 20x3 Sh 20x3 Sh 20x3 Sh
31/5 Bal c/f 2,300 18/5 MM 2,300 21/5 Bal c/f 500 31/5 Bank 500
Unity A/c (Debtor) Motor vehicle A/c

20x3 Sh 20x3 Sh 20x3 Sh 20x3 Sh
23/5 Sales 7,700 31/5 Bal c/f 7,700 24/5 Bank 30,000 31/5 Bal c/f 30,000
Wages A/c (Expenses) Drawings A/c

20x3 Sh 20x3 Sh 20x3 Sh 20x3 Sh
30/5 Cash 11,700 31/5 Bal c/f 11,700 31/5 Cash 4,400 31/5 Bal c/f 4,400
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LESSON FOUR
THE ACCOUNTING CYCLE
Learning objectives
 Identify the various sources of financial data
 Prepare journal entries per transactions
 Post journal entries into respective ledger accounts
 Preparation of a cash book and a petty cash book
 Extraction of a trial balance
 Adjustment entries to the journals, ledgers and trial balance
 Understand the procedures to preparing financial Statements
 Understand and clearly define the accounting cycle with its various steps
Introduction
The accounting cycle involves a series of steps undertaken in order to produce financial statements
to aid in economic decision making for the various users of the accounting information. Basically
the accounting cycle comprises of the following major parts;
(a) Capture source documents.

(b) Enter transactions in the books of original entry (Journalizing).
(c) Post journal entries to ledgers.
(d) Extract a trial balance.
(e) Adjustment entries.
(f) Prepare financial statements.
4.1 Capture Source Documents

This step involves collection and capturing of source documents that record the evidence of a
business transaction that occurred. The documents are collected, recorded, filed and the postings
made in the books of prime entry.
Main Source documents include;

 Sales invoice
 Purchases invoice
 Credit note
 Debit note
 Receipts
 Cheques
 Petty cash vouchers
 Any other correspondences
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4.1.1 Sales Invoice
A sales invoice is sent by a business firm to its debtors after transacting a credit sale.
Particulars of a sales invoice include;
 Business name and address of the transacting parties.
 Date of the sale.
 Sales invoice number and amount due.
 Good description.
 Terms of sale.
4.1.2 Purchases Invoice

A purchase invoice is sent by a creditor to a business firm that makes a credit purchase.
Particulars of a purchases invoice include;
 Date of the purchase.
 Purchases invoice number and amount due.
 Goods description.
 Terms of purchase.
4.1.3 Credit note

A credit note is sent by a business firm to a debtor in response to some goods returned by the
debtor back to the business firm.
Particulars of a credit note include;
 Date.
 Credit note number.
 Amount to be refunded.
 Reason for goods returned. (Sales Returns)
4.1.4 Debit note

A debit note is sent by the creditor to a business firm that returns some goods to the creditor after
it had initially made credit purchases.
 Date.
 Debit Note number.
 Amount to be refunded.
 Reason for goods returned. (Purchases Returns)
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4.1.5 Receipts
A receipt is sent by the business firm to its customers or debtors after transacting inform of cash
or cheques.
 Date.
 Receipt number.
 Amount received. (Cash or Cheque)
4.1.6 Cheques
A business firm can make payments against the account held in the bank via cheques. The
cheque authorizes the respective bank to honour payments against the business firm’s account
name.
Particulars of a cheque include;
 Name of payee and drawer
 Date.
 Amount payable in words and figures
 Cheque number
 The authorized signature(s)
4.1.7 Petty cash vouchers

A petty cash voucher is sent by a cashier requesting for payment of trivial cash or petty cash to
seek authority for payments.
Particulars of a petty cash vouchers include;
 Date.
 Amount paid.
 The authorized signature(s)
 Payment reason.
 Person(s) responsible for approving and receiving.
4.1.8 Other correspondence

Any other correspondence can emanate from internal or external side of the business firm as long
as it has a financial implication in the accounts. For example extra charges made in the accounts.
4.2 JOURNALIZING
Journalizing involves recording transactions in a journal. It also involves the initial record of
transactions in Books of Original Entry.
Books of original entry can also be referred to as; Books of Prime Entry or Subsidiary Books/
Journals/ Day Books/. These are books where transactions are first recorded and they include;
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4.2.1 Sales Journal
Sales journal is also known as Sales Day Book. It records all sales invoices issued by the firm
during a particular time. Individual entries on the sales day book are posted on the debit side of
debtors account in the sales ledger. The total is posted on the credit side of general ledger.
The following is an illustration to show a sales journal.
Sales Journal
Date Details Invoice No. Folio No. Amount (Kshs)
1/5/20x3 John 01345 SL10 20,000
2/5/20x3 Peter 00512 SL11 10,000
SUNDRY DEBTORS 30,000
Recording in the sales ledgers

Dr John A/C Cr Dr John A/C Cr
Kshs Kshs Kshs Kshs
1/5 Sales 20,000 2/5 Sales 10,000
Recording in the General Ledger

Dr Sales A/C Cr
Kshs Kshs
31/5 Sundry debtors 30,000
Illustration 4.1
You are to enter up the sales journal from the following details. Post the items to the relevant
accounts in the sales ledger and then show the transfer to the sales account in the general ledger.
Date Credit Sales to; Amount

1/6/20x3 Michel Sh. 1,800
4/6/20x3 Herbert Sh. 2,000
7/6/20x3 Jessica Sh. 900
9/6/20x3 Cecilia Sh. 450
16/6/20x3 Andrew Sh. 1,390
21/6/20x3 Richard Sh. 380
DATE DETAIL FOLIO NO. AMOUNT

1/6/20x3 Michael 0010 Sh. 1,800
4/6/20x3 Herbert 0020 Sh. 2,000
7/6/20x3 Jessica 0030 Sh. 900
9/6/20x3 Cecilia 0040 Sh. 450
16/6/20x3 Andrew 0050 Sh. 1,390
21/6/20x3 Richard 0060 Sh. 380
30/6/20x3 Albert 0070 Sh. 500
SUNDRY DEBTORS Sh. 7,420
19
Michael Herbert
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
1/6 Sales 1,800 4/6 Sales 2,000
Jessica Cecilia
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
7/6 Sales 900 9/6 Sales 450
Andrew Richard
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
16/6 Sales 1,390 21/6 Sales 380
Albert Sales a/c

20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
30/6 Sales 500 Sundry 7,420
Debtors
4.2.2 Purchases Journal

Purchases Journal is also known as Purchases Day Book. It records all purchase invoices received
by the firm during a particular financial period. Individual entries are posted to the credit side of
creditors account in the purchase ledger. The total is posted to the debit side of the purchases
account in the general ledger.
The following is an illustration to show a Purchases Journal.
Purchases Journal
Date Details Invoice No. Folio No. Amount (Kshs)
6/5/20x3 Ken 00545 SL21 5,000
10/5/20x3 Timothy 00519 SL16 3,000
SUNDRY CREDITORS 8,000
Recording in Purchases ledgers
Dr Ken A/C Cr Dr Timothy A/C Cr

Kshs Kshs Kshs Kshs
6/5 Purchases 5,000 10/5 Purchases 3,000
Recording in General Ledger
Dr Purchases A/C Cr
Kshs Kshs
31/5 Sundry creditors 8,000
20
4.2.3 Return Inwards Journal
Return Inwards Journal is also known as Return Inwards Day Book. It records all credit notes
received by the firm. Individual entries in a return inwards day book are posted to the credit side
of the debtors account in the sales ledger and the total is posted in the debit side of return inwards
account in the general ledger.
Return inwards day book

Date Details Credit Note No. Folio No. Amount (Kshs)
7/5/20x3 Tony 00100 SL28 1,000
8/5/20x3 Mark 00101 SL30 500
SUNDRY DEBTORS 1,500
Recording in Sales ledgers
Dr Tony A/C Cr Dr Mark A/C Cr

Kshs Kshs Kshs Kshs
7/5 R/inwards 1,000 8/5 R/inwards 500
Dr Return inwards A/C Cr

Kshs Kshs
4.2.4 Return Outwards Journal

Return Outwards Journal is also known as Return Outwards Day Book. It records all debit notes
sent to suppliers. Individual entries in a return outwards day book are posted to the debit side of
the creditors account in the purchases ledger and the total is posted to the credit side of return
outwards account in the general journal.
Return outwards day book

Date Details Debit Note No. Folio No. Amount (Kshs)
10/5 Robert 0202 SL41 1,500
12/5 Maxwell 0223 SL62 800
SUNDRY CREDITORS 2,300
Recording in Purchases ledgers

Dr Robert A/C Cr Dr Maxwell A/C Cr
Kshs Kshs Kshs Kshs
10/5 R/Outwards 1,500 12/5 R/Outwards 800

Dr Return outwards A/C Cr
Kshs Kshs
21
Illustration 4.2
The following transactions relate to Jasho Enterprises. Enter the transactions in the relevant
books of original entry and show the postings made in the general ledger.
20x3
1/10/20x3 Credit purchases from: Martin Sh. 38,000; Mark Sh. 5,000; Mike Sh. 1,060.
3/10/20x3 Credit sales to: Rick Sh. 5,100; Raps Sh. 2,460; Rachael Sh. 3,560.
5/10/20x3 Credit purchases from: Matthew Sh. 2,000; Mabel Sh.1,800 ; Marshal Sh. 4,100;
Michael Sh.660.
8/10/20x3 Credit sales to: Stephen Sh. 3,070; Stella Sh. 2,500; Samuel Sh. 1,850.
12/10/20x3 Returns outwards to: Mark Sh. 300; Mike Sh. 160.
14/10/20x3 Returns inwards from: Raps Sh. 180; Rachael Sh. 220.
20/10/20x3 Credit sales to: Raps Sh. 1,880; Shakes Sh. 3,100; Slim Sh. 4,200.
24/10/20x3 Credit purchases from: Peter Sh. 5,500; Patrick Sh. 9,000.
31/10/20x3 Returns inwards from: Raps Sh. 270; Rick Sh. 300.
31/10/20x3 Returns outwards to: Mabel Sh. 130; Michael Sh. 110.
SALES JOURNAL
DATE DETAIL AMOUNT (Sh.)

3 October Rick 5,100
3 October Raps 2,460
3 October Rachael 3,560
8 October Stephen 3,070
8 October Stella 2,500
8 October Samuel 1,850
20 October Raps 1,880
20 October Shakes 3,100
20 October Slim 4,200
TOTAL 27,720
Sales Ledger
Rick Raps
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
3/10 Sales 5,100 3/7 Returns 300 3/10 Sales 2,460 14/10 Returns 180
Inwards
20/10 Sales 1,880 31/10 Returns 270
in
Rachael Samuel
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
3/10 Sales 3,560 14/10 Returns 220 8/10 Sales 1,850
in
22
Stephen Shakes
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
8/10 Sales 3,070 20/10 Sales 3,100
Stella Slim
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
8/10 Sales 2,500 20/10 Sales 4,200
PURCHASES JOURNAL
DATE DETAIL AMOUNT (Sh.)
1 October Martin 3,800

1 October Mark 5,000
1 October Mike 1,060
5 October Matthew 2,000
5 October Mabel 1,800
5 October Marshal 4,100
5 October Michael 660
24 October Peter 5,500
24 October Patrick 9,000
Total 32,920
Purchases Ledger
Mike
20x3 Sh. 20x3 Sh.
12/10 Returns out 160 1/10 Purchases 1,060
Mark
20x3 Sh. 20x3 Sh.
Mabel
20x3 Sh. 20x3 Sh.
Michael
20x3 Sh. 20x3 Sh.
31/10 Returns out 110 5/10 Purchases 660
Martin
20x3 Sh. 20x3 Sh.
1/10 Purchases 3,800
Matthew
20x3 Sh. 20x3 Sh.
23
Marshal
20x3 Sh. 20x3 Sh.
Peter
20x3 Sh. 20x3 Sh.
Patrick
20x3 Sh. 20x3 Sh.
RETURNS INWARDS JOURNAL

DATE DETAILS AMOUNT
14 October Raps 180
14 October Rachael 220
31 October Raps 270
31 October Rick 300
TOTAL 970
RETURNS OUTWARDS JOURNAL

DATE DETAILS AMOUNT
12 October Mark 300
12 October Mike 160
31 October Mabel 130
31 October Michael 110
TOTAL 700
General Ledger
Sales a/c
20x3 Sh. 20x3 Sh.
Purchases a/c
20x3 Sh. 20x3 Sh.
Returns Inwards a/c

20x3 Sh. 20x3 Sh.
31/10 Sundry debtors 970
Returns Outwards a/c
20x3 Sh. 20x3 Sh.
31/10 Sundry creditors 700
24
4.2.5 General Journal
General Journal is also known as Journal Proper. It is used to record transactions or
correspondences that are not in other prime books. It contains the date, details, debit and credit
columns, explanation/ narrative of the transaction and folio reference to source documents.
The General Journal uses double entry system where a debit entry must be corresponded with a
credit entry or a set of credit entries and vice versa.
Uses of a General journal

1.) Used to correct presence of any errors in ledger accounts.
2.) Used to make necessary adjustments to entries in the ledgers.
3.) Records purchase and sale of non current assets on credit.
4.) Used to record bad debts written off.
5.) Records opening and closing balances of assets and liabilities.
6.) Records drawings for goods or other assets from the business by the owner.
The following is a journal format is:
Date Details Folio No. Debit Credit

01/01/20x3 Bank SL 0010 XXX
Capital NL 2370 XXX
(Narration to explain the transaction recorded above in the journal)
NOTE: Debit entries should be recorded first on the first line then followed by the credit entries
being on the second line.
Illustration 4.3
Record the following entries in a journal for the year 2011.
 On May 1st bought a vehicle on credit from Kenya motors for Kshs 96,000.
 On May 3rd a debt of Kshs 6,000 owing from John was written off as a bad debt.
 On May 8th credit purchase of furniture for 12,500 was returned to the supplier BB ltd as
it was unsuitable and full allowance will be given.
 On May 12th a Ken a debtor who owed us Kshs 4,000 was declared bankrupt and we
received Kshs 1050 in full settlement of the debt.
 On May 14th we take goods costing Kshs 3,500 out of the business stock without paying
for them.
 On May 28th we discovered that Kshs 1,500 of the insurance paid, belonged to private use.
 On May 30th bought machinery for Kshs 25,000 on credit from Electronics ltd.
Solution
25
DATE DETAILS Dr. (Kshs) Cr. (Kshs)
1/5 Vehicle A/c 96,000
Kenya Motors A/c 96,000
(To record purchase of vehicle from Kenya Motors ltd on credit)
3/5 Bad debts A/c 6,000

John A/c 6,000
(To record bad debt written off owing from John)
8/5 BB ltd A/c 12,500

Furniture A/c 12,500
(To record furniture returned to BB ltd)
12/5 Bank A/c 1,050

Bad debts A/c 2,950
Ken A/c 4,000
(To record amount paid by Ken and amount treated as bad debt)
14/5 Drawings A/c (Goods) 3,500

Purchases A/c 3,500
(To record goods taken out of the business )
28/5 Drawing A/c 1,500

Insurance A/c 1,500
(To record private insurance paid for by the business)
30/5 Machinery A/c 25,000

Electronics Ltd A/c 25,000
(To record machinery bought from Electronics ltd on credit)
Illustration 4.4
Prepare journal entries to record the following transactions that took place in the month of
February, 20x3:
01/02/20x3: Bought office fittings on credit from Heritage Ltd for Ksh 77,000.
05/02/20x3: Goods costing Ksh 34,000 were taken out of the business without paying for them.
08/02/20x3: Ksh 6,800 of the goods taken by us on 5th February is returned back into the
business stock by us and no money is taken in exchange for the return.
13/02/20x3: Johnson owes us Ksh 26,400 and he is unable to pay his debt so we agree to take
some of his computers worth the same amount to cancel his debt.
17/02/20x3: Paid Heritage Ltd Ksh 50,000 by cheque in partial settlement of the amount due.
25/02/20x3: A debt owing to us by Hicks of Ksh 13,450 is written off as a bad debt.
28/02/20x3: Bought equipment on credit from ART Ltd for Ksh 31,500.
Solution:
26
DATE DETAILS Dr. (Kshs) Cr. (Kshs)
1/2 Office Fittings A/c 77,000
Heritage Ltd A/c 77,000
(To record purchase of Office Fittings from Heritage Ltd on credit)
5/2 Drawings (Goods)A/c 34,000

Purchases A/c 34,000
(To record goods taken out of the business )
8/2 Purchases A/c 6,800

Drawings (Goods) A/c 6,800
(To record return of goods taken out of the business)
13/2 Computer A/c 26,400

Johnson A/c (Debtor) 26,400
(To record computers taken in settlement of Johnson’s debt)
17/2 Heritage Ltd A/c 50,000

Bank A/c 50,000
(To record partial payment to Heritage Ltd for amount due)
25/2 Bad debts A/c 13,450

Hicks A/c (Debtor) 13,450
(To record bad debt written off owing from Hicks)
30/5 Equipment A/c 31,500

ART Ltd A/c 31,500
(To record Equipment bought from ART Ltd on credit)
4.3 LEDGER ACCOUNTS

Once entries are made in books of original entry they are summarized using double entry concept
to accounts in various ledgers.
Types of Ledgers
a.) Sales Ledger; used to record debtors personal accounts.
b.) Purchases Ledger; used to record creditors personal accounts.
c.) General Ledger/ Nominal Ledger; Used to record accounts not represented in the sales
or purchases account e.g. accounts related to expenses, incomes, other assets, liability and
capital.
The ledger accounts can also be classified as follows:
Diagram 4.1: Classification of Accounts
27
ACCOUNTS
PERSONAL ACCOUNTS IMPERSONAL ACCOUNTS
DEBTORS CREDITORS REAL ACCOUNTS NOMINAL ACCOUNTS

ACCOUNTS ACCOUNTS Records; Records;
 Non current  Expenses
Assets  Income
 Inventory/  Capital
Stock  Other Assets
 Other Liabilities
4.3.1 Cash Books

A Cash Book is used to record all the Receipts and Payments inform of cash or cheques for a
particular financial period. The cashbook also shows the available cash at bank and cash in hand.
The cashbook forms part of the general ledger and records the source documents; that is receipts
and cheques.
Types of cash books
4.3.1.1 One Column Cash Book/ Single Column Cash Book

It contains an individual cash or bank account column but not both at the same time.
Dr Receipts Payments Cr
Date Details Cash Date Details Cash
OR
Date Details Bank Date Details Bank
4.3.1.2 Two Column Cash Book/ Double Column Cashbook

This cash book combines both cash and bank accounts. The amount column is sub-divided into
two; cash and bank columns.
Date Details Bank Cash Date Details Bank Cash
4.3.1.3 Three Column Cash Book
28
This cash book combines cash, bank and discounts columns. The amount column is sub-divided
into three; cash, bank and discounts columns.
Date Details Discount Bank Cash Date Details Discount Bank Cash
Allowed Received
The balances in the cash book form part of the ledger balances. The cash book can have either a
credit or debit balance. A debit balance means the business has cash at the bank and a credit
balance means that the account at the bank is overdrawn resulting to a bank overdraft (That is the
business firm owes the bank some money).
Totals from discounts allowed and discounts received columns are posted to the respective
discount accounts.
Purpose of keeping three column cash book
1.) Accurate recording of cash discounts allowed (Dr. side) and cash discount received (Cr. side)
2.) Accurate recording of cash and cheque receipts and payments.
3.) Records opening and closing balances at beginning and end of financial year respectively.
4.) Helps detect errors and fraud.
4.3.1.3.1 Discounts
Discounts are allowances given by a trader or manufacturer to another trader or customer to enable
or encourage them pay promptly or buy in bulk or earn profits. Discounts can be classified into
either:
i. Trade Discount
ii. Quantity Discount Discount Allowed
iii. Cash Discount
Discount received
 Trade Discount
Trade discount is allowance given by a trader to another trader to enable them earn a profit on
goods that have low profit margin or have fixed prices.
 Quantity Discount
Quantity discount is allowance given by a trader to encourage bulk purchasing from the customers.
Accounting treatment for Trade and Quantity discounts;

These discounts are shown as a deduction from invoice price and only NET AMOUNT paid or
received is treated in the books of accounts.
 Cash Discount
29
Cash discount is allowance given to encourage buyers or customers to pay promptly within the
stipulated period. Cash discount is further sub-divided into;
(i) DISCOUNT ALLOWED

Discounts allowed are allowances made by a business firm on the amounts receivable from
customers so as to encourage prompt payment. The amount for discount allowed is deducted from
the sales invoice. This allowance given to debtors and is treated as an EXPENSE.
Accounting treatment for Discount Allowed

When incurred Debit : Discount allowed Account
Credit : Debtors Account/ Accounts Receivable
At year end Debit : Income Statement/ Profit and loss Account
Credit : Discount allowed Account
(ii) DISCOUNT RECEIVED

Discounts received are allowances given by the creditors or suppliers to a business firm to
encourage payment of amount due within the agreed time. The amount for discount received is
deducted from the invoice price.
This allowance is given by creditors and is treated as INCOME.
Accounting treatment for Discount Received

When earned Debit : Creditors Account/ Account Payable
Credit : Discount received Account
At year end Debit : Discount received Account
Credit : Income Statement/ Profit and loss Account
Illustration 4.5
The following details belong to JJ Wholesalers. Prepare a two column cashbook for the month
ending March, 20x3.
01/03/20x3: Started business with capital inform of cash Sh. 100,000.

02/03/20x3: Paid rent by cash Sh 10,000.
03/03/20x3: Received Loan of Sh 500,000 via cheque from Barclays bank.
04/03/20x3: Paid Kenya Motors Sh 65,000 by cheque.
05/03/20x3: Made Cash sales of Sh 98,000.
07/03/20x3: Nathan a debtor paid us by cheque Sh 62,000.
09/03/20x3: Paid Bakes Ltd in cash Sh 22,000.
11/03/20x3: Made cash sales paid directly into the bank for Sh 53,000.
15/03/20x3: Gilbert paid us in cash Sh 65,000.
16/03/20x3: Took Sh 50,000 out of the cash till and deposited it into the bank account.
19/03/20x3: Made loan repayment of Sh 100,000 by cheque to Barclays Bank
22/03/20x3: Made cash sales paid directly into the bank for Sh 66,000.
26/03/20x3: Paid motor expenses by cheque Sh 12,000.
30/03/20x3: Withdrew Sh 100,000 cash from the bank for business use.
31/03/20x3: Paid wages in cash for Sh 97,000.
Solution:
30
Dr. Receipt Payments Cr.
Date Details Cash Bank Date Details Cash Bank
1/3 Capital 100,000 2/3 Rent 10,000
3/3 Barclays Loan 500,000 4/3 Kenya Motors 65,000
5/3 Sales 98,000 9/3 Bake Ltd 22,000
7/3 Nathan 62,000 16/3 Bank (Contra) 50,000
11/3 Sales 53,000 19/3 Barclays Loan 100,000
15/3 Gilbert 65,000 26/3 Motor Expenses 12,000
16/3 Cash (Contra) 50,000 30/3 Cash (Contra) 100,000
22/3 Sales 66,000 31/3 Wages 97,000
30/3 Bank (Contra) 100,000 Balances c/d 184,000 454,000
363,000 731,000 363,000 731,000
Illustration 4.6
Mwananchi traders had the following account balances as at 1st January 20x3.
Cash Ksh 2,900
Bank Ksh 65,400
Debtors accounts: Creditors accounts:
Benson Ksh 12,000 Unity Ltd Ksh 6,000
Nathan Ksh 28,000 ABC Ltd Ksh 44,000
Dennis Ksh 4,000 Riper Ltd Ksh 10,000
The following transactions also took place in the month of January;
02/01/20x3: Benson cleared his account by cheque after deducting 8% cash discount.
08/01/20x3: Mwananchi traders paid Riper Ltd by cheque less 5% cash discount.
11/01/20x3: Made drawings for Ksh 10,000 from the bank for business use.
16/01/20x3: Nathan paid us his amount due by cash after deducting 3% discount allowed.
25/01/20x3: Mwananchi traders paid office expenses in cash for Ksh 9,200.
28/01/20x3: Dennis settled his account by cash.
29/01/20x3: Paid Unity Ltd the amount due by cheque.
30/01/20x3: Paid ABC Ltd partly Ksh 40,000 by cheque.
Solution:
Dr. Receipt Payments Cr.
Date Details Disc Cash Bank Date Details Disc Cash Bank
All Rec
1/1 Balance b/f 2,900 65,400 8/1 Riper Ltd 500 9,500
2/1 Benson 960 11,040 11/1 Cash (Contra) 10,000
11/1 Bank (Contra) 10,000 25/1 Office expenses 9,200
16/1 Nathan 840 27,160 29/1 Unity Ltd 6,000
28/1 Dennis 30/1 ABC Ltd 40,000
31/1 Balance c/f 30,860 10,940
1,800 40,060 76,440 500 40,060 76,440
SALES LEDGER
31
Dr Benson Account (Debtor) Cr
1/1 Balance b/f 12,000 2/1 Bank 11,040
2/1 Discount Allowed 960
12,000 12,000
Dr Nathan Account (Debtor) Cr

1/1 Balance b/f 28,000 16/1 Cash 27,160
16/1 Discount Allowed 840
28,000 28,000
Dr Dennis Account (Debtor) Cr

1/1 Balance b/f 4,000 28/1 Cash 4,000
PURCHASES LEDGER
Dr Unity Ltd Account (Creditor) Cr
29/1 Bank 6,000 1/1 Balance b/f 6,000
Dr ABC Ltd Account (Creditor) Cr

30/1 Bank 40,000 1/1 Balance b/f 44,000
31/1 Balance c/f 4,000
44,000 44,000
Dr Riper Ltd Account (Creditor) Cr

8/1 Bank 9,500 1/1 Balance b/f 10,000
8/1 Discount Received 500
10,000 10,000
GENERAL LEDGER
Dr Office Expenses Account Cr

25/1 Cash 9,200 31/1 Balance c/f 9,200
Dr Discount Allowed Account Cr

2/1 Benson 960
16/1 Nathan 840 31/1 Balance c/f 1,800
1,800 1,800
Dr Discount Received Account Cr

31/1 Balance c/f 500 8/1 Riper Ltd 500
Illustration 4.7
32
Michael Kamau runs a general groceries shop in Nairobi. The following transactions relate to the
shop for the month of September 20x3.
Sept 1st: Cash in hand Sh. 31,400; Bank balance Sh. 50,800; Capital account Sh. 82,200
Sept 3rd: Bought goods in cash for Sh. 8,200
Sept 4th: Purchased goods on credit from Jambo ltd for Sh. 11,600 less 10% trade discount.
Sept 7th: Sold goods on credit to Simon at Sh. 17,800 less 20% trade discount.
Sept 10th: Withdrew cash from the bank amounting to Sh. 1,000 for private use.
Sept 12th: Sold goods on credit to Eric at Sh. 12,800.
Sept 14th: Paid Sh. 10,000 in cash to Jambo ltd in full settlement of their account.
Sept 15th: Received Sh. 8,000 in cash from Eric in part settlement of his account
Sept 17th: Goods worth Sh. 800 were returned by Eric.
Sept 21th: Purchased goods on credit at Sh. 17,400 from Shauri ltd.
Sept 24th: Paid Sh. 12,000 to Shauri ltd by cheque; discount given was Sh. 600.
Sept 25th: Purchased furniture on credit from Magic furniture for Sh. 16,000
Sept 26th: Transferred Sh. 4,400 from the cash till to the bank account.
Sept 27th: Eric was declared bankrupt and could only pay Sh.2,000 of the debt by cheque the
rest being treated as a bad debt.
Sept 28th: Goods worth Sh. 1,200 were returned to Shauri ltd.
Sept 29th: Goods worth Sh. 800 were taken by Michael Kamau for his personal use.
Sept 29th: Paid Sh. 1000 by cheque for advertising.
Sept 29th: Paid wages to shop assistant in cash amounting to Sh. 3,600.
Sept 29th: Made cash sales of Sh. 43,600
Sept 29th: Banked Sh. 40,000
Sept 29th: Received cash of Sh. 11,800 from Simon in part payment of their account after
allowing a discount of Sh. 200.
Required;
a) Record the above transactions in the appropriate ledger accounts including the three column
cash book.
b) Extract a trial balance as at 30th September 20x3.
Date Details Disc Cash Bank Date Details Disc Cash Bank
All Rec
1/9 Bal b/d 31,400 50,800 3/9 Purchases 8,200
15/9 Eric 8,000 10/9 Drawings 1,000
26/9 Cash 4,400 14/9 Jambo ltd 440 10,000
27/9 Eric 2,000 24/9 Shauri ltd 600 12,000
29/9 Sales 43,600 26/9 Bank 4,400
29/9 Cash 40,000 29/9 Advertising 1,000
29/9 Simon 200 11,800 29/9 Wages 3,600
29/9 Bank 40,000
30/9 Bal c/d 28,600 83,200

200 94,800 97,200 1040 94,800 97,200
Dr Capital A/c Cr Dr Purchases A/c Cr
33
Sh. Sh. Sh. Sh.
30/9 Bal c/d 82,200 1/9 Bal b/d 82,200 3/9 Cash 8,200 29/9 Drawings 800
4/9 Jambo 10,440
21/9 Shauri 17,400 30/9 Bal c/f 35,240
36,040 36,040
Dr Jambo ltd A/c (creditor) Cr Dr Sales A/c Cr

Sh. Sh. Sh. Sh.
14/9 cash 10,000 4/9 Purchases 10,440 7/9 Simon 14,240
Disc received 440 12/9 Eric 12,800
10,440 10,440 30/9 Bal c/f 70,640 29/9 Cash 43,600
70,640 70,640
Dr Simon A/c (debtor) Cr Dr Drawings A/c Cr
Sh. Sh. Sh. Sh.
7/9 Sales 14,240 29/9 Cash 11,800 10/9 Bank 1,000
Disc Allowed 200 29/9 Purchases 800 30/9 Bal c/f 1,800
30/9 Bal c/f 2,240 1,800 1,800
14,240 14,240
Dr Eric A/c (debtor) Cr Dr Return inwards A/c Cr
Sh. Sh. Sh. Sh.
12/9 Sales 12,800 15/9 Cash 8,000 17/9 Eric 800 30/9 Bal c/f 800
17/9 R/inward 800
27/9 Bank 2000
27/9 B/debts 2000
12,800 12,800
Dr Shauri ltd A/c (creditor) Cr Dr Magic furniture A/c Cr

Sh. Sh. Sh. Sh.
24/9 Bank 12,000 21/9 Purchases 17,400 30/9 Bal c/f 16,000 25/9 Furniture 16,000
Disc received 600
28/9 R/outward 1,200
30/9 Bal c/f 3,600
17,400 17,400
Dr Furniture A/c Cr Dr Bad debts A/c Cr

Sh. Sh. Sh. Sh.
25/9 Magic F 16,000 30/9 Bal c/f 16,000 27/9 Eric 2000 30/9 Bal c/f 2,000
Dr Return Outwards A/c Cr Dr Advertising A/cCr

Sh. Sh. Sh. Sh.
30/9 Bal c/f 1,200 28/9 Shauri ltd 1,200 29/9 Bank 1,000 30/9 Bal c/f 1,000
Dr Wages A/c Cr
34
Sh. Sh.
29/9 Cash 3,600 30/9 Bal c/f 3,600
Dr Discount Allowed A/c Cr Dr Discount Received A/c Cr

Sh. Sh. Sh. Sh.
29/9 Simon 200 30/9 Bal c/f 200 14/9 Jambo 440
30/9 Bal c/f 1,040 24/9 Shauri 600
1,040 1,040
4.3.2 Petty Cash Book and the imprest system of Accounting.
A Petty Cash Book records all the petty cash vouchers maintained by a cashier. The petty cash
vouchers summarize expenses paid by the cashier. These expenses are classified in the petty cash
book as per the individual expense.
Format of a Petty Cash Book:

Receipts Date Detail Payments Expenses e.g.
Amount Postage Cleaning Stationery Traveling Ledger
The Closing balance of the petty cash book represents the balance of cash in hand. The totals
amount of the expenses is posted to the debit side of the expense accounts. In case a business firm
operates another cashbook together with a petty cash book, then the totals of the expenses are
posted on the credit side of the cash in hand cashbook.
The Imprest system

The imprest system refers to the system where a petty cashier is given enough cash by an
accountant to meet the petty cash needs for a particular period. At the end of the period, the
accountant finds out the amounts spent by the petty cashier, by accessing the Petty Cash Book.
The accountant now reimburses the value of the amount spent on petty cash in the period to the
petty cashier with the aim of restoring back the amount that was available at the beginning of the
period. This system is referred to as the Imprest System and the reimbursed amount is referred to
as the Petty Cash Float.
Activity 4.1: The following illustrates how an imprest system works.

Ksh
Petty Cash Float at the beginning of the period 20,000
Expenses incurred and fully paid (14,500)
Balance 5,500
Reimbursement 14,500
The Cash float still remains to be the same that is 20,000
Illustration 4.8
35
ABC Ltd has a cashier who was issued with Ksh 20,000 as the Cash Float at the beginning of the
month of May, 20x3. The following petty expenses were incurred during the month. Prepare a
detailed petty cash book showing the balance to be carried forward to the next period.
Ksh
02/05/20x3: Bought stamps for 800
03/05/20x3: Paid bus fare for 1,200
05/05/20x3: Cleaning materials 2,400
07/05/20x3: Bought fuel 1,500
10/05/20x3: Cleaning wages 3,000
14/05/20x3: Bought stamps 2,000
19/05/20x3: Paid Jack (creditor) 4,000
22/05/20x3: Fuel costs 1,500
24/05/20x3: Bought 2 packets of biro pens 1,450
Solution:
Receipts Date Detail Payments Expenses e.g.

Amount Postage Cleaning Stationery Traveling Ledger
(Ksh) (Ksh) (Ksh) (Ksh) (Ksh) (Ksh) (Ksh)
20,000 1/5 Balance b/f
2/5 Stamps 800 800
3/5 Bus fare 1,200 1,200
5/5 Cleaning 2,400 2,400
7/5 Fuel 1,500 1,500
10/5 Wages 3,000 3,000
14/5 Stamps 2,000 2,000
19/5 Jack 4,000 4,000
22/5 Fuel costs 1,500 1,500
24/5 Biro pens 1,450 1,450
17,850 2,800 5,400 1,450 4,200 4,000
17,850 30/5 Cash

30/5 Balance c/f 20,000
37,850 37,850
20,000 1/6 Balance b/f
4.4 Extraction of a Trial Balance
36
A trial balance is a list of balances extracted from ledger accounts including cash book balances.
Trial balance is extracted after the ledger entries are made and balanced off. It summarizes the
status of each ledger account.
Purpose / Importance of a trial balance
1.) Instrumental for preparing financial statements.
2.) Used to check for errors and fraud.
3.) Summarizes ledger accounts.
4.) Used to assess accuracy of recording.
Trial Balance Format DETAILS Debit Credit

Capital xxx
Cash/ Bank xxx
Sales xxx
Discount Allowed xxx
Discount Received xxx
Debtors xxx
Creditors xxx
Expenses xxx
TOTAL XXX XXX
Activity 4.2
With reference to the previous Illustration 4.7, a trial balance extracted from the transactions would
appear to be as follows;
MICHAEL KAMAU GENERAL GROCERIES
TRIAL BALANCE AS AT 30TH SEPT 20x3
DETAILS Dr. Cr.
Bank 83,200
Cash 28,600
Capital 82,200
Purchases 35,240
Sales 70,640
Debtor 2,240
Creditor 3,600
Drawings 1,800
Bad debts 2,000
Return inwards 800
Return outwards 1,200
Advertising 1,000
Furniture 16,000
Magic furniture 16,000
Wages 3,600
Discount allowed 200
Discount received 1,040
TOTAL 174,680 174,680
4.5 Adjustment entries to the journals, ledgers and trial balance
37
Adjustments can further be made on the books of accounts depending the necessary changes,
omitted transactions or errors realized. Errors in the books of accounts will be covered in the
next lesson.
4.6 Preparation of Financial Statements

The most important and basic financial statements used for reporting accounting information in a
business firm are:
 Income Statement/ Statement of financial Performance/ Trading, Profit and Loss account
 Balance sheet/ Statement of financial position
 Cash Flow statement
Theses statements are prepared after the necessary adjustment have been made in the journals,
ledgers and trial balance. These statements will be covered into detail later in the next lessons.
38
LESSON FIVE
ERROR AND SUPSENSE ACCOUNTS

Learning objectives
 Describe the various types of errors.
 Differentiate between errors that are revealed by the trial balance and those that are not.
 Correct errors that do not affect the balancing of a trial balance.
 Explain the importance of suspense accounts.
 Preparation of suspense accounts.
Introduction
This lesson covers the various types of errors can be experienced in preparation of books of
accounts. The lesson shall identify errors that affect the balancing of a trial balance and those
that do not. Correction of a range of errors arising when financial transactions are entered in the
ledger accounts and preparation of suspense accounts will also be introduced.
5.1 Errors on Accounts

Errors in books of accounts can be classified in two major categories;
i) Errors that affect the balancing of a trial balance
ii) Errors that DO NOT affect the balancing of a trial balance
5.1.1 Errors that affect the balancing of a trial balance

Presence of these errors is revealed by the trial balance owing to the fact that the debit side and the
credit side of the trial balance does not balance. They include:
 Arithmetic errors in the trial balance.
 Arithmetic errors from the ledgers.
 Partial recording or not observing double entry rule when recording transactions.
 Failure to bring forward balances from previous accounting period.
 Failure to list some accounts in the trial balance or omitting a balance from the ledger.
5.1.2 Errors that DO NOT affect the balancing of a trial balance

Presence of these errors is not revealed by the trial balance because the debit side and the credit
side of the trial balance appear to be balancing at a common amount. On a close look on the
transactions posted in the ledgers, errors might have been made hence leading to an overstatement
or understatements of the posted figures or amounts. These errors include;
5.1.2.1 Error of omission

This error occurs when a transaction is completely omitted from the book of accounts and hence
the double entry is not observed.
For Example:
Credit sales of Ksh 30,000 made to Albert a debtor being totally omitted in the books of accounts.
This understates both the debtors and sale figures.
Correction of the Error:
Debit Albert Account (Debtors Account) and Credit Sales account with Kshs 30,000.
39
5.1.2.2 Error of Commission
This error occurs when a transaction is posted to a wrong personal account but in the same class
of accounts.
For Example:
Credit sales of Ksh 5,000 made to J. Patel is posted M. Patel’s account instead yet the double
entry is still observed.
Debit J. Patel account with Ksh 5,000 (to now have a correct entry in the account) and Credit M.
Patel account with Ksh 5,000 (to cancel the previous wrong entry). The corresponding credit entry
in the sales account is correct so it remains the same
5.1.2.3 Error of principle

This error occurs when a transaction is posted to a wrong class of account yet the double entry is
still observed.
For Example:
Cash Purchase of a motor vehicle for Ksh 200,000 is debited in Purchases Account.
Debit Motor Vehicle Account with Ksh 200,000 (to now have a correct entry in the account) and
credit Purchases Account with Ksh 200,000 (to cancel the previous wrong entry).
Note: Motor Vehicle falls under the category of a non current asset thus a capital expenditure and
not revenue expenditure as posted earlier.
5.1.2.4 Complete reversal of entries

This error occurs when a transaction is posted to the correct accounts but to the wrong sides of the
accounts that is a debit entry is posted as a credit entry and a credit entry is posted as a debit entry.
For Example:
Credit sales of Ksh 40,000 made to Simon a debtor. An error of complete reversal occurs when
Sales account is debited with Ksh 40,000 and Simon’s account is credited with Ksh 40,000. This
error understates both the debtors and sale figures.
To correct this error it requires doubling the amounts used so as to cancel the error first and leave
a correct entry. Debit Simon Account with Ksh 80,000 and Credit Sales Account with Ksh 80,000.
5.1.2.5 Error of Original entry

This error occurs when a transaction is posted to the correct accounts but the amount posted is
wrong or not correct. (Amount might either be understated or overstated)
For Example:
Credit sales of Ksh 10,000 made to Jack a debtor is wrongly recorded in the books of accounts as
Ksh 8,000. This means that Jack Account is debited with Ksh 8,000 instead of Ksh 10,000 while
Sales Account is credited with Ksh 8,000 instead of Ksh 10,000.
To correct this error it requires doubling the amounts used so as to cancel the error first and leave
a correct entry. Debit Simon Account with Ksh 80,000 and Credit Sales Account with Ksh 80,000.
5.1.2.6 Compensating Errors
This error occurs when transactions that are wrongly posted in the books of accounts tend to cancel
out each other.
40
For Example:
A debit entry that is overstated with a particular amount on one account and a credit entry that is
also overstated with a similar amount in another account or a debit entry that is understated with
a particular amount on one account and a credit entry that is also understated with a similar amount
in another account.
A debtor account being overstated with Ksh 2,000 on the debit side and the sales account being
overstated with Ksh 2,000 on the credit side.
Credit Debtor account with Ksh 2,000 so as to reduce the overstated amount and Debit Sales
account with Ksh 2,000 so as to also reduce the overstated amount in the sales account
5.1.2.7 Transposition error

This error occurs where a wrong sequence of digits within a number is entered.
For Example:
Recording a credit purchase of Ksh 1,240 as Ksh 1,420 instead hence this appears to be an
overstatement of Ksh 180.
Debit creditors account with the difference that is Sh. 180 and credit purchases account with Sh.
180.
5.2 Suspense Account

A Suspense Account takes charge of the amount of difference on the debit and credit of a trial
balance mostly due to errors. If errors are not found before the financial statements are prepared,
the suspense account balance will be included in the balance sheet. If the suspense account is a
debit balance, it will be shown on the asset side and if it is a credit balance, it will be shown on the
capital and liabilities side.
Activity 5.1
Trial Balance Extra Dr Suspense account Cr
Details Dr.(Sh.) Cr. (Sh.) Sh. Sh.
Capital 100,000 Diff per trial balance 33,000
Debtors 80,000
Creditors 25,000
Returns Inwards 15,000
Return Outwards 4,000
Discount Allowed 2,000
Discount Received 1,000
Suspense Account 33,000
TOTALS 130,000 130,000
Illustration 5.1
MM Traders when preparing their financial statements realized the following errors upon
investigation in the books of accounts
41
.
a) Extra capital of Ksh 400,000 paid into the bank had been credited to Sales account.
b) MM took goods for own use Ksh 7,000 but this had been debited to General Expenses.
c) Private insurance Ksh 1,500 had been debited to Insurance account.
d) A credit purchase of goods from ABC Ltd Ksh 35,000 had been entered in the books as Ksh
25,000.
e) Credit sales of Ksh 14,500 to Albert did not appear anywhere in the books.
f) Cash drawings of Ksh 4,000 had been credited to the bank column of the cashbook.
g) Returns inwards Ksh 16,800 from Simon had been entered in error in Simpson account.
h) A sale of a motor van Ksh 240,000 had been credited to Motor Expenses.
Required:
Prepare journal entries to correct the above errors.
Solution
MM Traders Journal entries
Details Dr. (Sh.) Cr. (Sh.)
1. Sales A/c 400,000
Capital A/c 400,000
(To Correct extra capital wrongly credited in sales A/c)
2. Drawings A/c 9,000
General Expenses A/c 9,000
(To Correct goods drawings debited in General Expenses A/c)
Insurance A/c 1,500
(To Correct private insurance debited in Insurance expense account)
4. Purchases A/c 10,000
ABC Ltd A/c (Creditor) 10,000
(To Correct undercast purchases)
5. Albert A/c (Debtor) 14,500
Sales A/c 14,500
(To Correct omitted sales to Albert)
6. Bank A/c 4,000
Cash A/c 4,000
(To Correct cash drawings credited in bank account)
7. Simpson A/c 16,800
Simon A/c 16,800
(To Correct Return inwards credited in Simpson account instead of Simon account)
8. Motor vehicle Expenses A/c 240,000
Motor Vehicle disposal A/c 240,000
(To Correct sale of Motor vehicle credited in Motor Vehicle account )
42
Illustration 5.2
The trial balance for XYZ ltd at 31 December 20x3 showed a difference of Sh. 8,000, being a
shortage on the debit side. Show the journal entries to correct the following errors and prepare a
suspense account.
1. Extra capital of Sh. 5,000 paid into the bank had been credited to sales account.
2. Sales account had been overcast by Sh. 9000
3. Insurance expense was undercast by Sh. 4,000
4. Private rent of Sh. 1,900 had been debited in the rent account.
5. Cash of Sh. 5000 received from a debtor was entered in the cash book only.
6. A credit purchase of Sh. 5,900 was entered in the books as Sh. 9,500
XYZ Journal entries as at 31st December 2009

1. Sales A/c 5,000
Capital A/c 5,000
(To Correct extra capital wrongly credited in sales A/c)
2. Sales A/c 9,000
Suspense A/c 9,000
(To Correct sales overcast of Sh. 9,000)
3. Insurance A/c 4,000
Suspense A/c 4,000
(To Correct insurance expense undercast by Sh. 4,000)
Rent A/c 1,900
(To Correct private rent paid from the rent account of the business)
5. Suspense A/c 5,000
Debtors A/c 5,000
(To Correct cash received and omitted from the debtors account)
6. Creditors A/c 3,600
Purchases A/c 3,600
(To Correct an overcast of credit purchases in books entered)
Dr. Suspense A/c Cr

Sh. Sh.
Difference as per trial balance 8,000 Sales 9,000
Debtors 5,000 Insurance 4,000
13,000 13,000
43
Illustration 5.3
Tempo Ltd prepared a trial balance that failed to balance having a shortage on the credit side. A
suspense account was opened for the difference. Upon some thorough investigations the following
errors were discovered.
a) Sales day book had been undercast by Sh 4,000.

b) Credit sales of Sh 12,200 to JJ Electronics had been debited in error to JJ Enterprise
account.
c) Rent account had been undercast by Sh 18,000.
d) Discounts Allowed account had been overcast by Sh 2,000.
e) The sale of a computer at net book value had been credited in error to the Sales account Sh
4,600.
Required:
i. Journal entries to correct the discovered errors.
ii. A suspense account and determine the difference as per the trial balance.
Tempo Ltd Journal Entries

Sales A/c 4,000
(To Correct sales under cast)
2. JJ Electronics A/c 12,200
JJ Enterprise A/c 12,200
(To Correct credit sales debited in JJ Enterprise A/c instead of JJ Electronics A/c)
3. Rent A/c 18,000
Suspense A/c 18,000
(To Correct undercast rent)
Discount Allowed A/c 2,000
(To Correct overcast Discount Allowed)
5. Sales A/c 4,600
Computer Disposal A/c 4,600
(To Correct disposal of computer credited in sales account)
Dr. Suspense A/c Cr

Sh. Sh.
Difference as per trial balance 12,000 Rent 18,000
Sales 4,000
18,000 18,000
44
LESSON SIX
BANK RECONCILIATION STATEMENTS

Learning objectives
 Explain the importance of bank reconciliation statements
 Identify items that cause the cash book balance to differ with the bank statement balance
 Reconcile Cash Book balances with bank statement balances
Introduction
This lesson equips the students on how to prepare a bank reconciliation statement and explains the
essence of preparation. There are various items that lead to a difference in the cash book balance
as well as the bank statement balance and they are clearly high lighted hence leading to the
reconciliation of the Cash Book balances with bank statement balances.
6.1 Bank Reconciliation Statement

A bank reconciliation statement explains the difference between the balance reported in the bank
statement and that reported in the cashbook.
6.1.1 Bank statement

This is a periodic statement sent by the bank to the bank account holder showing transactions with
the bank that is withdrawals, deposits, bank charges and balances.
In the bank statement; DEPOSITS are credited while WITHDRAWALS are debited.
6.2 Reasons for differences in the bank statement balance and the cash book balance
Bank column of the cash book should show some information as the bank statement but in many
occasions they reflect different balances due to;
6.2.1 Items Appearing In The Cashbook And Not Reflected In The Bank Statement.
a) Unpresented Cheques: These are cheques issued by the business firm for payment to the
creditors or other supplies but have not been presented to the firm’s bank for payment
although they are recorded in the cash book.
They appear on the credit side of the cash book but don’t appear in the bank statement.
b) Uncredited deposits/cheques: These are cheques and deposits from customers and other
sources that are not credited by a bank so as to avail funds for the business firm’s account.
c) Errors in the cashbook

This includes recording errors in the cash book from either receipts or payments e.g
 Over or understated payments.
 Over or understated deposits.
 Mis-posted deposits and payments
 Over or undercasting the balance b/f or c/f in the cashbook.
6.2.2 Items appearing in the bank statement and not reflected in the cashbook:
45
a) Bank charges; these charges levied by the bank and not in the cash book.
b) Interest charges; these include charges on overdrafts and loans.
c) Direct Debits; these are payments made by the bank without necessarily giving it
instructions but instead the creditor is given permission to collect money from the bank.
d) Standing orders; these are payments made by the bank on behalf of the business
according to the instructions given to the bank by the business.
e) Dishonored cheques/ Return to Drawer cheques; these are cheques received by the bank
but not honoured due to may be insufficient funds in the account, the cheque was stale,
post dated cheque or a cheque whose amount in words differ from those in figures.
f) Direct credits; these are amounts paid into the bank directly.
g) Interest Income/Dividend incomes;
h) Errors in the bank statements; these errors may arise when recording deposits or
withdrawals e.g. over or understating deposits or withdrawals.
6.3 Importance of a bank reconciliation statement.

 To update cash book with items appearing on bank statement and not t in the cash book.
 To correct and detect errors from the cash book or bank statement.
 To record omissions.
 Explain the difference in the cash book balance and bank statement balance.
6.4 Steps in preparing a bank reconciliation statement

 Update the cash book with items appearing in the bank statement and not appearing in the
cash book apart for the errors made in the bank statement. Errors in the cash book should
also be corrected.
 Compare the debit side of cash book with credit side of the bank statement to determine
uncredited deposits by the bank.
 Compare the credit side of the cash book with debit side of bank statement to determine
Unpresented cheques.
 Prepare the bank reconciliation statement.
Format (i) for a Bank Reconciliation Statement
Balance as per the updated cash book xxx
Add: Unpresented cheques xxx

Errors which upon correction will reduce bank balance xxx
(E.g overstated deposit or understated bank payment) xxx
Less: uncredited cheques (xxx)

Errors which upon correction will increase bank balance (xxx)
(E.g understated deposit or overstated/ unknown bank payment) (xxx)
Balance as per bank statement XXX
Format (ii) for a Bank Reconciliation Statement
46
Balance as per bank statement xxx
Add: uncredited cheques xxx

Errors which upon correction will increase bank balance xxx
(E.g understated deposit or overstated/ unknown bank payment) xxx
Less Unpresented cheques (xxx)

Errors which upon correction will reduce bank balance (xxx)
(E.g overstated deposit or understated bank payment) (xxx)
Balance as per the updated cash book XXX
Illustration 6.1
The following bank statement and cash book relates to Sunshine Enterprises. Prepare an updated
cash book and a bank reconciliation statement to explain the difference in their balance as on 31st
December 20x3.
Dr Cash book Cr
2009 Sh. 2009 Sh.
1/12 Balance b/f 34,190 8/12 Bob 4,620
7/12 Ford 1,010 15/12 James 210
22/12 Golf 440 28/12 Tom 2,090
31/12 Trish 3,190
31/12 Smith 2,460 31/12 Balance c/f 34,370
41,290 41,290
Bank Statement
Date Transactions Dr. (Sh.) Cr. (Sh.) Balance (Sh.)
1/12 Balance b/f - - 34,190
7/12 Cheque deposit - 1,010 35,200
11/12 Bob 4,620 - 30,580
20/12 James 210 - 30,370
22/12 Cheque deposit - 440 30,810
31/12 Credit Transfer: Morris - 930 31,740
31/12 Bank Charges 470 - 31,270
SOLUTION (Alternatively)
Dr Updated Cash book Cr Dr Updated Cash book Cr
2009 Sh. Sh. 2009 Sh. Sh.
1/12 Bal b/f 34,190 8/12 Bob 4,620 Balance b/f 34,370 Bank Charges 470
7/12 Ford 1,010 15/12 James 210 Morris 930 Balance c/f 34,830
22/12 Golf 440 28/12 Tom 2,090 35,300 35,300
31/12 Trish 3,190 31/12 Bank charges 470
31/12 Smith 2,460
31/12 Morris 930 31/12 Balance c/f 34,830
42,220 42,220
Bank Reconciliation Statement
47
Sh.
Balance as per the updated cash book 34,830
Add Unpresented cheques
Tom 2,090
2,090
Less uncredited cheques
Trish (3,190)
Smith (2,460)
(5,650)
Balance as per bank statement 31,270
Illustration 6.2
Haze Ltd had a Credit balance of Ksh 351,300 in the bank statement and a debit balance of Ksh
389,600. Upon investigation the following transactions were missing in the books of accounts.
Sh.
Deposits made but not yet entered on bank statement 606,000
Bank charges on bank statement but not yet in cashbook 28,000
Unpresented cheques amounted to 117,000
A standing order for salaries entered on bank statement, but not in cash book 55,000
Credit transfer from a customer entered on bank statement only 189,000
Required
Prepare a bank reconciliation statement to reconcile the difference in the two balances.
Solution
Updated Cashbook
Sh. Sh.
Balance b/f 3,896,000 Bank charges 28,000
Standing order 55,000
Credit transfer 189,000 Balance c/f 4,002,000
4,085,000 4,085,000
Bank Reconciliation as at 31/03/2003
Sh Sh
Balance as per updated cashbook 4,002,000
Add: Unpresented cheques 117,000
Less: Uncredited deposits (606,000)

Balance at bank as per Balance Sheet 3,513,000
Illustration 6.3
48
The following cash book relates to Jockey Ltd for the month of October, 20x3. The bank statement
had a debit balance of Sh 1,353,000.
Dr Cash book Cr
Sh. (000) Sh.(000)
Receipts 1,469 Balance b/f 761
Balance c/f 554 Payments 1,262
2,023 2,023
On investigation the following was discovered;

1. Bank charges of Sh. 136,000 in the bank statement have not been reflected in the cash
book.
2. Cheques drawn amounting to Sh. 267,000 had not been presented to the bank for payment.
3. Cheques received totaling to Sh. 726,000 had been entered in the cash book but credited
by the bank by 3rd November.
4. A cheque for Sh. 22,000 for expenses had been entered in the cash book as a receipt instead
of a payment
5. A cheque received from John for Sh. 80,000 had been returned by the bank and marked
“No Funds Available”. No adjustment has been made in the cash book
6. A standing order for business rates of Ksh 150,000 on 30th October had not been entered
in the cash book.
7. Dividends of Sh. 62,000 were received and credited directly to the bank account with no
entries in the cash book.
8. A cheque drawn for Sh. 66,000 for stationery had been incorrectly entered in the cash book
as Sh. 60,000.
9. The balance brought forward in the cash book should have been Sh. 711,000 not Sh.
761,000.
Required:
Prepare an adjusted cash book and a bank reconciliation statement as at 31 October, 20x3 to
reconcile the difference in the cash book and bank statement balance.
Solution:
49
Dr Updated Cash book Cr
Sh. (000) Sh.(000)
Dividends received 62 Balance b/f 554
Error in cash book 50 Bank charges 136
Dishonoured cheque 80
Expenses 44 (22 x 2)
Standing order 150
Balance c/f 858 Understated cheque 6
970 970
Bank Reconciliation Statement

Sh.000
Balance as per the updated cash book (858)
Add Unpresented cheques 267
Less uncredited cheques (762)
Balance as per bank statement (1,353)
Point to Note:
A debit balance in the bank statement means this is negative amount that is an overdraft.
50
LESSON SEVEN
CONTROL ACCOUNTS
Learning objectives
 Explain the importance of control accounts
 Prepare sales ledger control accounts
 Prepare purchases ledger control accounts
 Explain contra settlements
 Reconcile the purchases and sales ledger with their respective control accounts
Introduction
This lesson explains the benefits of using control accounts in manual accounting systems and
how to prepare the sale ledger control account and the purchases ledger control account.
7.1 Control Accounts

These accounts are used to check the accuracy and correctness of posting in a ledger to which the
control account belongs or relates to. The control mean that the total on the control accounts should
be the same as the totals on the ledger accounts. The two main types of control accounts include:
7.1.1 Sales ledger control Account

Sales Ledger Control Account is also referred to as Total Debtors Account. The balance on the
sales ledger control account should be the same as the total of the balances in the sales ledger.
It deals with credit customers (debtors). This control account is used to check the posting in the
sales ledger account. Debit entries increase debtors balance and Credit entries decrease their
balance.
Items that increase debtor’s balance (They are debited)

 Credit Sales
 Dishonoured cheques
 Interest Charged on overdue accounts
 Refunds to credit customers
Items that decrease debtor’s balance (They are credited)

 Cash/ bank payments from debtors
 Return inwards
 Discount allowed
 Contra Settlements/ Set offs
 Bad debts written off
Format of Sales Ledger Control Account
51
Balance b/f xxx Balance b/f (Shows overpaid amounts) xxx
Items increasing debtors balance xxx Items decreasing debtors balance xxx
Balance c/f (Shows overpaid amts) xxx Balance c/f xxx

xxx xxx
Activity 7.1
Draw a Sales Ledger control A/c to record the following details relating to a business.
Shs
Sales ledger debit balance at the beginning of the period 18,940
Total credit sales for the month 102,900
Total cheques received from customers 72,840
Total cash received from customers 12,360
Total return inwards from customers 2,960
Sales ledger debit balance at the end of the period 33,680
Dr Sales Ledger Control A/c Cr

2007 Sh. Sh.
Balance b/f 18,940 Cheques received from debtors 72,840
Credit Sales 102,900 Cash received from customers 12,360
Return inwards from customers 2,960
Balance c/f 33,680
121,840 121,840
7.1.2 Purchases ledger control Account

Purchases Ledger Control Account is also referred to as Total Creditors Account. The balance on
the purchases ledger control account should be the same as the total of the balances in the purchases
ledger.
It deals with suppliers on credit (Creditors). This control account checks the arithmetic accuracy
of posting in the purchases ledger account. Debit entries reduce creditor’s balance and Credit
entries increase the creditors balance.
Items that increase creditor’s balance (They are credited)

 Credit Purchases
 Dishonoured cheques
 Interest Charged on overdue accounts
 Refunds from credit suppliers
Items that decrease creditor’s balance (They are debited)

 Cash/ bank payments to creditors
 Return outwards
 Discount received
 Contra Settlements/ Set offs
Format of Purchases Ledger Control Account
52
Balance b/f (Shows overpaid amounts) xxx Balance b/f xxx
Items decreasing creditors balance xxx Items increasing creditors balance xxx
Balance c/f xxx Balance c/f (Shows overpaid amts) xxx

xxx xxx
Activity 7.2
Prepare a Purchases Ledger Control A/c from the following details for the month of June 2008.
Shs
Purchases ledger credit balance at the beginning of the period 3,676
Total credit purchases for the month 42,257
Return outwards 1,098
Cheques paid to suppliers 38,765
Discounts received from suppliers 887
Purchases ledger credit balance at the end of the period 5,183
Dr Purchases Ledger Control A/c Cr

2008 Sh. Sh.
Return outwards 1,098 Balance b/f 3,676
Cheques paid to suppliers 38,765 Credit purchases 42,257
Discounts received 887
Balance c/f 5,183
45,933 45,933
7.2 Contra Settlement

Some debtors may also be creditors in the same business firm. If the amount due to the debtors
(now being the creditors) is less than what they owe as debtors, then the credit balance is
transferred from their creditor’s a/c to their debtors a/c as a contra entry or a set off. In other words
this occurs when the same person is both a supplier and a customer of the business. The business
will off set the amount it owes the person from what that same person owes the business.
Activity 7.3: The following example illustrates a contra settlement
A business enterprise sold product X to Peterson worth Sh. 800 on credit and Peterson supplied
product Y to the business worth Sh. 1000 on credit.
Their accounts appear as follows initially;
Dr Peterson (Debtor) A/c Cr Dr Peterson (Creditor) A/c Cr

Sh. Sh. Sh. Sh.
Sales 800 Purchases 1000
The Sh.800 owing by Peterson is now to be offset against Sh. 1000 owed to him. The net effect
is that the business owes Peterson Sh. 200.
Now the accounts will appear as follows;
53
Dr Peterson (Debtor) A/c Cr Dr Peterson (Creditor) A/c Cr
Sh. Sh. Sh. Sh.
Sales 800 Set off 800 Set off 800 Purchases 1000
(Purchases ledger) (Sales Ledger)
Balance c/f 200
1,000 1,000
7.3 Importance of Control Accounts

 Facilitates detection of errors and fraud committed in either the sales ledger or purchases
ledger.
 To provide a very quick method of supervising the junior staff by the senior staff hence
it’s a supervision tool.
 To facilitate delegation of duties among the debtors and creditors clerks.
Points to Note:
 Refunds to debtors increase their balance and their accounting treatment is as follows;
Debit : Debtor’s Account
Credit : Cashbook
 Cash sales should NOT be included in sales ledger control account

 Cash purchases should NOT be included in Purchases ledger control account.
 Only cash discounts that are either allowed or received should be included. Trade
discounts should NOT be included.
 Provision for doubtful debts is NOT included in the sales ledger control account.
Illustration 7.1
The following information relates to Zeta Ltd for the month of June, 20x3.
Balances as at 1st June,20x3

Sales Ledger Sh. 642,000 on Debit side
Purchases Ledger Sh. 103,700 on Credit side
The following were the transactions during the month

Credit Purchases 4,225,700
Returns outwards 109,800
Cheques paid to suppliers 3,876,500
Discounts received from suppliers 88,700
Refunds from suppliers 21,500
Credit Sales 1,280,000
Cheques received from debtors 1,037,000
Discounts allowed 39,500
Contra settlements on ledger A/cs 14,500
Solution
Purchases Ledger Control A/C
54
Sh Sh
Returns out 109,800 Balance b/f 103,700
Cheques paid to suppliers 3,876,500 Credit Purchases 4,225,700
Discounts received 88,700 Refunds 21,500
Contra Settlements 14,500
Balance c/f 261,400
4,350,900 4,350,900
Sales Ledger Control A/C

Sh Sh
Balance b/f 642,000 Discounts allowed 39,500
Credit Sales 1,280,000 Contra Settlements 14,500
Cheques from debtors 1,037,000
Bal c/d 831,700
1,922,700 1,922,700
Illustration 7.2
The following information was obtained from Juja traders as at 31/12/2010. Balances as at 1 st
January 2010 are as follows;
Sales Ledger Purchases Ledger

Sh.120,000 on Debit side Sh. 186,000 on Credit side
Sh. 15,000 on Credit side Sh. 8,000 on Debit side
The following transactions took place during the year 2010;

Sh. Sh.
Sales in cash 150,000 Bad debts written off 14,600
Sales in credit 425,000 Return inwards 12,300
Purchases in cash 38,000 Return outwards 22,000
Purchases in credit 560,000 Refunds to credit customers 3,200
Cheques from credit customers 178,000 Provision for doubtful debts 1,400
Cheques to credit suppliers 258,000 Creditors cheques dishonoured 16,400
Contra Settlements 9,000 Refunds from creditors 4,400
Customer cheques dishonoured 21,000 Balance as at 31/12/2010
Interest charged on overdue debtors 5,600 Sales ledger 18,000 (Cr. Bal)
Discount Allowed 12,000 Purchases ledger 14,000 (Dr. Bal)
Discount Received 9,600
Required: Prepare sales ledger and purchases ledger control accounts
Solution
55
Dr Sales ledger Control A/c Cr Dr Purchases ledger Control A/c Cr
2010 Sh. Sh. 2010 Sh. Sh.
Balance b/f 120,000 Balance b/f 15,000 Balance b/f 8,000 Balance b/f 186,000
Credit Sales 425,000 Cheques (customers)178,000 Cheques (suppliers) 258,000 Credit Purchases 560,000
Dis cheques 21,000 Sett offs 9,000 Sett offs 9,000 Dis cheques 16,400
Interest charged 5,600 Discount allowed 12,000 Discount received 9,600 Refund s 4,400
Refund s 3,200 Bad debts w/off 14,600 Return outwards 22,000
Return inwards 12,300 Balance c/f 474,200Balance c/f 14,000
Balance c/f 18,000 Balance c/f 351,900 780,800 780,800
592,800 592,800
Illustration 7.3 (Examination Question)

The following transactions relate to Jaime Ltd for the month of December 20x3. Prepare sales
ledger and purchases ledger control account for that month.
Sh.
Balances on 1 December 20x3:
Sales ledger 9,123,000 (debit balance)
211,000 (credit balance)
Purchases ledger 4,490,000 (credit balance)
88,000 (debit balance)
Transactions during the month of December 20x3:
Purchases on credit 18,135,000
Allowances from suppliers 629,000
Receipts from customers by cheques 27,370,000
Sale on credit 36,755,000
Discount received 1,105,000
Payments to creditors by cheques 15,413,000
Contra settlements 3,046,000
Bills of exchange receivable 6,506,000
Allowances to customers 1,720,000
Customers cheques dishonored 489,000
Cash received from credit customers 4,201,000
Refunds to customers for overpayments 53,000
Balances on 30 November 1997
Sales ledger 136,000 (credit balance)
Purchases ledger 67,000 (debit balance)
Solution
56
Sales Ledger Control A/C
20x3 Sh 20x3 Sh
1/11 Bal b/d 9,123,000 1/11 Bal b/d 211,000
Sales 36,755,000 Bank 27,370,000
Dishonored cheques
489,000 Contra 3,046,000
Refunds to Bills of exchange
customers 53,000 receivable 6,506,000
Allowances 720,000
Cash 4,201,000
30/11 Bal c/d 136,000 30/11 Bal c/d 2,770,000
46,556,000 46,556,000
Purchases Ledger Control A/C

20x3 Sh 20x3 Sh
1/11 Bal b/d 88,000 1/11 Bal b/d 4,490,000
Allowances from Purchases 18,135,000
suppliers 629,000
Discounts received 1,105,000
Bank 15,413,000
Contra settlement 3,046,000
30/11 Bal c/d 2,411,000 30/11 Bal c/d 67,000
22,692,000 22,692,000
57
LESSON EIGHT
ADJUSTMENTS TO FINAL ACCOUNTS
Learning Objectives
 Adjustments in the trading account
 Make adjustments for accrued expenses and income
 Make adjustments for prepaid expenses and income
 Record accruals and prepayments in the financial statements
 Explain how bad debts are written off in the books of accounts
 Understand why a provision for bad and doubtful debts is made
 Make entries to record a provision for doubtful debts and bad debts written off
 Define depreciation and understand why it is prepared
 Calculate depreciation on non current assets
 Make entries to record a provision for depreciation and disposal of non current assets
Introduction
This lesson covers several adjustments made to final accounts at the end of a financial period. The
adjustments range from adjustments made in the trading account to; accounting for accrued income
and expenses, prepaid income and expenses, bad debts written off and provision for bad and
doubtful debts, depreciation and disposal of non current assets. The various adjustments will
require appropriate entries to be made in the books of accounts for instance recording an increase
or decreases in the provision for doubtful debts.
8.1 Adjustments in the Trading Account

A trading account captures elements that lead to generation of the Gross Profit.
 Returns:
Return inwards (sales return) is deducted from sales while return outwards (purchases return) is
deducted from purchases as discussed in Lesson Three.
 Carriage (Freight):
Carriage or freight is the transportation cost incurred by a trader to carry purchased goods to the
premises or when giving an after sale service to the customers. Carriage can be classified as either;
Carriage Inwards; Transportation cost incurred by a business on purchases. It is added to
purchases in the trading account. The accounting treatment is as follows:
Dr: Carriage inwards Account
Cr: Bank/ Cash Account
Carriage Outwards; Transportation cost incurred by a business on sales to the customers. It is

treated as an expense in the profit and loss A/c. The accounting treatment is as follows:
Dr: Carriage inwards Account
Cr: Bank/ Cash Account
 Omissions:
58
Transactions left out from the books of accounts should be recorded appropriately for example
omitted sales should be added back to sales amount that was initially reported.
 Drawings:
Drawings can be made by the owner(s) of a firm in various ways
i. Drawings in the form of Goods; arises when the owner(s) of the business takes out
some of the business goods out of the stock or purchases made for his own use. This
was covered in lesson three.
This is the ONLY form of drawings that is accounted for in the trading account.
Accounting treatment for goods drawings in the trading account:
Credit : Purchases Account
Accounting treatment at the end of the financial period (in the balance sheet)
Debit : Capital Account
Credit : Drawings Account
ii. Cash or bank withdrawals; arises when the owner(s) withdraws money from the
business for other objectives (E.g personal objectives) other than that of the business.
Accounting treatment for cash or bank drawing
Credit : Cash/ Bank Account
Accounting treatment at the end of a financial period

iii. Drawings in the form of Personal expenses paid by the business; arises when the
owner(s) pay for personal expenses being included in under the business expenses.
Accounting treatment for drawings in the form of personal expenses
Credit : Expense Account
Accounting treatment at the end of a financial period

8.2 Accruals and Prepayments

In accordance to the Accrual Concept, revenue and costs are recognized when earned or incurred
and not when money is received or paid therefore all incomes and expenses relating to a particular
financial period will be matched together to determine the profit for the year. The Matching
principle holds that costs incurred are matched with their associated revenues. This is a principle
of profit determination whereby profits are determined by comparing revenues and expenses.
8.2.1 Accruals
59
Accrued Expenses:
This is an expense that is payable or due for payment in a financial period but has not yet been
paid during that period.
Accrued expenses should be charged to the income statement (profit and loss account) by adding
them back to the expenses and they are also treated as a current liability in the balance sheet.
Profit and Loss extract Balance sheet extract

Expenses xxx Current Liability
Accrued expenses xxx Accrued expenses xxx
Accrued Income:
This is income earned in the current year but cash is not yet received. An accrued income should
be reported in the income statement (profit and loss account) by adding them back to other incomes
and they are also treated as a current asset in the balance sheet.

Gross profit xxx Current Asset
Revenue and other income xxx Accrued income xxx
Accrued income xxx
8.2.2 Prepayments
Prepaid Expenses
A prepaid expense is an expense that is not payable but cash has already been paid. A prepaid
expense should not be charged in the income statement (profit and loss account) thus deducted
from the reported expenses therefore should be carried forward to the next financial period. Prepaid
expenses are treated as a current asset in the balance sheet.

Expenses xxx Current Asset
Prepaid expenses (xxx) Prepaid expense xxx
Accrued income xxx
Prepaid Income
This is income that is not yet due but cash has been received for it. This is income paid in advance.
Prepaid income should not be reported to the income statement (profit and loss account) thus
deducted from the reported income therefore should be carried forward to the next financial period.
Prepaid income is treated as a current liability in the balance sheet.
8.3 Bad and Doubtful Debts

A business that has debtors is not guaranteed to collect all the amounts owed by the credit
customers. Some credit customers may fail to pay their accounts due for various reasons like; going
bankrupt, death, change of business etc. Such accounts that are not in a position to be paid up end
up becoming bad debts.
Business firms should write off bad debts and this is treated as an expense in the income statement.
60
Practically a business firm may not be certain whether it will collect all the amounts due from the
debtors because some will not honour their obligations and some might only partly honour them.
This gives room for doubtful debts. Business firms should therefore provide a provision for such
debts and this is referred to as Provision for doubtful debts. The provision may either maybe
specific or general. A specific provision relates to a specific debtor (with a specified amount)
whom the business is doubtful with while a General Provision relates to the debtors generally and
it’s mostly given as a certain percentage of the debtors.
Accounting treatment for Bad debts

Debit : Bad debts Account
Credit : Debtor Account
Debit : Income statement/ Profit & loss Account

Credit : Bad debts Account
Accounting treatment for provision for bad debts & doubtful debts
Accounting for the provision for bad debts will depend on:
i. If it’s the First time a provision for doubtful debts is given

Debit : Income statement/ Profit & loss Account
Credit : Provision for doubtful debts
ii. If it’s in subsequent years; when there is an increase in provision for doubtful
debts
Debit : Income statement/ Profit & loss Account (with the increase only)
Credit : Provision for doubtful debts (with the increase only)
iii. If it’s in subsequent years; when there is a decrease in provision for doubtful debts
Debit : Provision for doubtful debts (with the decrease only)
Credit : Income statement/ Profit & loss Account (with the decrease only)
Illustration 8.1
The debtors account for ABC Ltd was Ksh 500,000 by end of the year 20x3. Bad debts amounting
to Ksh 50,000 were written off from this balance. The specific provision stood at Ksh 10,000 while
the general provision was maintained at 5% on the debtors balance.
Required:
i. Debtors Account
ii. Bad debts Account
iii. Provision for bad debts Accounts
iv. Income statement Extract
v. Balance sheet Extract
Solution:
Debtors Account Provision for doubtful debts
61
20x3 Sh 20x3 Sh 20x3 Sh 20x3 Sh
Bal B/d 500,000 Bad debts 50,000 Bal c/d 22,750 Inc Statement (P&L) 10,000
Bal c/d 450,000 (Specific Provision)
500,000 500,000 Inc Statement (P&L) 22,000
(General Provision)
32,000 32,000
Bad debts
20x3 Sh 20x3 Sh
Debtors 50,000 Inc Statement (P&L) 50,000
Income Statement (Extract)

Sh
Expenses:
Bad debts 50,000
Increase in provision for D/debts 32,000
Balance Sheet (Extract) as at 31/12/99

Sh Sh
Current Assets
Debtors 450,000
LESS: Provision for bad debts (32,000)
418,000
Workings Sh
Debtors 500,000
Bad debts (50,000)
450,000
Specific Provision (10,000)
440,000
General Provision (5% of 440,000) (22,000)
418,000
Illustration 8.2
XYZ Ltd started trading on 1 January 20x3. The following are some of the bad debts that were
written off during two years that XYZ Ltd has been trading.
62
Year 20x3 Amount (Ksh) Year 20x4 Amount (Ksh)
14/04/20x3 8,500 12/03/20x4 18,000
06/07/20x3 14,000 23/08/20x4 6,000
------ ----- 16/10/20x4 25,000
On 31 December 20x3 debtors balance was Ksh 4,050,000. Provision for bad debts was
maintained at 3%.
On 31 December 20x4 debtors balance increased to Ksh 4,730,000. Provision for bad debts was
maintained at 5%.
Required:
i. Debtors Account for the two years
ii. Bad debts Account for the two years
iii. Provision for bad debts Accounts for the two years
iv. Income statement Extract for the two years
v. Balance sheet Extract for the two years
Solutions
Debtors Account
20x3 Sh 20x3 Sh
Balance b/f 4,050,000 Bad debts 22,500
Balance c/f 4,027,500
4,050,000 4,050,000
20x4 20x4
4,730,000 4,730,000
Bad Debts Account

20x3 Sh 20x3 Sh
Debtors 22,500 Income statement (P&L) 22,500
20x4 20x4
Provision for doubtful debts for year 20x3 Provision for doubtful debts for year 20x4
3% x 4,027,500 = 120,825 5% x 4,681,000 = 234,050
Note; Provision for doubtful debts is calculated on the net debtors that is after deducting the bad
debts written off in a particular financial year or period.
Provision for Doubtful Debts Account
20x3 Sh 20x3 Sh
Balance c/f 120,825 Income statement (P&L) 120,825
63
20x4 20x4
Balance b/f 120,825
Income statement (P&L)
Balance c/f 234,050 (The increase only) 113,225
234,050 234,050

20x3 Sh
Expenses:
Bad debts 22,500
Provision for doubtful debts 120,825
20x4 Sh
Expenses:
Bad debts 49,000
Increase in Provision for doubtful debts 113,225
(The increase only)
Balance Sheet (Extract)

20x3 Sh Sh
Current Assets:
Debtors 4,027,500
3,906,675
20x4
Current Assets:
Debtors 4,681,000
4,446,950
Note: In the balance sheets we deduct the whole provision for doubtful debts that relates to a
particular financial year from the debtors amount under the current assets.
We do not deduct the increase or decrease in provision as it is the case of the income statement.
Illustration 8.3
With reference to illustration 8.2 assume that;
64
On 31 December 20x4 debtors balance decreased to Ksh 3,600,000. Provision for bad debts was
maintained at 3% the same as the previous year.
Required:
i. Debtors Account for the two years
ii. Bad debts Account for the two years
iii. Provision for bad debts Accounts for the two years
iv. Income statement Extract for the two years
v. Balance sheet Extract for the two years
Solutions
Debtors Account
20x3 Sh 20x3 Sh
4,050,000 4,050,000
20x4 20x4
3,600,000 3,600,000
Bad Debts Account

20x3 Sh 20x3 Sh
20x4 20x4
Provision for doubtful debts for year 20x3 Provision for doubtful debts for year 20x4
3% x 4,027,500 = 120,825 3% x 3,600,000 = 108,000
Provision for Doubtful Debts Account

20x3 Sh 20x3 Sh
Balance c/f 120,825 Income statement (P&L) 120,825
20x4 20x4
Income statement (P&L) Balance b/f 120,825
(The decrease only) 12,825
Balance c/f 108,000
120,825 120,825

20x3 Sh
65
Expenses:
Bad debts 22,500
Provision for doubtful debts 120,825
20x4 Sh
Income:
Decrease in Provision for doubtful debts 12,825
(The decrease only)
Expenses:
Bad debts 49,000
Balance Sheet (Extract)

20x3 Sh Sh
Current Assets:
Debtors 4,027,500
3,906,675
20x4
Current Assets:
Debtors 3,600,000
3,492,000
8.3.1 Bad Debts Recovered

A bad debt that was previously written off by a business firm may be recovered again. If such a
situation is present, the following entries are made:
i. The bad debt recovered is first reinstated by;
Debit : Debtors Account With amount recovered
Credit : Bad debts recovered Account
ii. When payment is received from the debtor in settlement of all or part of the debt:
Debit : Cash/ Bank Account With the cash received
Credit : Debtors Account
iii. Accounting treatment in the income statement

Debit : Bad debts recovered account.
Credit : Income Statement (Profit & Loss A/c)
Illustration 8.3
66
A business firm that had previously written of bad debts amounting to Ksh 34,000 now recovers
the same amount that was paid by cheque. In the same financial year the debtor account amount
to Ksh 270,000 and out of this the firm will write off bad debts amounting Ksh 20,000.
Required:
i. Debtors Account
ii. Bad debts (written off) Account
iii. Bad debts recovered Account
iv. Bank Account
Debtors Account
Sh. Sh.
Balance b/f 270,000 Bad debts written off 20,000
Bad debts recovered 34,000 Bank 34,000
Balance c/f 250,000
304,000 304,000
Bad debts (Written off) Account

Sh. Sh.
Debtors 20,000 Income statement 20,000
Bad debts recovered Account

Sh. Sh.
Income statement 34,000 Debtors 34,000
Bank Account
Sh. Sh.
Debtors 34,000 Balance c/f 34,000
8.4 Depreciation
67
This is that part of the original cost of a non current asset that is consumed or lost during its period
in a business. The loss in value is treated as an expense in the profit & loss A/c.
8.4.1 Causes of Depreciation

 Physical Factors
These factors include wear and tear, rot, decay, rust or erosion due to elements of nature like rain.
 Economic Factors
These factors occur when an asset either becomes;
Obsolete – Where the non current assets becomes out of date or not fitting with modern technology
Inadequate – Where the non current assets lose value due to becoming inadequate for example
after a business prospers and expands, some of its buildings may become inadequate due to limited
space hence no longer used due to changes in size of the business firm.
 Time Factors
These factors apply to assets which have a legal life fixed in terms of years for example properties
on lease terms.
 Depletion
This is depreciation made on non current assets of wasting character for instance mineral fields
will depreciate due to constant extraction of raw materials.
8.4.2 Methods of Calculating Depreciation

These are the methods used ascertain the depreciation charge for non current. The depreciation is
charged in the income statement as an expense. The two main methods are; Straight-line method
and Reducing Balance method. There are other methods for calculating depreciation that will be
briefly highlighted in this chapter.
8.4.2.1 Straight Line Method
Depreciation is charged evenly for all the years. The cost is divided by the number of estimated
years of use. A certain percentage can also be given to calculate straight line depreciation on cost.
Depreciation = Cost – Scrap Value (Salvage/ Residue Value)
Useful Life in years
Activity 8.1
A Machine was bought for Sh. 220,000 and it was estimated to be in operation for 4 years with a
residue value of Sh. 20,000. Calculate the depreciation expense for each year.
In case there was no residue value
220,000 – 20,000 = 50,000 220,000 = 55,000
4 4
8.4.2.2 Reducing Balance Method/ Diminishing Balance Method
68
A fixed percentage for depreciation is deducted from the cost in the first year and in the later years
it is deducted form the net book value (NBV)
Activity 8.2
Calculate the reducing balance depreciation charged at 20% for the first 3 years on a machine
bought for Sh. 10,000.
Net Book Value
st
1 year 20% of 10,000 = 2,000 10,000 – 2,000 = 8,000
2nd year 20% of 8,000 = 1,600 8,000 – 1,600 = 6,400
rd
3 year 20% of 6,400 = 1,280 6,400 – 1,280 = 5,120
The other methods include:
8.4.2.3 Sum of Years Digits Method

A base from sum of all years of estimated life is obtained. Each year’s depreciation rate is obtained
by reversing the years of the estimated life divided by the base.
Activity 8.3
A company purchased a machine at a cost of Sh. 450,000. The estimated life of this machine is 5
years. Using the sum of years digits determine its depreciation.
Sum of years = 5 + 4 + 3 + 2 + 1 = 15
Year 1 Depreciation P.A = 5/15 X 450,000 = 150,000

8.4.2.4 Revaluation Method
Depreciation is calculated by adding assets bought during the year to the opening balance then
LESS assets sold during the year while together with the closing balance of assets.
Depreciation p.a. = {Opening balance + Purchases} – {Closing balance + Disposals}
8.4.2.5 Machine Hour Method
Depreciation is based on the number of hours the machine operated during the period compared to
the total expected hours.
Depreciation p.a. = Hours Operated X COST

Total expected hours
8.4.2.6 Depletion Unit Method

This method is applied to assets of wasting character. Depreciation rate is based on quantity
extracted compared with the total estimated quantity available.
69
Depreciation p.a. = Quantity extracted X COST
Total quantity available
8.4.2.7 Unit of Output Method

The method establishes the total expected units of output expected from the asset and depreciation
is based on cost less the salvage value multiplied to periodic production or units produced as a
proportion total expected output.
Depreciation = Units produced X (Cost – Salvage value)

Total expected units
Activity 8.4
A machine is expected to produce 10,000 electrical gadgets in its useful life. It has a cost of Sh.
6,000 and has an expected salvage value of Sh. 1,000. If in the first year a total of 1,500 gadgets
are produced, what is the depreciation for the year?
1,500 X (6,000 – 1,000) = Sh. 750

10,000
8.4.3 Accounting Treatment on Depreciation

Depreciation for non current assets is posted directly into the provision for depreciation account
and the accounting treatment is as follows;
Debit: Income Statement Account (Profit and Loss A/c)

Credit: Provision for depreciation A/c (Accumulated Depreciation account)
8.4.4 Accounting Disposal of fixed assets

When a non current asset is disposed, it may involve disposal in either of the following ways;
i. Sale of the non current asset.

ii. Non current asset written-off due to damage, accident or theft.
iii. Non current asset that is scrapped (Asset not in use anymore)
i. Sale of the non current asset.
When non current asset are sold, they should be removed from the books of accounts. This means
that the cost of the asset needs to be deducted from the asset account, the accumulated depreciation
of the asset also needs to be deducted from the provision for depreciation account and lastly profit
or loss on sale should be reflected in the profit & loss account.
Accounting Treatments when asset is sold

a) Debit: Asset disposal Account With cost of asset being disposed
Credit: Asset Account
70
b) Debit: Provision for depreciation Account With Accumulated depreciation
Credit: Asset disposal Account
c) Debit: Cash/ Bank Account With amount received on disposal

d) Debit: Asset disposal Account If a Profit on disposal

Credit: Income statement (Profit & Loss A/c)
e) Debit: Income statement (Profit & Loss A/c) If a Profit on disposal

ii. Non current asset written-off due to damage, accident or theft.
When a non current asset is insured, in the case of loss of the asset the insurance company is
obliged to meet the liability.
If by the end of the financial period the insurance company has not yet paid the obligation;
a) Debit: Asset disposal Account With cost of asset being damaged


c) Debit: Insurance receivable Account With amount expected from the insurance
d) Debit: Asset disposal Account If a Profit on disposal

e) Debit: Income statement (Profit & Loss A/c) If a Profit on disposal

If by the end of the financial period the insurance company has paid the obligation, instead
of having the Insurance receivable account, it will change to Cash/ bank and the accounting
treatment is as follows;
a) Debit: Cash/ Bank Account With amount expected from the insurance
iii. Non current asset that is scrapped (Asset not in use anymore)
71
Non current asset that are no longer used in a business firm will need to be eliminated from the
books of accounts. Entries to eliminate them are to be made in the asset account and provision for
depreciation account only. The accounting treatment is as follows;
a) Debit: Asset disposal Account With cost of asset no longer in use


c) Debit: Asset disposal Account If a Profit on disposal

d) Debit: Income statement (Profit & Loss A/c) If a Profit on disposal

Illustration 8.4
A business firm started trading on 1st January in year 20x3. On 1st April, it bought a new motor
vehicle costing Ksh 400,000 and later on 1st July it bought another motor vehicle costing Ksh
550,000. The financial year for the business ends on 31st December and it has a policy of
depreciating motor vehicles at 20% p.a. using straight line basis.
Required:
i. Motor vehicle account as at 31st December 20x3
ii. Provision for depreciation account as at 31st December 20x3
iii. Income statement extract for year ending 31st December 20x3
iv. Cash/ bank account extract
Motor Vehicle Account

20x3 Sh. 20x3 sh.
1/4 Cash/ bank 400,000
1/7 Cash/ bank 550,000 31/12 Balance c/f 950,000
950,000 950,000
Provision for depreciation Account

20x3 Sh. 20x3 sh.
31/12 Balance c/f 115,000 31/12 Income statement 115,000
Income statement extract

Expenses
Motor vehicle depreciation 115,000
Cash/ bank Account

20x3 Sh. 20x3 sh.
Workings
72
Depreciation charge for motor vehicle bought on 1st April; 20% x 400,000 x 9/12 = 60,000
Depreciation charge for motor vehicle bought on 1st July; 20% x 550,000 x 6/12 = 55,000
Total depreciation charge = 115,000
Illustration 8.4
XYZ Ltd has three machines in operation. Machine A was bought on 1st January 20x3 at Ksh
250,000 and the other two machines; machine B and machine C were bought on 1st January 20x4
at Ksh 350,000 and Ksh 300,000 respectively. The business has a policy to depreciate all non
current assets at 15% using straight line basis of depreciation. On 1st July 20x4, XYZ Ltd disposed
off the machine bought on 1st January 20x3 for Ksh 188,000. Assuming that the financial year of
XYZ Ltd ends on 31st December.
Prepare the following accounts relating to financial year ending 31st December 20x4 only.
i. Machine Account
ii. Provision for depreciation Account
iii. Disposal Account
Solution
Machine Account
20x4 Sh. 20x4 sh.
1/1 Balance b/f 250,000 1/7 Disposal 250,000
1/1 Cash/ bank (Machine B) 350,000
1/1 Cash/ bank (Machine C) 300,000 31/12 Balance c/f 650,000
900,000 900,000
Provision for Depreciation Account

20x4 Sh. 20x4 sh.
1/7 Disposal 56,250 1/1 Balance b/f 37,500
31/12 Balance c/f 116,250 31/12 Income statement 135,000
172,500 172,500
Disposal Account
20x4 Sh. 20x4 sh.
1/7 Machine 250,000 1/7 Provision for depreciation 56,250
1/7 Proceeds/ Cash/ Bank 188,000
1/7 Income statement
(Loss on disposal) 5,750
250,000 250,000
Points to Note
 Asset (Machine) account is always maintained at cost
 Balance b/f in the provision for depreciation account relates to machine A
(15% x 250,000 = 37,500)
 The disposal in the provision for depreciation account is the accumulated depreciation for
machine A since 1st January 20x3 to 1st July 20x4
For year 20x3 = (15% x 250,000 = 37,500)
For year 20x4 = (15% x 250,000 x 6/12 = 18,750)
Total = 37,500 + 18,750 = 56,250
Illustration 8.5
73
A company depreciates its plant at the rate of 20% p.a. straight line method for each month of
ownership.
On 1st January 1999 bought plant costing Sh. 9,000. On 1st October 1999 also bought plant costing
Sh. 6,000. On 1st July 2001 bought plant costing Sh. 5,500.
On 30th September 2002, the plant that had been bought for Sh. 9,000 on 1st January 1999 was sold
for Sh. 2,750.
Required: (a) Plant A/c (b) Provision for depreciation A/c (c) Disposal A/c
Dr Plant A/c Cr Dr Provision for depreciation A/c Cr

Yr 1999 Shs Yr 1999 Shs Yr 1999 Shs Yr 1999 Shs
1/1 Cash 9,000 31/12 Bal c/f 2,100 31/12 P & L 2,100
1/10 Cash 6,000 31/12 Bal c/f 15,000
15,000 15,000
Yr 2000 Yr 2000 Yr 2000 Yr 2000

1/1 Bal b/f 15,000 31/12 Bal c/f 15,000 1/1 Bal b/f 2,100
15,000 15,000 31/12 Bal c/f 5,100 31/12 P & L 3,000
5,100 5,100
Yr 2001 Yr 2001 Yr 2001 Yr 2001
1/1 Bal b/f 15,000 1/1 bal b/f 5,100
1/7 Cash 5,500 31/12 Bal c/f 20,500 31/12 Bal c/f 8,650 31/12 P &L 3,550
20,500 20,500 8,650 8,650
Yr 2002 Yr 2002 Yr 2002 Yr 2002
1/1 Bal b/f 20,500 30/9 Disposal 9,000 30/9 Disposal 6,750 1/1 Bal c/f 8,650
31/12 Bal c/f 11,500 31/12 Bal c/f 5,550 31/12 P & L 3,650
20,500 20,500 12,300 12,300
Dr Disposal A/c Cr
Shs Shs
Plant 9,000 Provision for dep. 6,750
P & L(Profit) 500 Proceeds/ Cash 2,750
9,500 9,500
Year Depreciation Amount

1999 20% of 9,000 = 1,800; 20% of 6,000 (3/12) = 300; 1,800 + 300 = 2,100
2000 20% of 15,000 = 3,000
2001 20% of 15,000 = 3,000; 20% of 5,500 (6/12) = 550; 3000 + 550 = 3,550
2002 20% of 11,500 = 2,300; 20% of 9,000 (9/12) = 1,350 (Part of plant that depreciated & later sold)
2,300 + 1,350 = 3,650
Accumulated depreciation for plant disposed; Has been in operation for 3 years and 9 months
20% of 9,000 x 3.75 years = 6,750
LESSON NINE
74
FINANCIAL STATEMENTS
Learning Objectives
 Prepare an income statement
 Calculate cost of goods sold, gross profit, and net profit
 Prepare a balance sheet
 Accounting for all the necessary adjustments in the financial statements
 Understand and explain the notes attached to the financial statements
Introduction
This lesson covers the preparation of financial statements more so the income statement and the
balance sheet. It captures various aspects of adjustments necessary in the final accounts that have
been discussed in the previous lessons.
9.1 Income Statement

The income statement is also referred to as the Statement of financial performance or also the
Trading, profit and loss account. An income statement is used to ascertain the financial
performance of a business firm.
Format of an Income Statement relating to a sole trader
TRADING PROFIT & LOSS ACCOUNT
FOR THE YEAR ENDING xx/xx/xx
Sales (Less return inwards) XXX
Less: Cost of Sales
Opening stock XX
Add purchases XX
Less return outwards (XX)
Add carriage inwards XX
Less drawing (goods) (XX)
Goods available for sale XXX
Less Closing Stock (XX)
(XXX)
GROSS PROFIT XXX
Add other income XX
e.g rent received, discount received
EXPENSES
Administration expenses
e.g rent, salaries, electricity, depreciation XX
Selling and distribution expenses
e.g Advertisement, carriage outwards XX
Financing expenses
e.g interest XX
Add accrued expenses XX
Less prepaid expenses (XX) XX (XX)
NET PROFIT XXX
9.2 Balance Sheet
75
The balance sheet is also referred to as the statement of financial position. It’s used to ascertain
the financial position of a firm. The balance sheet summarizes the accounting equation that is given
as; ASSETS = CAPITAL + LIABILITIES. This was well discussed in Lesson Three.
The following is a format for a balance sheet relating to a sole trader.
Balance sheet as at 31.12.20x3

xxx xxx xxx
Current Assets
Stock xx
Debtors xx
Prepaid expenses xx
Bank xx
Cash xx
Total current assets xx
Current Liabilities
Creditors xx
Accrued expenses xx
Bank overdraft xx
Total current liabilities (xx)
Working Capital xxx
NET WORTH XXX
FINANCED BY:
Capital xxx
XXX
OR
xxx xxx xxx
Current Assets
Stock xx
Debtors xx
Prepaid expenses xx
Bank xx
Cash xx xx
Total Assets XXX
FINANCED BY:
Capital xxx
Current Liabilities
Creditors xx
76
Accrued expenses xx
Bank overdraft xx xxx
XXX
Illustration 9.1
The following trial balance was extracted from books of Simpson, a sole trader as at 31st Dec 20x3.
Sh. Dr. Sh. Cr.
Capital 5,920,000
Drawings 1,200,000
Trade debtors 1,821,400
Trade creditors 2,169,000
Sales 8,905,600
Purchases 4,188,400
Stock 1st Jan 2003 2,533,300
Sales returns 144,700
Purchases returns 218,800
Cash at hand 56,800
Balance at bank 1,056,400
Warehouse expenses 640,000
Discounts received 170,400
Office salaries 600,000
Office lighting 188,800
Rates 108,200
Motor vehicle (cost) 1,280,000
Freehold premises at cost 2,600,000
Fixtures and fittings at cost 576,000
General expenses 142,400
Insurance 28,000
Provision for bad debts 50,000
Motor vehicle expenses 150,400
Bad debts written off 28,800
17,433,800 17,433,800
Additional information
1) Stock as at 31st Dec 20x3 was valued at Sh. 1,760,000
2) Depreciation on fixtures and fittings and motor vehicle is provided at 5% and 10% p.a. on
cost respectively.
3) Included in sales are goods for Sh. 13,000 ordered by Mr. Patel in the month of April. He
has never communicated though the goods have been included in the closing stock.
4) Rates prepaid as at 31st Dec 20x3 amounted to Sh. 25,600.
5) Unexpired insurance as at 31st Dec 20x3 was Sh. 4,000.
6) Provision for bad debts as at 31st Dec 20x3 is to be made at 2.5 % of net trade debtors.
Required
a) Trading and profit and loss account for year ended 31st Dec 20x3
77
b) Balance sheet as at 31st Dec 20x3.
Solution
SIMPSON SOLE TRADER
TRADING, PROFIT & LOSS A/C
FOR THE YEAR ENDING 31 DECEMBER 20x3
Sh. Sh. Sh.
Sales 8,905,600
Less Sales Returns (144,700)
Less unrealized sales (13,000)
8,747,900
Less: COST OF SALES
Opening stock 2,533,300
Add Purchases 4,188,400
Less Purchases Returns (218,800)
Goods available for sale 3,969,600
Less Closing stock (1,760,000)
(4,742,900)
Gross Profit 4,005,000
Add Discount received 170,400
Add Reduction of provision 4,790
4,180,190
EXPENSES
Depreciation: Motor vehicle 128,000
: Fixtures and fittings 28,800
156,800
Rates 108,200
Less Prepaid Rates (25,600)
82,600
Insurance 28,000
Less unexpired insurance (4,000)
24,000
Warehouse expenses 640,000
Discount allowed 90,200
Office salaries 600,000
Office lighting 188,800
General expense 142,400
Bad debts written off 28,800
(2,104,000)
Net Profit 2,076,190
Workings
Net debtors = Sh. 1,821,400 – Sh. 13,000 = Sh. 1,808,400 Motor vehicle Dep. 10% of 1,280,000 = Sh.
Provision of bad debts = 1,808,400 x 2.5% = Sh. 45,210 1,280,000
Decrease in provision = Sh. 50,000 – Sh. 45,210 = Sh. 4,790
78
Furniture and fittings Dep. 5% of 576,000 =
Sh. 28,800
SIMPSON SOLE TRADER
BALANCE SHEET
AS AT 31 DECEMBER 20x3
Sh. Sh. Sh.
NON CURRENT ASSETS COST ACC DEP. N.B.V
Freehold premises 2,600,000 - 2,600,000
Motor Vehicle 1,280,000 (128,000) 1,152,000
Fixture and fittings 576,000 (28,800) 547,200
4,456,000 (156,800) 4,299,200
CURRENT ASSETS
Stock 1,760,000
Debtors 1,808,400
Less Provision (45,210)
1,763,190
Prepayments: Rent 25,600
Insurance 4,000
Bank 1,056,400
Cash 56,800
4,665,990
CURRENT LIABILITIES
Creditors (2,169,000)
Working Capital 2,496,990
6,796,190
FINANCED BY
Capital 5,920,000
Add Net profit 2,076,190
Less Drawings (1,200,000)
6,796,190
79
Illustration 9.2
Maxwell is a sole proprietor operating business in Juja and the following trial balance relates to
his business for the year ended 31st December, 20x3.
Particulars Dr. (Kshs ‘000’) Cr. (Kshs ‘000’)

Motor vehicles 5,600
Furniture 3,200
Buildings 3,300
Stock (1/1/2011) 2,000
Sales 30,000
Purchases 20,000
Provision for depreciation: Motor vehicles 1,600
Provision for depreciation: Furniture 200
Returns 2,000 1,000
Discount 800 1,000
Debtors/creditors 8,000 4,000
Bad debts 1,000
Motor vehicles expenses 700
Rent 500
Salaries and wages 800
Electricity 1,500
Telephone 300
General expenses 500
Drawings 2,000
Capital 14,300
10% Long term loan 1,500
Bank 1,400
TOTAL 53,600 53,600
1. Stock at 31/12/20x3 amount to Kshs 3,000,000
2. Motor vehicle expenses unpaid amount to Kshs 300,000.
3. A quarter of telephone bills relate to the year 20x4.
4. Un paid electricity and water amount to Ksh 100,000
5. Depreciation on motor vehicles and fixtures is at 20% and 10% respectively on cost.
6. Salary and rent prepaid were Kshs 200,000 and Kshs 100,000 respectively.
7. Interest on loan was outstanding as at 31st December 20x3.
Required
i. Income Statement for the year ended 31/12/20x3.
ii. Balance sheet as at 31/12/20x3.
80
Solution
MAXWELL SOLE TRADER
INCOME STATAEMENT
FOR THE YEAR ENDING 31 DECEMBER 20x3
Ksh. Ksh. Ksh.
Sales 30,000,000
Less Return inwards (2,000,000)
28,000,000
Less: COST OF SALES
Add Purchases 20,000,000
Less returns outwards (1,000,000) 19,000,000
Goods available for sale 21,000,000
Less Closing stock (3,000,000)
(18,000,000)
Gross Profit 10,000,000
Add Discount received 1,000,000
11,000,000
EXPENSES
Add unpaid m/vehicle expenses 300,000
1,000,000
Telephone bills 300,000
Less1/4 telephone bills for 2012 (wk1) (75,000)
225,000
Electricity 1,500,000
Add unpaid electricity & water (100,000)
1,600,000
Depreciation
Motor vehicle(wk2) 1,120,000
Furniture and fixtures (wk3) 320,000
1,440,000
Salaries and wages 800,000
Less prepaid salaries (200,000)
600,000
Rent 500,000
Less prepaid rent (100,000)
400,000
Accrued interest on loan 150,000
Bad debts 1,000,000
General Expenses 500,000 (7,715,000)
NET PROFIT 3,285,000
81
Workings
Wk 1= ¼ x 300,000= 75,000
Wk2 = depreciation on motor vehicle 20% x 5,600,000 = 1,120,000
WK3= depreciation on fixtures 10% x 3,200,000 = 320,000
MAXWELL SOLE TRADER

BALANCE SHEET
AS AT 31 DECEMBER 20x3
Sh. Sh. Sh.
NON CURRENT ASSETS COST ACC DEP. N.B.V
Motor vehicles 5,600,000 (2,720,000) 2,880,000
Furniture and fixtures 3,200,000 (520,000) 2,680,000
Buildings 3,300,000 ------------ 3,300,000
12,100,000 (3,240,000) 8,860,000
CURRENT ASSETS
Stock( closing stock) 3,000,000
Debtors 8,000,000
Bank 1,400,000
Prepayments: Rent 100,000
Salary 200,000
Telephone 75,000 375,000
bills
12,775,000
CURRENT LIABILITIES
Creditors 4,000,000
Accruals: m/vehicle expenses 300,000
: electricity 100,000
: Interest on loan 150,000 (4,550,000)
WORKING CAPITAL 8,225,000
17,085,000
FINANCED BY
Capital 14,300,000
Add Net profit 3,285,000
Less Drawings (2,000,000)
ADD: 10% Long term loan 1,500,000
17,085,000
82
Illustration 9.3
The following trial balance was extracted from the books of K. Kalif a sole trader as at 31st Dec
20x3.
Details DR (Sh.) CR (Sh.)

Building at cost 3,000,000
Motor vehicle at cost 1,600,000
Provision for depreciation on motor vehicle 1st Jan 700,000
2009.
Discounts allowed and received 20,000 15,600
Purchases 15,769,000
Sales 20,804,400
Electricity 255,000
Rates 130,000
Insurance 105,000
Returns inward and outward 189,000 149,400
Bad debts 92,000
Provision for bad and doubtful debts 1st Jan 1994 72,000
Debtors and creditors 1,920,000 1,485,000
Stock in trade 1st Jan 1994 2,875,600
Balance at bank 484,000
Capital 3,131,600
10% loan from bank 1,000,000
Wages 1,286,400
Drawings 600,000
27,842,000 27,842,000
The following additional information is relevant:

1) Stock as at 31st Dec 20x3 amounted to Sh. 3,072,600
2) Amounts accrued as at 31st Dec 20x3.
 Electricity Sh. 15000
 Bonus to employees Sh. 100,000
3) Insurance prepaid at 31st Dec 20x3 was Sh. 35,000.
4) Included in the insurance payment is an amount of Sh. 15,500 for K. Kalif’s personal
vehicle.
5) Provision for bad and doubtful debts is 5% of debtors.
6) Interest on loan had not yet been paid.
7) Depreciation is to be provided as follows;
 20% on motor vehicle on reducing balance.
 10% on building on straight line basis.
Required
a) Income Statement for the year ended 31st Dec 20x3.
b) Balance sheet as at 31st Dec 20x3.
83
Solution
K. KALIF SOLE TRADER
INCOME STATEMENT
AS AT 31ST DECEMBER 20x3
Sales 20,804,400
Less Returns inwards (189,000)
20,615,400
Less: COST OF SALES
Add purchases 15,769,000
Less Returns outwards (149,400)
15,619,600
Good available for sale 18,495,200
Less closing stock (3,072,600)
(15,422,600)
Gross profit c/d 5,192,800
Gross profit b/d 5,192,800
Add discount received 15,600
5,208,400
EXPENSES
Electricity 255,000
Add accrual 15,000
270,000
Bonus to employees accrued 100,000
Insurance 105,000
Less prepayment (35,000)
Less insurance for personal vehicle (15,500)
54,500
Increase in provision for bad debts 24,000
Accrued Interest on loan 100,000
Depreciation on motor vehicle 180,000
Depreciation on building 300,000
Discount allowed 20,000
Rates 130,000
Bad debts 92,000
Wages 1,286,400
(2,556,900)
Net profit 2,651,500
Workings
Provision for bad debts = 5% of 1,920,000= Sh. 96,000 Depreciation on m/vehicle (reducing balance)
Increase in provision = 96,000 – 72,000 = Sh. 24,000 20% of (1,600,000-700,000) = Sh. 180,000
Depreciation on building (straight line)
10 % of ( 3,000,000) = Sh. 300,000
84
K. KALIF SOLE TRADER
BALANCE SHEET
AS AT 31ST DEC 20x3
FIXED ASSETS COST ACC DEP N.B.V
Building 3,000,000 (300,000) 2,700,000
Motor vehicle 1,600,000 (880,000) 720,000
4,600,000 (1,180,000) 3,420,000
CURRENT ASSETS
Debtors 1,920,000
Less provision for bad debts (96,000)
1,824,000
Prepaid insurance 35,000
Stock 3,072,600
4,931,600
CURRENT LIABILITIES
Creditors 1,485,000
Accruals: Electricity 15,000
: Bonus of employees 100,000
: Accrued interest 100,000
Bank overdraft 484,000
(2,184,000)
Working Capital 2,747,600
6,167,600
FINANCED BY:
10% loan from bank 1,000,000
Capital 3,131,600
Less : Drawings 600,000
: Personal vehicle insurance 15,500
(615,500)
Add net profit 2,651,500
6,167,600
85
LESSON TEN
Review Questions
1. Briefly discuss the basic assumptions used in recording accounting transactions.
2. Which are the Generally Accepted Accounting Principles (GAAPs)?
3. State the essence of accounting for transactions in a business.
4. Who are the users of accounting information and what is their interest in it?
5. Discuss the errors that can be disclosed by a trial balance.
6. Discuss the errors that can not be disclosed by a trial balance.
7. What are some of the source documents that you know and what is their importance?
8. What are the qualitative characteristics of financial information?
9. Describe the importance of a bank reconciliation statement.
10. What are the major and relevant steps in preparing a bank reconciliation statement?
11. Highlight some of the reasons that lead to different balances of the cash book and the bank
statement.
12. What are some of the factors that lead to depreciation of non current assets?
13. Discuss the various methods used to generate the depreciation charge.
14. What is the accounting treatment for provision of depreciation?
15. Differentiate between the following terms.
a.) Return inwards and Return outwards.
b.) Carriage inwards and carriage outwards.
c.) Personal and impersonal accounts.
d.) Discount allowed and discount received.
e.) Revenue expenditure and capital expenditure.
f.) Specific provision for bad and doubtful debts and General provision for bad and
doubtful debts.
g.) Loss and losses.
h.) Gain and profit.
i.) Reliability and relevance.
j.) Accruals and prepayments.
k.) Straight line method and reducing balance method of depreciation.
86
16. Describe the various steps involved in the accounting cycle.
17. What are the most common financial statements of a business and what is the importance of
each?
18. What are the uses of a control account?
19. What is the essence of a trial balance in accounting?
20. What are the uses of a general journal?
21. What are the accounting treatments for bad debts and the provision for bad and doubtful
debts?
22. What are some of the accounting constraints?
23. Discuss the accounting equation and its importance.
24. Highlight the various types of discounts offered in a trading business.
25. State the various types of cash books and briefly state the merits and demerits of each.
26. What is the use of a suspense account?
27. The following information was extracted from the books of XYZ traders for the period ended
31/3/2011.
March 1: started business with Ksh 100,000 cash from private sources
March 2: bought goods on credit from A clicks Ksh 29,600
March 3: paid rent by cash Ksh 2,800
March 4: paid Ksh. 100,000 of the cash into the bank account
March 5: sold goods on credit to J Simpson for Ksh 5,400
March 7: Bought stationary Ksh 1,500 by cheque
March 11: Cash sale of Ksh 4,900
March 14: Goods returned by Mapato Traders to A clicks worth Ksh 1,700
March 17: Sold goods on credit to Peter Ksh 1,800
March 20: Paid for building repairs by cash Ksh 1,800
March 22: J Simpson returned goods to Mapato Traders worth Ksh 1,400
March 27: Paid A Clicks by cheque Ksh 27,900
March 28: Cash purchases Ksh 12,500
March 29: Bought a motor vehicle by cheque Ksh 39,500
March 30: Paid motor expenses in cash Ksh 1,500
87
March 31: Bought fixtures Ksh 12,000 on credit from R west
Required
a) Prepare journal entries to record the above transactions.
b) Prepare the ledger accounts and bring down the balances.
28. Johnson’s cash book showed a debit balance of Sh. 117,010 on 31st March 20X7. His bank
statement showed a credit balance of Sh. 38,257 on the same date. A careful examination of
the two records revealed that the difference was due to the following;
1. Bank charges amounting to Sh. 1,712.
2. The bank had paid Sh. 5,340 to Johnson’s insurance company as per standing order.
3. David who was Johnson’s tenant had paid rent Sh. 14,500 direct into Johnson’s bank
account.
4. Cheques from debtors for Sh. 43,275 deposited by Johnson on 29th March were returned
unpaid but no entry had been made in the cash book to record the return.
5. Cheques totaling Sh. 149,088 deposited by Johnson on 30th March were credited by the
bank on 2nd April, 2011.
6. Cheques totaling Sh. 134,402 issued by Johnson to his creditors did not appear on the bank
statement. One of these cheques for Sh. 6,420 is dated 3rd September 2010.
7. A cheque for Sh. 8,240 issued by Peter another customer at the bank was credited on 1st
April.
8. The cashier in totaling the cash book pages overstated the debit balance of the cash book
by Sh. 20,000.
Required:
(a) Updated cash book or adjustment of the cash book balance.
(b) A bank reconciliation statement as at 31st March 20X7.
29. Juma is a sole proprietor operating business in Juja and the following trial balance relates
to his business for the year ended 31st December, 20X1.
Particulars Dr. (Kshs ‘000’) Cr. (Kshs ‘000’)
Motor vehicles 4,000
Furniture 3,000
Stock (1/1/20X1) 2,000
Sales 30,000
88
Purchases 20,000
Returns 2,000 1,000
Discount 3,000 1,000
Debtors/creditors 8,000 4,000
Bad debts 1,000
Motor vehicles expenses 700
Rent 500
Salaries and wages 800
Electricity 1,500
Telephone 300
General expenses 500
Drawing 3,000
Capital 14,300
TOTAL 50300 50300
1. Stock at 31/12/20X1 amount to Kshs 3,000,000
2. Motor vehicle expenses unpaid amount to Kshs 300,000.
3. A quarter of telephone bills relate to the 2010
4. Un paid electricity and water amount to Ksh 100,000
5. Depreciation is provided on motor vehicles and fixtures at 20% and 10% respectively on
cost.
6. Salary and rent prepaid were Kshs 200,000 and Kshs 100,000 respectively.
7. Goodwill is valued to be Kshs 75,000.
Required
i. Statement of financial performance for the year ended 31/12/20X1.
ii. Statement of financial position as at 31/12/20X1.
89

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LESSON THREE

INTRODUCTION TO ACCOUNTING EQUATION AND DOUBLE ENTRY SYSTEM

3.1 The Accounting Equation

(Horizontal Format) Balance sheet as at 31.12.20x3

(Vertical Format II) Balance sheet as at 31.12.20x3

1.) Introduction of Capital for a New Business

Balance sheet as at 01/01/20x3

2.) Purchase of a Non Current Asset via Cheque

Balance sheet as at 04/01/20x3

3.) Purchase of a Current Asset on Credit

Balance sheet as at 07/01/20x3

4.) Sale of a Current Asset on Credit Terms

Balance sheet as at 11/01/20x3

5.) Sale of a Current Asset on Cash Terms

6.) Payment of a liability

Balance sheet as at 16/01/20x3

7.) Collection of a current asset

Balance sheet as at 30/01/20x3

Solution using vertical format

ASSETS = LIABILITIES + CAPITAL Therefore;

ASSETS Ksh LIABILITIES Ksh

ii. To Extract a balance sheet we need to consider the reported transactions

3.2 The Double Entry System

The following is a layout of accounts with a debit and credit side:

Dr. Title of Account Cr.

3.4.1 Accounting for Assets, Liabilities and Capital.

Increase in ASSET = DEBIT entry

Capital A/c Bank A/c

20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.

Motor Vehicle A/c

Fixtures & Fittings A/c

A balance sheet from the above accounts will be as follows:

Double Entry System for Elements in the Income Statement

Increase in EXPENSES = DEBIT entry

Summary table Income Statement Elements

Summary table All elements

3.4.2.1 Accounting for Sales:

 Accounting Treatment for Cash Sales

 Accounting Treatment for Cash Sales

 Accounting Treatment for Credit Purchases

3.4.2.3 Accounting for Income:

 Accounting Treatment for Income received

3.4.2.4 Accounting for Expenses:

 Accounting Treatment for Expenses

3.5 The Asset of Stock (Inventory)

3.5.1 Accounts to record increase of stock

3.5.1.2 Returns Inwards Account (Sales Returns Account)

 Accounting Treatment for Return inwards relating to Credit Sales:

3.5.2 Accounts to record decrease of stock

3.5.2.1 Sales Account

3.5.2.2 Returns Outwards Account (Purchases Returns Account)

 Accounting Treatment for Return Outwards relating to Credit Purchases:

 Accounting treatment for Return Outwards in the trading account:

01/05/20x3: Started business by depositing Ksh 200,000 in the bank.

MM Wholesalers A/c (Creditor)

Equipment A/c Sales A/c

Cash A/c Pp Shah a/c

Rent A/c (Expenses) Stationery A/c (Expenses)

Returns – Out A/c Rent A/c (Income)

Unity A/c (Debtor) Motor vehicle A/c

Wages A/c (Expenses) Drawings A/c

THE ACCOUNTING CYCLE

(a) Capture source documents.

4.1 Capture Source Documents