READING MATERIAL

FINANCIAL ACCOUNTING

Prepared by
xxx
DEPARTMENT OF ACCOUNTING
FACULTY OF COMMERCE
MAKERERE UNIVERSITY BUSINESS SCHOOL

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 Introduction
This reading material/ study pack has been specifically developed to provide a
complete course of study for Financial Accounting examination for the
business programme first years. The aim of the syllabus is to develop an
appreciation of the role of accounting and an understanding of the techniques.
The reading material gives a complete coverage of the approved syllabus.

It is essential that you work through the questions at the end of each topic as
soon as you complete the topic. They have been specially written to reflect
examination type of questions.

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 Financial accounting syllabus
1.0 Course Objective
Preparation of Books of Accounts and Periodic Financial Statements is a vital function
in every organisation. The objective of this course therefore is to equip students with
fundamental accounting skills and principles necessary for preparation of books of
account and financial statements.

Students are expected by the end of the course to be able to prepare various books of
account, final accounts and other accounting records/statements in accordance with
General Accepted Accounting Principles (GAAP)

2.0 Course Content/ Outline

2.1 Theoretical framework of accounting
Introduction
 What accounting is and its role
 Users of accounting information
 Different branches/discipline within accounting
2.2 Accounting regulatory framework (accounting rules)
 Accounting principles/conventions/concepts
 Accounting standards.
2.3 Fundamental accounting equation and elementary treatment of Balance Sheet.
2.4 Double Entry System and preparation of Books Of Account
 What double entry is, accounting process
 Journals – Books of original entry
a) General Journal
b) Day books
c) Cash book
 Ledgers
a) General Ledger
b) Subsidiary Ledgers
2.5 Checking accuracy of double entry –Trial balance including errors not detected by it.
2.6 Year-end adjustments/provisions – Depreciation, bad debts, prepayments and accruals.
2.7 Preparation Of Final Accounts/Financial Statements for internal use (vertical formats –
IAS 1)
 Income statement including appropriations
 Balance sheet
2.8 Cash book preparations
2.9 Bank Reconciliation
2.10 Manufacturing accounts
2.11 Fixed Assets – Depreciation and disposals
2.12 Suspense accounts and correction of errors
2.13 Control accounts
2.14 Accounts for non-profit making organization (receipts and payment accounts)

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 How to study financial accounting
General Tips for Studying Accounting

1. Learning Accounting is like building a house. You cannot build the walls without
building the foundation. Accounting is like a pyramid. What you learn in each new
chapter builds on knowledge from previous chapters. If the base of the pyramid is not
firmly in place, your accounting skills will be weak. The material covered early in the
course is necessary to do problems covered later in the course. If you do not understand
the first few chapters of this textbook, you need to go back and study those chapters
before going on to later chapters of this textbook.
2. You are trying to learn as many points as you can. If you are stuck on a particular
point, do not spend a long time trying to look it up or figure it out. Make a note of it
and ask a friend or the lecturer about it later.
3. Accounting is not exactly like math. In math, the rules tend to be absolute. In
accounting, many of the rules have exceptions and often the "final answer” depends a
great deal on the context of the problem.
4. Find a friend. Spend part of your study time by yourself and part of your study time
with someone else. A portion of the study time by yourself can be used to identify what
things you understand and what things you do not. You and your study partner can
trade notes on this and teach each other. Studies have shown that by teaching others
you ensure that you will recall the information later. The most important rule about
working with someone else.
5. Time. Time management is very important in accounting courses. Be sure to keep up
with the work, completing assignments as soon after they are assigned as possible. Set
aside some time each every day to practice the problems. Always remember, “Practice
makes perfect”

Making The Best Use Of Class Time

1) Never miss a lecture session, you will find it difficult and time consuming to
learn by your self what was covered in class.
2) Classes are never interesting unless you actively take part.
3) Always be prepared before you go to class. Read what you covered in the
previous lecture; attempt the questions and illustration provided by the lecturer.
4) Don't be afraid to ask questions. If you have a question, at least ten other students
or more probably have the same question but are afraid to ask. So you ask.
5) Note: Students, who fail to attend classes, fail to pay attention during class, fail to
do their homework, and fail to ask the instructor for help until it is too late also
fall tier accounting examinations.

Preparing For Exams

1. Be specific in your study; concentrate on the things, which seem to be most
important. Note items that the lecturer emphasizes in class and course work
questions that are assigned.
2. Every exam has an element of speed. If you are slow, you probably need to study

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 and practice more. Allocate appropriate time to all questions you are attempting
in an examination. In case you find that you are spending more time on a question
than you had allocated it, it wise you start on another question. In most cases the
extra time, above the allocated time.
3. The questions that appear on exams approach the material from a slightly
different direction to test your ability to reason and understand rather than your
ability to memorize.
4. When reading or revising, don’t stop with just “getting the idea”. It is often a
great shock to students who thought they understood the material but did poorly
on the exam. This is because they never understood and practiced the skills and
knowledge they learnt. Unless you can “apply” what you have learned, the results
you get on an exam will be very disappointing. You should be able to work out a
number of accounting questions from each topic correctly during your revision
without looking at the solutions. If you can’t do that, you are not ready to take the
exam and apply what you have learned.
5. Again, read the question more than once. Endeavour to understand the
requirement of the question. Avoid getting over excited if the examination
question seems similar to a question you have attempted before. They may seem
similar but very different in content and requirements. A number of students fail
their accounting examinations because they do not carefully read the examination
questions before attempting them. Read what the question is really asking, not
what you think or you want it to ask. Avoid careless errors. At the end of the
exam allow enough time to look exam, errors and omissions.
6. An excellent strategy to use when taking an exam is to quickly look through the
entire exam and identify the questions that are easy for you. Attempt those
questions first as they help to relieve the pressure when you go back to work on
the more difficult and time-consuming problems.
7. Read the instructions and flow them. A number of students fail their accounting
examination, because of failure to follow examination instructions.
8. Come to the examination hall equipped with the necessary item, including
calculators, rulers, pens, pencils, watch, examination card, identity card etc.
9. Arrive at the examination hall at 30 minutes before the examination starting time.

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 Topic 1
Theoretical Framework of Accounting
Learning objectives
By the end of the topic, you will be able to;
Define Accounting
To discuss the categories of persons who use accounts and their information needs
Explain and discuss the accounting principles and concepts
Explain the Qualitative characteristics of financial statements and the extent to which
accounting statements display such characteristics

Introduction
Like any other profession, accountancy has rules. These are normally, in order for the
consistency to be exhibited, enshrined in a framework. Every system has users; so the outputs
of the process of financial accounting have interested users. These outputs must have
characteristics that make them useful. These together with the components of the accounting
system are exemplified below.

What is financial accounting?

Financial Accounting is the art and science of recording and classifying financial transactions
in the books, summarizing and communicating financial information through production of
financial statements/reports, and interpretation of the operating results portrayed in financial
statements/reports to facilitate decision-making (Omonuk, 1999)

Financial Accounting is the process of identifying, measuring and communicating economic

information to permit informed and rational decisions to be made. Rational decisions made by
the organization include for example; working capital decisions, capital budgeting decisions,
investment decisions, etc. It is beyond the scope of this book to go into details of these
decisions. Without limiting accounting to finances, in general use, accounting means
explaining and defending or justifying actions or results of those actions. All those who have
been entrusted with safe custody of others resources are usually required to account or submit
accountability to the owners of the resources.

By what means can we provide Financial Accountability?

Managers and accountants are required to show evidence of good financial management by
submitting accountability of money received and spent. The following are methods of
accountability:
1. Production of documentary evidence
This involves producing documents as evidence of money received and well spent. The key
accountability documents are receipts, vouchers, invoices, etc.
 Receipt – is a document prepared as evidence of money received
 Voucher – is a document that shows details and supports payment
 Invoice – is a document submitted by suppliers demanding payment for goods and
services provided on credit

2. Books of accounts

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 After documenting transactions, these transactions should be recorded into books of
accounts. In case of a query or even in the normal monitoring of transactions by owners of
the wealth, examination of books of account is normally carried out. In order to account
properly, transactions must be accurately recorded into books of accounts e.g. a cashbook.
3. Financial statements / reports
Financial statements (also called final accounts) are prepared to show results of the
operations for the year ended. The major financial statements are the income statement, the
balance sheet and the cash flow statements. Some monthly statements such as bank
reconciliation statements, budget performance reports and monthly trial balance are also
required for accountability purposes in many organisations.
4. Output / result
Apart from paper accountability, there is need for tangible outputs and concrete results to
show evidence of money well utilized. For example, if someone is given UGX 500 million
for building classroom blocks, the first accountability to be looked at are the classrooms
themselves - some times called effectiveness.

Why accounting?
The ultimate role of accounting is to provide information to decision makers. Besides that,
preparation of accounts plays the following roles:
1. Ascertainment of profit and loss
One of the main purposes of any business is to make profits. For this reason, accurate and
complete recording of all business transactions is essential because this information will be
helpful to determine whether there was a profit or loss in any trading period.
2. Assessment of tax
Governments in all countries impose taxes. For the accurate assessment of tax, accurate
records must be maintained properly; otherwise, a business enterprise may be required to
pay high taxes to the government. Accounting therefore forms an objective and reliable
basis of computing taxes.
3. To facilitate the credit transactions
Most business transactions are made on credit basis. In this case, goods are purchased or
sold without cash payment. These transactions are made on the basis of promises to make
payments in future. Without credit transactions, business cannot be expanded beyond
certain limits. If goods are purchased from a supplier on credit basis, then this supplier is
known as the creditor. Similarly, if goods are sold to a customer on credit then this
customer is known as a debtor. Accounting records facilitate such credit transactions
because these records will determine the amounts due to creditors and due from debtors.
For easy monitoring of debtors and creditors, proper accounting records must be
maintained. They also act as a Base for credit facilities for example, a loan. A business
enterprise can be able to acquire credit from financial institution once it has proper and
accurate accounting records.
4. A tool for control
A business enterprise can maximize its profits by increasing the gap between income and
expenses. Proper control of unnecessary expenses and misappropriation of funds is
essential. A proper and accurate accounting system will be helpful to maintain this control.

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5. Base for further planning
For further expansion, a business enterprise can formulate its plans based on the resent and
past achievements. Accounting records can provide sufficient data relating to sales, profit,
investments etc, for making decision about the future programme.
6. Monitoring of management
Preparation of accounts helps shareholders to monitor management and other stakeholders
to evaluate the performance of the organisation. The managers are not the owners of the
business and therefore accounting forms an objective basis for monitoring the actions of
managers by the owners of the business.
Who are the Users/interested parties of accounting information?
It is easy to assume that the only users of accounting information are shareholders- since it is a
requirement of the company law that shareholders must receive periodic accounting
statements. However, in reality there are many users of accounts. Every organisation whether
profit making or not has people or parties interested in it. These interested parties (stakeholder)
have to make decisions connected with the organisation. Accounting information is very
necessary if decisions are to be made accurately and rationally. Various parties are interested in
accounting information to facilitate their decision-making.

Accounting information is in form of financial statements/ reports, entries in books of accounts

and business documents. The users or decision makers interested in accounting information are
broadly divided into two groups, i.e. internal users and external users.

Internal users
These are involved in the day to day running of the organisation.
1. Management
The managers of the business will want to know how things are going. They need financial
information in order to plan for the future; they then need more up-to-date information in order
to check whether actual performance is on target. This process is known as controlling the
costs and finances. In accounting it is known as management accounting. So, management
accounting is done by the managers, for the managers, for the purposes of planning and
control.

2. Employees
Employees (and organisations that represent them – e.g trade unions) require information about
the stability and continuing profitability of the business. They are crucially interested in
information about employment prospects and the maintenance of pension funding and
retirement benefits. They are also likely to be interested in the pay and benefits obtained by
senior management. Employees will, therefore look for information on:
 Revenue and profit growth
 Levels of investment in the business
 Overall employment data (numbers employed, wage and salary costs)
 Status and valuation of company pension schemes / levels of company pension
contributions.

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External users
They are external in the sense that they are not involved in the day to-day running of the
organisation.
1. Shareholders
These are the primary stakeholders of the business because they invest capital in the
business. Investors are concerned about risk and return in relation to their investments.
They require information to decide whether they should continue to invest in a business.
They also need to be able to assess whether a business will be able to pay dividends, and to
measure the performance of the business’ management overall. The key accounting
information for an investor is therefore:
 Information about growth – sales, volumes
 Profitability (profit margins, overall level of profit)
 Investments (amounts invested, assets owned)
 Business value (share price)
 Comparative information of competitors
2. Potential investors
These need accounting information in order to be able to decide whether investing in a
company is worthwhile. This may be with help of an analyst who analyses the company’s
past and projected financial performance before they can buy shares in it.
The key accounting information for a potential investor is therefore:
 Information about growth – sales, volumes
 Profitability (profit margins, overall level of profit)
 Investments (amounts invested, assets owned)
 Business value (share price)
 Comparative information of competitors
3. Creditors
Suppliers and trade creditors require information that helps them understand and assess the
short-term liquidity of a business. They need accounting information to establish the credit
worthiness of the customers or clients i.e. is the business able to pay short-term debt when
it falls due? Creditors will therefore, be looking for information on:
 Cash flow
 Management of working capital
 Payment policy
4. Lenders
Banks and financial institutions who lend money to a business require information that helps
them determine whether loans and interest will be paid when they fall due. The key accounting
information for lenders therefore:
 Cash flow
 Security of assets against which the lending may be secured
 Investment requirements in the business

5. Debtors
Customers and trade debtors require information about the ability of the business to survive
and prosper. As customers of the company’s products, they have a long-term interest in the
company’s range of products and services. They may even be dependent on the business for
certain products or services. Customer will be particularly interested in:

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  Sales growth
 New product development
 Investment in the business (e.g. production capacity)
6. Donor/funding agencies
Non profit making organisations like NGOs get funding from donor agencies. These agencies
are always interested in making sure that the money they donate is used to achieve the
objectives for which it was released. They monitor utilization of their money by examining
accounting records i.e. financial reports, books of accounts and documents of the organisation
that they support.
7. Government
There are many government agencies and departments that are interested in accounting
information. For example, the Inland Revenue needs information on business profitability in
order to levy and collect corporation tax. Value Added Tax; local government need similar
information to levy local taxes and rates. The government also needs accounting information
from state owned public companies existing alongside private ones, to monitor their
performance. It needs accounting information from companies to enable it analyze the effect
its policies have on business. This enables formulation of policies that promote sector
development.
8. Competitors
These need accounting information of firms in the same industry so as to judge whether they
are performing poorly or fairly in comparison with other players in the same business.
9. General public
These include individuals and organisations which ensure that businesses make their profits in
a socially acceptable manner without damage to the environment and consumers. They have
specific interest in the activities and performance of businesses. Environmental pressure
groups push for minimization of pollution of the environment while consumer groups like
Uganda National Bureau of Standards (UNBS) try to ensure that businesses offer safe products
and don’t charge high prices for poor quality products.

Desirable qualitative characteristics of accounting information

Having identified the users of financial reports, the problem arises as to what are the qualities
of useful accounting information? These characteristics are the attributes that make the
information in financial statements useful to investors, creditors, and others. Four principal
qualitative characteristics are identified i.e.:
 Understandability
 Relevance
 Reliability
 Comparability

Understandability
This implies the expression, with clarity, of accounting information in such a way that it will
be understandable to users - who are generally assumed to have a reasonable knowledge of
business and economic activities. In other words, the information should be in a form which is
understandable to user groups. However, this poses problems. Users have very different levels
of financial sophistication in addition; the very complexity of business transactions makes it
difficult to prove adequate disclosure whilst maintaining simplicity.

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Relevance
This implies that, to be useful, accounting information must assist a user to form, confirm or
maybe revise a view - usually in the context of making a decision (e.g. should I invest in this
business? should I lend money to this business? Should I work for this business?). Relevant
accounting information is capable of making a difference in a decision by helping users to
form predictions about the outcomes of past, present, and future events or to confirm or correct
prior expectations. Information can make a difference to decisions by improving decision
makers' capacities to predict or by providing feedback on earlier expectations. The problem is
how to identify these needs given the variety of users.

Materiality is a component of relevance. Information is material if its omission or

misstatement could influence the economic decisions of users. A decision not to disclose
certain information may be made, say, because investors have no need for that kind of
information (it is not relevant) or because the amounts involved are too small to make a
difference (they are not material).

Timeliness is another component of relevance. To be useful, information must be provided to

users within the time period in which it is most likely to bear on their decisions. If information
is not available when it is needed or becomes available so long after the reported events that it
has no value for future action, it lacks relevance and is of little or no use. Timeliness alone
cannot make information relevant, but a lack of timeliness can rob information of relevance it
might otherwise have had.

Reliability
Information in financial reports is reliable if it is free from material error and bias and can be
depended upon by users to represent events and transactions faithfully. Information is not
reliable when it is purposely designed to influence users' decisions in a particular direction.
This implies that the accounting information that is presented is truthful, accurate, complete
(nothing significant missed out) and capable of being verified (for instance, by a potential
investor). The complexities of modern business make reliability difficult to achieve in all
cases.

Objectivity; This implies that accounting information is prepared and reported

in a "neutral" way. Financial statements should not be inclined (biased)
towards the needs of one user; they should be objective. The problem here is
that financial reports are prepared by one user group, management. An
external audit (an audit is an independent examination of the books of
accounts to ascertain the degree of correspondence between assertions and
the truth and fairness of financial reports in order to form an opinion on
these statements) should remove this bias, but some authorities question the
effectiveness of the audit in this respect.

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Comparability and consistency
Information about a particular organization gains greatly in usefulness if it can be compared
with similar information about other organizations; and with similar information about the
same organization for some other period or some other point in time. Comparability between
enterprises and consistency in the application of methods over time increases the informational
value of comparisons of relative economic opportunities or performance. The significance of
information, especially quantitative information, depends to a great extent on the user's ability
to relate it to some benchmark.

Much of the work that goes into setting accounting standards is based around the need for
comparability. The main problem has been the use of accounting policies (These will be
explained later in the Topic) by different organizations. Accounting standards (also explained
later in the Topic) have reduced, but not eliminated, this problem.

In order to have useful financial information presented to the users, the following generally
accepted accounting principles should be followed. These are explained here under.

Accounting concepts/principles/postulates/assumptions/conventions
To facilitate the explanation of phenomena, some factors must be taken for granted (all other
things being equal) as the platform or basis from which the explanation can proceed. The
factors taken for granted in explaining the conceptual structure of accounting are the
fundamental assumptions whose acceptance as such, and use in the systematic explanation are
assumed. In the science and art of accounting, these have come to be called “fundamental
accounting principles”.

Again in drawing up accounting statements, whether they are external "financial accounts" or
internally-focused "management accounts", a clear objective has to be that the accounts fairly
reflect the true "substance" of the business and the results of its operation. The theory of
accounting has, therefore, developed the concept of a "true and fair view". The true and fair
view is applied in ensuring and assessing whether accounts do indeed portray accurately the
business' activities.

To support the application of the "true and fair view", accounting has adopted certain concepts
and conventions which help to ensure that accounting information is presented accurately and
consistently. Attention is now to be focused on the fundamental postulates from which rational
accounting judgments proceed. First with the assumptions;

Business Entity Concept

This convention seeks to ensure that private financial transactions and matters relating to the
owner of a business is recorded and separated from financial transactions that relate to the
business. It should be noted that a business exists separate from its owner. A business owner
usually owns personal items as well as business items. The business’ financial records and
reports should not be mixed with the owner’s personal records and reports. For instance, a
business owner may incur rent for his home and rent for the business. Only the rent related to
the business should be recorded in the business’ financial records while the home rent is
recorded in the personal financial records. The business entity concept ensures that the amount

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invested by the owners in the business is defined (capital) and allows a return on capital
employed to be computed to show whether the investment is worthwhile.
Limitation
The main limitation of the concept is that the owner and the business are actually inseparable.
For instance if a sole trader sells and dwells on the same premises, then rent and utilities paid
will be difficult to apportion between the owner and the business especially if there are no
clear apportionment bases.

Monetary measurement / unit of measurement concept

According to this concept, all transactions to be recorded must be quantified in monetary
terms, since money is a common denominator for all transactions e.g. cost, sales, the value of
stocks, machinery, debts and investments. This is because a record of transactions is quantified
and assessed in a monetary unit. Thus it is assumed that the monetary unit is capable of acting
as the common denominator of the values to the point of determining exchangeable equivalents

Financial data is generally quantified and the measurements expressed in units of money.
Presentation involves adding, subtracting, multiplying and dividing numbers depicting
economic things of value and events.
Limitations
 It assumes money has a stable value over time, yet actually money may lose value with
time.
 It limits recognition of transactions to those that can be quantified and leaves out
qualitative factors that can have a direct impact on the business e.g. workforce skill,
morale, market leadership, brand recognition, quality of management etc

Going Concern/ continuity

This requires the accounting records to be maintained in such a way that the business is seen to
continue in its foreseeable future. That is, the financial reports are prepared with the
expectation that a business will remain in operation indefinitely. This makes it possible for the
accountant to prepare or project estimates for a long period into the future.

For example, a business bought machinery for shs 25,000,000/. This machinery is expected to
last for 10 years. The yearly depreciation therefore is recorded and reported based on the
expected life of the machinery. At the end of every year, the book value (cost less accumulated
depreciation) is reported.

A business is expected to continue indefinitely even if the owner retires or sells the business. If
a business is sold, the new owner is expected to continue the business’ operations. Continuity
of operations facilitates the allocation of both revenues and expenses to the pertinent
accounting periods. Without this presumption, Accrual Accounting (to be discussed here under)
would have no foundation. As the accounting entity stops being a going concern, the
accounting approach changes from accrual to realization and liquidation.

Periodicity and disclosure concept

This requires a company to prepare and disclose financial reports at the end of every
accounting or financial year. This enables comparability, timely performance measurement and
tax computations. Of course, the impact of transactions is measured for a specific time period

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usually known as the financial year. Thus, it is assumed that the continuous life time of the
entity (see going concern assumption) can be broken down into specific time periods. Then the
results of operation for each time period can be measured. At the end of each period, a “static”
picture of the resources and claims to those resources is taken. This depicts the financial
position of the entity at that specific point in the lifetime of the entity. In practice, this financial
year has come to be 12 months’ period and in Uganda, this principle has been enshrined in law
(see companies’ Act of Uganda).

Generally Accepted Accounting Principles

Let us now look at a second category of ideas that are in essence the basic guidelines in the
accounting process. Generally Accepted Accounting Principles (GAAP) is a term used to
describe broadly the rules and guidelines that governs the accounting for financial transactions
underlying the preparation of a set of financial statements. Generally accepted principles are
derived from a variety of sources, including promulgations of the Financial Accounting
Standards Board and its predecessor, the Accounting Principles Board, and the American
Institute of Certified Public Accountants. Other sources include the general body of accounting
literature consisting of textbooks, articles, papers, etc.

Historical cost
This principle requires transactions to be recorded at the price ruling at the time, and for assets
to be valued at their original cost. That is, the actual amount paid for items bought is recorded.
The actual amount paid for an item in a business transaction may be different from the value.
For instance, office furniture is valued at shs 12,000,000/. A business arranges to but the
furniture at shs 9,000,000/. The amount recorded in the accounting records for the office
furniture is the historical cost – shs 9,000,000/ - the actual amount paid.

In the process of acquiring assets by an entity, such assets are valued and recorded in books of
accounts at the cost at which they were acquired i.e. the price paid. Thus, assets are entered in
accounting records at their cost. This is generally called historical cost basically because it is
always the valuation of a consummated transaction.

Limitation
During inflation, historical cost will not reflect the true value of the assets of the business. e.g.
if an asset was bought at shs. 1,000,000/ at the beginning of the year, and the annual inflation
rate is 90%, its value at the end of the year will be shs. 1,900,000/. The historical cost concept
will require shs.1, 000,000/ and not shs.1, 900,000 to be recorded.

Realization concept
This concept requires that transactions (and any profits arising from them) are recognized and
recorded at the point of sale or transfer of legal ownership – rather than just when cash actually
changes hands. For example, a company that makes a sale to a customer can recognize that
sale when the transaction is legal – at the point of contract. The actual payment due from the
customer may not arise until several weeks (or months) later – if the customer has been granted
some credit terms.

For example, a business sells goods for shs 2,500,000. The business agrees to an initial
payment of shs 1,000,000 with the remaining balance to be paid in two monthly installments of

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shs 750,000/ each. The full amount of shs 2,500,000/ of revenue should be recorded at the time
of sale even though shs 1,500,000/ will be paid later.

Note that a realization is when a sale is made to a customer. The basic rule is that revenue is
created at the moment a sale is made, and not when the price is later paid in cash. Profit can be
taken to the profit and loss account on sales made even though the money has not been
collected.

The gist of this concept is that in order to determine the nature and magnitude of the impact of
transactions on the financial position of the accounting entity, inflowing values are recognized
if and when the earning effort is substantially expended or completed. Revenues represent
actual or expected cash inflows or the equivalent from the ongoing or central operations of the
enterprise during the accounting period. Realization in the most precise sense means the
process of converting non-cash resources and rights into money and most precisely used in
financial accounting and reporting to refer to sales of assets for cash or claims to cash.
Recognition is the process of formally recording or incorporating an item into the financial
reports of an entity.

Materiality
This requires the recognition of only material items and excluding immaterial or trivial items.
Information is material if its omission or misstatement could influence the economic decisions
of users taken on the basis of the financial reports. Financial statements should therefore show
material items separately, but immaterial items may be aggregated with amounts of a similar
nature. For example buying furniture for shs 14,000,000/ represents an amount large enough to
significantly affect the amount of net income reported if recorded as an expense. Therefore, the
furniture should be recorded as an asset and depreciated each year of its useful life.

Consistency
According to this concept, transactions and valuation methods are treated the same way from
year to year, or period to period. Business decisions are often made by comparing current
financial reports with previous financial reports. Users of accounts can therefore make more
meaningful comparisons of financial performance from year to year. Accounting information
recorded and reported differently each accounting period makes comparisons from one
accounting period to another impossible. Where accounting policies are changed, companies
are required to disclose this fact and explain the impact of any change.

Prudence/ conservatism
This concept requires the profits are not recognized until a sale has been completed. In
addition, a cautious vie should be taken for future problems and costs of the business as soon
as there is a reasonable chance that such costs will be incurred in the future i.e. provide for all
possible losses, for example, provision for bad debts. The concept can be summarized by the
phrase ‘anticipate no profit and provide for all possible losses’. Further still, the concept tends
to undervalue assets i.e. whenever there are alternative methods of valuing an asset, an
accountant should choose the one that leads to a lower value or profit and a higher liability.
This stems from the accountants’ fear that if they prepare the financial reports with too much
optimism they may overstate profits and cause dividends to be paid out of capital if these
profits are not realized.

15
Accrual concept
This requires the recognition of items at the occurrence of the transaction and not when cash is
received or paid. For example, Income is recorded as earned even though it might have not
been received. The portion of income that has not been received is recorded as an asset
(accrued income or debtors). Expenses or costs should be recorded as incurred although cash
may not have been paid. For example, if rent expenses paid by the year close was shs
1,500,000/ and yet some electricity equivalent to shs 200,000/ was used but not paid for, the
amount of rent expense be considered should be shs. 1,700,000/ (i.e. 1,500,000/ + 200,000/).
The unpaid shs. 200,000/ should be recorded as an accrued expense. It should be recorded as
current liability in the balance sheet.

Matching
This concept requires that revenues from business activities and expenses associated with
earning that revenue are recorded in the same accounting period. Business activities for an
accounting period are summarized in financial reports. To adequately report how a business
performed during an accounting period, all revenue earned as a result of business operations
must be reported. Likewise, all expenses incurred during the same accounting period in
producing the revenue must be reported. Matching expenses with revenue gives a true picture
of business operations for an accounting period. for example, if income of shs. 50,000,000/
was earned during a particular accounting period, and rent of shs. 1,800,000/ had been paid for
one and half years, not the whole shs1,800,000 should be written off or subtracted from the
shs. 50,000,000/ because part of the rent belongs to the next year. The correct amount to be
subtracted from the income shs.50, 000,000/ is shs.1, 200,000/ and not shs.1, 800,000/. The
difference is recorded as prepaid rent.

Likewise if electricity expenses paid was shs.500,00/ but some electricity equivalent to
200,000/ was used but not paid, that amount should as well be matched against the income i.e.
the amount of electricity expense to be subtracted from income of shs.50,000,000/ should be
shs.700,000/ (i.e. 500,000/ + 200,000/). The unpaid shs.200, 000/ should be recorded as an
accrual.

In determining whether, during the accounting period of concern, the accounting entity has had
an excess of inflowing values over the out flowing values or vice versa, the inflowing values –
revenues – are matched against out flowing values – expenses or expired costs. Thus, earned
revenues are matched against the costs incurred to earn such revenues whether cash payments
or cash receipts are involved or not. This guideline is generally known as accrual accounting.
In order to develop this principle fully, let us refer back to historical cost convention and focus
specifically on expenses.

Expenses are outflows. They represent actual or expected cash outflows or equivalents that
have occurred or will occur as a result of the ongoing major or central operations of the
enterprise during the period. Depending on the kind of operation and the manner in which
expenses are recognized, they are variously referred to as cost of sales, cost of services
provided, depreciation, interest, rent, salaries and wages, etc. They are essentially out flowing
values as a result of business activity. They reflect the effort to earn revenues.

16
Accrual accounting records the financial effects of transactions and other events and
circumstances in the period in which they take place rather than only in the periods in which
cash is received or paid. The accounting process recognizes that the buying, producing, selling
and other operations of the enterprise during a period, as well as other events that affect
enterprise performance, often do not coincide with cash receipts and payments of the period.

Precisely then, recognition of revenue, expenses, gains and losses and related increments and
decrements in assets and liabilities including matching of costs and revenues, allocation and
amortization – is the essence of using accrual accounting to measure performance of
commercial enterprises.

E.g. in a hire purchase, the buyer takes possession and use of the asset but does not become the
legal owner until the last installment has been paid. Though he is not the legal owner, he has to
recognize this transaction in his books.

Duality concept (dual aspect)

This is the basis of double entry book keeping and stems from the fact that every transaction
has a double (dual) effect on the position of a business as recorded in the accounts. For
example, when as asset is acquired, either another asset (cash) is reduced, or a liability
(promise to pay) is acquired, at the same time. When a business borrows money, a liability to
the lender is created, and at the same time an asset (cash) is increased. It follows that the assets
of the business are equaled by claims on the business, either by creditors or owners for the
funds they have invested in the business and which have been translated into assets for use by
the business. The balance sheet which summarizes assets and claims must therefore balance.
The double entry system is further explained in Topic three.

Accounting Regulatory Framework (Accounting Rules)

Having looked at the fundamental principles of accounts, qualitative characteristics, users and
so forth, we now have to summarize a number of rules that underlie accounting practice.

Accounting rules are imposed on accountants in order to make sure that their reporting is free
from bias. Accounting legislation requires financial accounts be prepared and presented in
conformity with GAAP (Generally Accepted Accounting Principles). GAAP refers to
accounting principles or practices that are regarded permissible by the accounting profession. It
includes requirements of the company acts, stock exchange etc. the key terms used in
accounting regulatory framework include:
 Accounting principles/ concepts/conventions
 Accounting bases
 Accounting policies
 Accounting standards

Accounting principles
Also known as accounting concepts, conventions or postulates, are basic ground rules which
must be followed when financial accounts are being prepared and presented. They are also
referred to as assumptions or prepositions that underlie the preparation and presentation of
financial reports. Most of these have already been discussed earlier.

17
Accounting bases
These are methods developed for applying fundamental concepts to financial transactions and
items for the purpose of final accounts and in particular:
 For determining the accounting periods in which revenue and costs should be
recognized in the profit and loss account.
 For determining the amounts at which material items should be stated in the balance
sheet.

Accounting policies
These are the specific accounting bases selected and consistently followed by a business
enterprise as being in the opinion of management, appropriate to its circumstances and best
suited to present fairly its results and financial position.

Accounting standards
These are guideline statements or rules issued by professional accounting bodies governing
accounting practice, relating to how accounts should be prepared and presented.

Fields of Accounting
Having looked at the major part of the conceptual framework of accounting, let us now look at
the particular fields of accounting. There are several accounting fields as a result of varied uses
of accounting information. The common fields are financial accounting, managerial
accounting, cost accounting, tax accounting, environmental accounting and auditing.

Financial accounting
This is a field of accounting that is concerned with the classification, measurement and
recording of business transactions of an entity in monetary terms and in accordance with
Generally Accepted Accounting Principles. The major focus of financial accounting is to
provide information to external users. External users of financial accounting information
include shareholders, creditors, government, financial institutions, and the public.

Managerial accounting
This deals with the analysis and interpretation of financial accounting information. Managerial
accounting provides management with information for internal decision making concerning
daily operations as well as planning and control of future operations.

Cost accounting
The determination and allocation of costs to products and services of a business organization is
called Cost Accounting. This field of accounting provides information for internal decision
making concerning the costs of operating service and manufacturing businesses

Tax accounting
This is the preparation of tax returns as well as tax planning. Tax accountants use financial
statement information to prepare tax returns. These tax returns are filed with the tax authorities
like Uganda Revenue Authority in case of Uganda.

Environmental accounting

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This is the reporting of environmental activities undertaken by an organisation. Environmental
accounting provides information for external users concerning environmental achievements.

Auditing
The independent reviewing and issuing of an opinion on the reliability of accounting records is
called Auditing. This is usually the duty of an auditor. The auditor is supposed to check
whether the books of accounts are prepared and presented according to the generally accepted
accounting principles and whether policies and procedures prescribed by management are
being followed. The auditor’s opinion enables external users to be confident of the information
reported in the financial reports.

Accounting Profession
Accounting is a growing profession world wide. Accounting employment is usually in:
Private accounting
 Public accounting
 Government accounting

Private Accounting
This is where qualified accountants are engaged in accounting work of individuals,
corporations, non – profit making organizations and or otherwise. Persons employed in private
accounting work for only one business. These persons may perform a variety of duties. In
small organizations they do all of the summarizing, analyzing and interpreting of financial
information for management. In large organizations, accountants typically specialize in one
field of accounting such as Financial accounting, Cost accounting, Management accounting,
Tax accounting and Social responsibility/environmental/green accounting

Public accounting
This is the provision of accounting services by highly qualified Certified Public Accountants to
various clients, which may include individuals, corporations and government. Persons
employed in public accounting may work independently or as a member of a public accounting
firm. Public accountants sell services to individuals, businesses, government units and non
profit making organizations. These services include; auditing work, providing management
advisory services, providing tax consultancy services such as preparing income tax returns, etc.

Government Accounting
This is the accounting for government institutions e.g. central government, local government,
etc. government accounts are unique from private companies and other organizations.
Government officials rely on financial information to help them direct affairs of their agencies.
Uganda Revenue Authority; is one of the government agencies that performs extensive
accounting work. It handles income tax returns filed by individuals and corporations, and
frequently performs auditing functions relating to these income tax returns and the accounting
records on which they are based.
Uganda Securities Exchange Commission is also another government agency involved in
accounting. USEC establishes the requirements regarding the content of financial reports and
the reporting standards, and the rules and regulations to be followed in order to be listed on the
exchange market.

19
 Topic 2
Accounting Equation
Learning objectives
By the end of this topic, you will be able to;
Demonstrate the accounting equation
oDefine the elements of the accounting equation
Draw up simple balance sheets after different transactions have occurred

Introduction
The accounting equation is the primary result of the dual effect/ double entry system. At its
simplest, the equation might be stated as;
Ownings = Owings
Assets = Liabilities + Capital
Where we define these as;
 Assets are the resources that are owned by the business
 Liabilities are amounts owed or debts to other organizations – in short, the financial
obligations of a business
 Capital is that amount of money (or other resources) that the owner invests in the
business

Illustration
Mukasa is a sole trader who set up his business in Kisenyi. The following were the transactions
that took place in the month of January. Amounts are in UGX
i) Started business with cash of 10,000,000and cash at bank of 20,000,000
ii) Purchased stock of goods on credit of 3,000,000
iii) Bought a Motor vehicle for business operations using the cash at bank of 2,000,000
iv) Sold goods to James for 600,000cash which had cost him 500,000
v) Paid the shopkeeper 50,000cash as salary
vi) Bought more stock of goods for 500,000 cash
vii) Used business cash of 300,000 to buy for his wife and children Christmas clothes

Required Construct an accounting equation for each of the transactions above and extract
prepare a simple balance sheet at the end.

i)
Assets = Liabilities + Owners equity
Bank 20,000,000 --------------- Capital 30,000,000
Cash 10,000,000
30,000,000 30,000,000

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 Mukasa’s Balance Sheet as at………

Non Current Assets Equity and liabilities

Motor vehicle 2,000,000 Capital 30,000,000
Current assets Profit 50,000
Stock 3,000,000 less drawings (300,000)
Bank 18,000,000 Current liabilities
Cash 9,750,000 Trade creditors 3,000,000
Total Assets 32,750,000 Total Equity & Liabilities 32 ,750,00

Exercise
Mukwano is a businessperson dealing in general merchandise. Below are the transactions for
the month of January. Show the accounting equation and the balance sheet for the transactions
below.
i) He started business with a lorry of 30,000,000and cash at bank of 20,000,000.
ii) A motor vehicle of 10,000,000 was bought on credit from Lonrho ltd
iii) He bought inventory of 6,000,000 using a cheque
iv) Bought furniture of 4,200,000 from Hwan Sung on credit
v) He used his salary to buy a shirt of 80,000
vi) He sold 2/3 of the inventory for 3,000,000 cash
vii) Secured a DFCU loan of 5,000,000, which was deposited on his bank account to be
paid within one year.
viii) Paid Hwan sung 2,200,000 cash
ix) Paid utilities of 800,000 by cheque
x) He used the business debit card to withdraw 1,000,000 for buying a mobile phone
for his girl friend.

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 Topic 3
Double-Entry accounting

Learning objectives
By the end of this topic, you will be able to;
Demonstrate the concept of double entry and how it follows the rules of the basic
accounting equation.
Record transactions following the double entry rule
Extract a simple trial balance and balance sheet.

Introduction
The double entry system of accounting recognizes the fact that every business transaction has
two effects; that of the business ‘receiving’ (+), and that of the business ‘giving’ (-). This
principle forms the basis of accounting.

The basic unit of double entry system is the account.

Accounts are a separate record that is kept of the increase and decrease in each asset, each
liability, and each aspect of owner’s equity.
Accounts Standard Form
 Account title and number are located at the top and identify each account as an asset,
liability, or aspect of owner’s equity.
 Debit side – left side
 Credit side – right side
The debit side and the credit side of an account contain the following columns:
 Date column – record date of transaction
 Item column – record description, if necessary
 P.R/folio column – record posting reference
 Debit or credit column – record amount

T- Accounts:
 Simplified version of the standard form of account
 Looks like the capital letter T.
 Contains title, debit and credit side

Title of Account
Debit side Credit side
Left side Right side

Debits and credits

The left side of any account is the debit side, and the right side is the credit side.
 To debit an account is to enter an amount on the left, or debit side.
 To credit an account is to enter an amount on the right, or credit side. Debit and credit
 Dr used for debit
 Cr used for credit.

22
The rule of debit and credit are based on the location of assets, liabilities, and owner’s equity.

The table below summarizes the items that are represented by debits and credits.
A debit entry represents A credit entry represents
1) An increase in the value of an asset 1) A decrease in the value of an asset
Or Or
2) A decrease in the amount of a 2) An increase in the amount of a
liability liability
Or Or
3) An item of expenditure 3) An item of income

Consider the T- accounts below;

Assets Liabilities
Dr Any asset Cr Dr Any Liability Cr
Increase Decrease Decrease Increase
+ - - +

Capital
Dr Capital Cr
Decrease Increase
- +

Expenses Revenue/ Income

Dr Expense Cr Dr Revenue/Income Cr
Increase Decrease Decrease Increase
+ - - +

Illustration
a. Ali Musa starts a travel agency with an investment of UGX25, 000 in cash. The owner’s
investment increases the assets cash by UGX25, 000. Assets accounts are debited to record an
increase. Thus, the cash account must be debited for UGX25, 000.
(a) Entry

Cash Ali Musa, Capital

+ - - +
(a) 25,000 (a) 25,000

b. Ali Musa buys a computer and other office equipment for the business for UGX 9, 000
on credit. The asset office equipment increased by UGX9, 000 and Asset accounts are debited
to record an increase. Thus, the office equipment account must be debited for UGX9, 000.

23
The liability accounts payable increases by UGX9, 000. Liability accounts are credited to
record an increase. Thus, the accounts payable account must be credited for UGX9, 000.

(b) Entry
Office Equipment Accounts Payable

+ - - +
(b) 9,000 (b) 9,000

c) Ali Musa buys offices supplies for the business for UGX300 in cash. The assets office
supplies are debited to record an increase. Thus, the office supplies account must be debited
with UGX300. The asset office supplies increases by UGX300. Assets accounts are debited to
record an increase. Thus, the office supplies account must be debited for UGX300.
(c) Entry

Office supplies Cash

+ - + -
(c) 300 (a) 25,000 (c) 300

d) Ali Musa pays UGX3000 of the amount her business owes for office equipment
previously brought on credit.
The liability payable decreases by UGX3000. Thus, the account payable must be debited for
UGX3000.
The asset cash decreases by UGX3000. Assets accounts are credited to record a decrease.
Thus, the cash account must be credited for UGX3000.

(d) Entry
Accounts Payable Cash

- + + -
(d) 3,000 (b) 9,000 (a) 25,000 (c) 300
(d) 3,000

24
Exercise

1. Show the following transactions, as they are entered in the double entry system

a) Sold goods for cash UGX 8,000

b) Bought Furniture for UGX 5,000 and paid by cheque
c) Bought goods in trade for UGX 3,000 on credit
d) Part payment of UGX 1,000 cash was made to a creditor
e) Tom was paid UGX 2,000 cash
f) Some furniture, which had cost UGX 3,000, sold for cash at cost.

2. Show the following transactions, as they are entered in the double entry system

a) Bought goods in trade for UGX 7,000 on credit

b) Sold goods for UGX 5,000 cash
c) Sold goods on credit for UGX 2,000
d) Paid Salaries UGX 2,000 cash
e) Bought Goods UGX 3,000 cash
f) Sold goods UGX 6,000 by cheque
g) Paid creditors UGX 3,000 by cheque

25
 Topic 4
The preparation of books of account

Learning objectives
By the end of the topic, you will be able to;
Classify accounts
Explain the subsidiary books and sources of accounting information
Post and balance off accounts
Enter transactions using the double entry system
Prepare a trial balance.

Introduction
In this Topic, we introduce the books kept by an enterprise and economic transactions recorded
there. We shall acknowledge and illustrate that the ledger is the main book accounts.
Research more on source documents receipt, invoice, deposit in slip,
delivery note.

Subsidiary books
These are books of original entry. We post the transactions recorded in the subsidiary books to
the ledger accounts at the end of every month and in case of some transactions, only total
amounts are posted. The books used to record all transactions of a particular category prior to
posting to the ledgers are the books known as subsidiary books or books of prime entry. They
include;
The purchase daybook or journal; this book records the details of all goods purchased
on credit. We write up the purchases daybook is from the incoming invoices.
Sales daybook or journal; this book records the details and amounts of all goods sold
on credit. We write up the sales daybook from the outgoing invoices.
Purchases return book or returns outwards journal; this book records the details and
amounts of goods returned to the creditors. We write up the returns out ward daybook is
written up from the incoming credit notes
Sales return book or return inwards journal; this books records the details and amounts
of goods returned by the debtors. We write up the return in wards daybook from the out
going credit notes.
Petty cash book; this book records the small cash receipts or payments. This books are
also used to analyze the expenses the expenses paid in cash
Journal or diary; the journal is that daybook in which we can record the details of any
transaction that cannot be recorded in any other subsidiary book. We call all other
books of original entry the division of journal for recording specific type of
transactions. The main uses of the journal are the following.
 To record purchases or sales of assets
 To correct the errors
 To record opening and closing entries
 Writing off of bad debts; etc

26
JOURNALS
A journal may also be defined as a book of original entry where transactions are first recorded
when they occur. Businesses maintain several types of journals and the nature of operations
determine the number and the types of journals needed. The journal was once the most used
book in bookkeeping, but today entries in the journal are limited to records of ‘unusual’
transactions, which are improperly recorded in any of other books of original entry that will be
described. Such transactions are those which do not purely involve the receipt or payment of
money (whether in cash or through the bank), and which are not credit sales or purchases or
returns inwards or returns. However, the types of Journals are;
a. General journal
b. Sales day book/sales journal
c. Purchases day book/purchases journal
d. Cash book
e. Returns inwards day book
f. Returns outward day book

A) General Journal
We can also use this journal for all types of transactions with two money columns, although in
the diagram above we have said it used to record other types of transaction other than those
specifically identified with other journals. We also call it a journal proper. XYZ Ltd journals
below are examples of general journal.

Procedural steps for recording transactions in the General journal

a. Recording the date on which the transaction occurred.
b. Write the name of the account to be debited and recording the amount in the first money
column
c. Write the name of the account to be credited in the second money column
d. A brief explanation is given about the transaction immediately after the account is credited
e. Journals have a Ledger page column. This column provides a convenient cross-reference
with the ledger.

Illustration
The following were the transactions of XYZ ltd for the month of January
i) On January 1st XYZ ltd started business with cash of UGX 2,000,000 and money at the
bank of UGX 3,000,000
ii) 3rd Jan Purchased goods for UGX 600,000 cash
iii) 6th Jan Bought a Motor vehicle for UGX 1,500,000 by cheque
iv) 7th Jan Sold goods for UGX 300,000 cash.
v) 15th Jan Purchased more goods on credit from TK ltd worth UGX 500,000
vi) 20th Jan obtained a bank loan of UGX 3,000,000 cash.
vii) 23rd Jan Sold goods for UGX 200,000 on credit to Mary
viii) 25th Jan Mary paid UGX 80,000 cash.
ix) 26th Jan Sold goods on credit to Peter for UGX 100,000.
x) 29th Jan purchased goods from John on credit for UGX 300,000

27
 Required Enter the above transactions in the General Journal

XYZ LTD
GENERAL JOURNAL FOR THE MONTH OF JANUARY
Date Account title & explanations LP/Folio Debit Credit
1st Jan Cash A/C 01 2,000,000
Bank A/C 02 3,000,000
Capital A/C 03 5,000,000
For starting the business
3rd Purchases A/C 04 600,000
Cash A/C 01 600,000
Being purchase of goods using
cash
6th Motor vehicle A/C 05 1,500,000
Bank A/C 02 1,500,000
Being for purchase of a motor
vehicle using cash
7th Cash A/C 01 300,000
Sales A/C 06 300,000
Being sale of goods for cash
15th Purchases A/C 04 500,000
TK Ltd A/C (Creditors) 11 500,000
For purchase of goods from
TK Ltd on credit
20th Cash A/C 01 3,000,000
Loan A/C 08 3,000,000
Being a loan obtained
23rd Mary A/C (Debtor ‘s A/c) 09 200,000
Sales A/C 06 200,000
To record sale of goods on
credit to Mary
25th Cash A/C 01 80,000
Mary A/C (Debtor s A/c) 09 80,000
To record receipt of cash
26th Peter A/C (Debtor’s A/C) 09 100,000
Sales A/C 06 100,000
To record sold of goods to
Peter on credit
29th Purchases A/C 04 300,000
John A/C (Creditor’s A/C) 07 300,000
To record purchase of goods
from John on credit
11,080,000 11,080,000

28
Exercise
Kyeswa commenced a Hardware enterprise on March 1 with UGX 50,000,000 on his account
in Stanbic Bank. The following transactions were carried out in that month.
Mar 2 Purchased goods of UGX10, 000,000 from Bridgestone Ltd on Credit.
3. Withdrew UGX3, 000,000 from the bank and kept it in the safe as petty cash.
5. Sold goods worth UGX5, 000,000 to Mukozi who paid UGX2, 000,000 by cheque;
UGX1, 500,000 cash and issued a notes receivable for the balance.
7. Bought land of UGX8, 000,000 by cheque from Akright Ltd to construct the business
premises
9. Paid a salary cheque of UGX800, 000 to his accountant
11 Returned goods of UGX100, 000 to Bridgestone Ltd because they had damages
13. Paid insurance to A.I.G of UGX200, 000 cash
15 Purchased goods worth UGX7, 000,000 from Kiseka Market and issued a Notes
Payable.
17 Mukozi rejected and returned defective goods worth UGX300, 000.
18 Paid Bridgestone a cheque of UGX6, 000,000 for goods purchased on credit.
19 Received a cheque of UGX500, 000 from Mukozi for goods sold to him.
21 Disposed off Part of the land at UGX2, 000,000 cash because it was redundant.
22 A cheque from Mukozi bounced because there were insufficient funds on his account.
23 Paid rent of UGX600, 000 cash.
25 Sold goods to Kiyembe Ltd for UGX2, 000,000 on credit
27 Mukozi Paid 400,000 cash for goods sold to him on credit.
29 Purchsed goods of UGX4, 800,000 from City tyres on credit
30 Received a cash of UGX1, 000,000 from Kiyembe Ltd to clear his debt.
31 Used business cash of UGX 200,000 to organize a dinner party at Fang-fang Restaurant
for his employees.
Required
Enter the above transactions in the general Journal.

B) SALESDAY BOOK (SALES JOURNAL)

In almost all businesses sales will be made on credit. The sales day book is used for
recording the credit sales. The sales day book contains the following:
 Date on which the transaction occurred
 Name of the customer. The person who bought the goods on credit (individual or
company)
 Invoice number. The number on the sales invoice. A sales invoice is a document
showing details of goods sold and the prices at which they have sold
 Folio column
 Amounts or Prices at which goods have been sold

Illustration
The company sold goods on credit to the following people.
On May 1st sold goods to Jackie of 400,000 and the invoice number was 011

29
 On May 4th sold goods to James of 300,000, invoice number 016
On 7th sold goods to Peter 700,000, invoice number 018
On 10th sold goods to Meyer 500,000 invoice number 020

Required: Prepare a Sales daybook

SALESDAY BOOK

Date Name of Invoice Folio amount

customer number
May 1st Jackie 011 400,000
4th James 016 300,000
7th Peter 018 700,000
10th Meyer 020 500,000
1,900,000

C) PURCHASES DAY BOOK

The purchases daybook is book of original entry for recording goods bought on credit.
The purchases daybook contains the following
 Date
 Name of creditor
 Invoice number
 Folio column
 Amount

Another illustration
The company bought the following goods on credit in the month of May
i) On May 3rd bought goods from Stephen for 1,500,000, invoice number 10
ii) On 7th purchased from Brian for 3,000,000, invoice number 14
iii) On 20th purchased from Derrick for 2,000,000, invoice number 18
iv) On 22nd bought goods from Adrian for 700,000, invoice number 20
Required Record the above transactions in the purchases daybook

PURCHASES DAY BOOK

Date Name of creditor Invoice number Folio Amount
May 3rd Stephen 10 1,500,000
7th Brian 14 3,000,000
20th Derrick 18 2,000,000
22nd Adrian 20 700,000
7,200,000

D) CASHBOOK

The cashbook is a book of original entry for recording cash and bank transactions. It shows the
business receipts and payments. We also classify a cashbook as a ledger. A cashbook can have
two columns or three columns.

30
 Two-column cashbook
The two-column cashbook has the bank and cash column both on the debit and credit side. The
cashbook therefore is a combination of the bank and the cash account.

Format of a two-column cashbook

Title
Date Particulars Bank Date Particulars Cash Bank

Using the illustration of XYZ ltd prepare a 2 column cashbook

XYZ two-column cashbook

Date Particulars Cash Bank Date Particulars Cash Bank

Jan 1st Capital 2,000,000 Jan 3rd Purchases 600,000
Jan 1st Capital 3,000,000 Jan 6th M. vehicle 1,500,000
7th Sales 300,000
20th Loan 3,000,000 Bal c/d 4,780,000 1,500,000
25th Mary 80,000
5,380,000 3,00,000 5,380,000 3,000,000

Use of folio columns in the cashbook

The particulars column of the cashbook just contains the name of the other accounts and
tracing such accounts may be difficult. Folio columns will indicate where we find such
accounts when we need more information.

The three-column cashbook

The three-column cashbook has additional columns of discount received and discount
allowed column in addition to the cash and the bank columns.
Discount allowed This is the discount (reduction in the prices) that is given to customers
by the business. It reduces the amount paid by the customer. We enter the discounts
allowed in the discount column on the debit side of the cashbook

Discount received
This is a discount received by the business from its suppliers. It reduces the amount paid to
suppliers. The discounts received are entered in the discounts column on the credit side of
the cashbook.

Illustration
The company purchased goods on credit from Mary for UGX2, 000,000.
i) The company was able to pay on 4 May (in time) using a cheque and therefore
qualified for a discount of 5%.

31
 ii) The company has a debtor John whose balance was UGX200, 000. He paid cash
on 10 April (in time) and this made him qualify for discount of 2%.
Required Show how the above transactions will appear in the cashbook

Discount received
2,000,000*5/100 = 100,000 (To be entered on the credit side of the cashbook)

The amount of money that the company paid to Mary amounted to

2,000,000-100,000 =1,900,000

Discount allowed
2/100*200,000 = 4,000
The discount allowed is UGX 4,000 (will appear in the discount column on the debit side
of the cash book)

The amount received from John a debtor was 200,000-4,000 = 196,000

Three-column cashbook
Date Details Discount Cash Bank Date Details Discount Cash Bank
10/4 John 4,000 196,000 4/05 Mary 100,000 1,900,000

Exercise:
Refer to the General Journal of Kyeswa Ltd and prepare a Cash book

RETURNS DAY BOOKS/JOURNALS

The returns day books record goods, which have been returned to and by the business
These books are:
 Return inwards day book
 Return outwards day book

Return inwards day book/Journal

Return inwards refers to goods which have been sold but have been returned to the business.
When the goods are returned and the amounts are refunded, a credit note is issued to the
customer. It is called a credit note because the customers account will be credited. The returns
on the credit notes will be recorded in the:
 The return inwards account
 Sales ledger (Debtors subsidiary ledgers) by crediting the individual customers
accounts

Illustration
The following customers returned goods to the company:
i) On 3rd September David returned goods for UGX50,000, credit note number 012
ii) On 8th September Isaac returned goods for UGX80,000, credit note number 019
iii) On 20th September Deborah returned goods for UGX100,000, credit note number
020
Required Record the above transactions in return in wards daybook

32
 Return in wards daybook
Date Details Credit note Folio Amount
number
3rd September David 012 50,000
th
8 “ Isaac 019 80,000
20th “ Deborah 020 100,000
Amounts to be
transferred to the return 230,000
inwards account

Return outwards account

The return outwards day book records the goods which have returned by the business to its
suppliers. When goods are returned, the business issues a debit note to the supplier and gives
reasons for their return.
The amounts of the debit note will be recorded thus;
 Return out wards account
 Purchases ledger by debiting in the individual accounts

Illustration
The company returned goods to the following suppliers
i) On 4th May returned goods to peter of UGX80,000, debit note number 013
ii) On 28th May returned goods to Ivan of UGX130,000, debit note number 015
iii) On 30th May returned goods to Mark of UGX200,000, debit note number 018

Required: Record the above transactions in the return outwards daybook

Return outwards daybook

Date Details Debit note Folio Amount
number
4th May Peter 013 80,000
28th May Ivan 015 130,000
30th May Mark 018 200,000
Amounts to be 410,000
transferred to the
return outwards
account

After recording transactions in the journals, we post them to the ledgers. We sometimes refer to
a ledger as the book of secondary entry. A ledger is a group of accounts (A/C) and in the
manual accounting system the ledger is a book where the accounts are kept.

THE LEDGER

33
The recording function of accounting is called preparation of books of accounts/book
keeping. The purpose of bookkeeping is to provide an accurate and detailed record of every
transaction involving the exchange of money or money’s worth between the enterprise and
others, whether they are individuals or organizations.

The books that are the subject of bookkeeping are referred to as the “books of accounts”. The
main book of accounts is the ledger. In a summarized form it records – and can provide – all
the following information:-
A) The total income of the business, and in general the different sources from which it is
derived;
B) The amounts involved in meeting each type of expense, and the total expenditure
incurred by the business;
C) What assets are owned by the business, the values of each general type and the total
value of all its assets;
D) The values of the different liabilities of the business, and the total value of all its
liabilities;
E) Who its debtors are, how much they owe to the business, and the total amount owed
to the business;
F) Who the creditors of the business are, how much is owed to each by the business, and
the total amount owed by the business;
G) Whether the business has made a profit or a loss during a given period of time, and
the amount of that profit or loss;
H) The amount of working capital available to the business at the point in time

A ledger comprises many different sections, each of which is called an account. In a ledger
‘book’, there will usually be one account on each page of it; in a large business, each account
may have its own card or sheet – all the account – cards or account – sheets together jointly
make up the business’ ledger.
The following important points must be noted about ledger accounts:
1. Each individual account is headed by a name or by a title. That name or title may be the
name of a person or an organisation or a type of assets, a type of liability, a type of
expense or a source of income
2. Only information about the transactions concerning the person, organisation or item
named at its head may be recorded in that account.
3. Each account must be kept separate, or treated separately, from all the other accounts in
the ledger, and there must be only one account in then ledger for any one particular
person, organization or item.
4. Each ledger account is divided into two sides by a line – or by two close parallel
(although for purposes of this book, we one line) lines – drawn down the middle of it,
from top to bottom (see the specimen below).
5. The left-hand side of an account is called its debit side, and it records all values received
by the person, organisation or item named at the head of it.
6. The right-hand side of an account is called its credit side, and it records all values given
(or paid out by) the person, organisation or item named at its head.
In addition to a name or title, each account also has a number located to it; that number is
called a folio or an account number.

34
 A specimen ledger account
Debit side (receipt) CLARENDON HOTEL credit side (value given out)

19 –----- UGX 19------ UGX

May 2 purchases SB7 474.60 May 4 returns R1 3 14.00
8 purchases SB7 339.40 15 payment CB 43 800.00
12 purchases SB7 162.50 balance c/d 458.70
14 purchases SB7 296.20
1,272.20 1,272.20

16 balance b/d 458.70 27 returns R1 4 21.00

25 purchases SB7 113.10 31 balance c/d 551.10
572.10 572.10

June1 balance b/d 551.10

The transactions – or entries – are rarely recorded direct into the ledger account. Generally,
information is first recorded in one of the ‘subsidiary books’ or ‘day to day’ – which are
collectively often called ‘the books of original entry’. The information is then transferred –
or ‘posted’, as the process is called in bookkeeping – to the appropriate ledger accounts in a
summarized form. The most commonly used subsidiary books are the cashbook, the sales
book, the purchases book and the returns inwards and outwards book, which have all been
described in this Topic already.

Now let us turn to an examination of the specimen ledger account and note the meaning of
the following abbreviations used in the specimen account, and which will frequently be met
with in bookkeeping and accounting;-
c/f – this is the abbreviation for “carried forward” and means that the figure, total or balance
against which it appears has been transferred to another place, for example from the
bottom of one page to the top of another, or to one book or account to another.
b/f – this abbreviation stands for “brought forward” and means that the figure, total or
balance alongside which it appears was transferred from another place, e.g. to the top of
one page from the bottom of another, or to another book or account from another.
c/d – this is the abbreviation for “carried down” and indicates that the balance alongside
which it is written has been transferred to a lower position on the same page
b/d – this abbreviation stands for “brought down” and means that the balance against which it
is written has been transferred from a higher position on the same page.
bal – this is the common abbreviation for the word “balance”, which is the difference between
the total value of the debit entries in an account and the total value of the credit entries in
it.

35
 Balancing a ledger
After making the entry for the payment from Clarendon on the 15th, Mr. Trader needed to know
how much was still owed to his business by Clarendon. To obtain that information, he carried
out a process called balancing. What he did was first to add up the values of the entries on the
debit side of Clarendon’s account in the ledger; their total amount to UGX 1,272.70. He wrote
that total below the fourth entry – remember that fig. 1/1 shows an ‘historical record’, and that
on the 14th the other entries shows in the account had not yet been made.
Next, he added up the value of entries on the credit side of the account – their total, which was
UGX. 814, was deducted from UGX 1,272.70 to give the balance – the amount still owing by
Clarendon – of UGX 458.70. that amount was entered on the credit side, making the totals of
the entries on both sides equal, and so the total was entered on the credit side, on the same line
as the total of the debit entries; and both – equal – totals are neatly underlined, or ‘ruled off’ as
the process is called.
Finally, the balance was carried down from the credit side to the debit side, showing that
Clarendon had received an excess value of UGX 458.70 over what it had been given out.

Balancing is an easy process and can be carried out on any account at any time it is considered
necessary to do so. It is generally carried out on the account of all debtors and creditors at the
end of each month, and on each account at the end of a financial or trading year or other
accounting period and you will learn why that is done as you progress with your studies.
Before we proceed, it is important to look at the classification of accounts.

Classification of accounts
An account may be defined as a record of transactions of a particular type or with a particular
person usually expressed in financial terms and maintained in a ledger. Each page of a ledger is
given a heading or title and it is used to record transactions of a similar nature. For example, all
sales of goods are recorded on one page and it is known as sales account and so on.
In a ledger, we classify various accounts as under;
ACCOUNTS

IMPERSONAL ACCOUNTS PERSONAL ACCOUNTS

NOMINAL ACCOUNTS REAL ACCOUNTS

Adopted from: Saleemi (1982)

We explain these as under;

36
Personal accounts - These accounts contain the name of a business, person or firm. In a
ledger, there may be three types of personal accounts.
Capital account; this account records the transactions between the proprietor and
the business. Any amount invested or withdrawn by the proprietor is recorded in
this account.
Creditors’ account; the persons to whom money is owed by the business are called
creditors. The goods purchased on credit basis from suppliers create a liability of
the business. These amounts owing to creditors are recorded in their personal
accounts, which are opened separately for each creditor.
Debtors’ account; debtors are the persons owing money to the business. This
money is owed to the business against goods sold to the customers on credit basis.
A separate account is opened for each debtor.

Impersonal accounts – The accounts, which do not contain the name of any person or
business, are called impersonal accounts. They may be of two kinds;
Real accounts; these relate to tangible items. These are accounts always represent
something we can see, touch, or move. The accounts of assets like land and
buildings, plant and machinery, motor vehicles, furniture and fittings and cash are
real accounts.
Nominal accounts; these relate to tangible items. These accounts record
transactions for which we have nothing tangible to show; for example, purchases,
rent, sales, wages and salaries, electricity, printing and stationery and so on.

Accounts and the dual concept

The classification of accounts enables us to establish rules for making double entry (we saw
double entry principle in operation in Topic 4) in case of different transactions. When faced
with any transaction, the following three points must be considered.
1) What two accounts are affected?
2) What type of accounts are they?
3) Which account is to be debited and which one to be credited?
The following figure gives an idea of making double entry in case of different transactions.

ACCOUNTS

Nominal a/cs Real a/cs Personal a/cs

DR. Expenses DR. CR.

CR. Incomes The The
and losses and Gains receiver giver

DR. What CR. What

comes in. goes out

37
Adapted from: Saleemi (1982)

We divide all the many accounts, which jointly make up the ledger of a business, into these
three classes – Real accounts, personal accounts and nominal accounts.

General ledger
It is a ledger for all accounts in an organisation .In an organisation the general ledger will
contain accounts such as cash account, bank account, purchases account etc but on different
pages. It is important to note that the general ledger will not contain individual accounts for the
debtors and creditors. For example, the account for Mary as a debtor will not appear in the
general ledger but the debtors account will appear having information about all the debtors.

Subsidiary ledgers
Businesses have so many customers and suppliers therefore it is necessary to have each
individual debtor or creditors account separate to determine each one’s balance.
We call these individual accounts subsidiary ledgers because they support and general ledger
controls them.

Types of subsidiary ledgers

 Debtors subsidiary ledger
 Creditors subsidiary ledger
 Private ledger
 Cash book

Debtors’ subsidiary ledger

This is a summary of an individual debtor’s transaction. The general ledger shows information
concerning all the debtors but does not bring out the details about each individual debtor. The
subsidiary ledger brings out these details. For example, Mary who is a debtor will have
transactions concerning her alone summarized in Mary’s account.

Creditors’ subsidiary ledger

This is a summary of individual creditor’s transactions. The general ledger will show
information concerning all the creditors but will not details of each individual creditor. In the
creditors subsidiary ledger each creditor will have their account.

Private ledger
The private ledger columns contain accounts that the proprietors wish to keep secret from other
people .These accounts may include: capital A/C, drawings A/C, income A/C depending on the
organization etc

Posting transactions from the Journals to the Ledgers

The transfer of transactions from the journals to the ledgers is referred to as posting. The
transactions that appear in the debit column of the general journal will be posted to the debit
side of the respective ledger.
The transactions that appear in the credit column of the general journal will be posted on the
credit side of the respective ledger account.

38
Balancing off the ledger accounts (you may wish to refer to the specimen of ledger
account of Clarendon Hotel)

There, we noted that the ledger accounts are balanced off to determine the balance by the end
of the financial period. Balancing off the accounts involves the following stages:
i) Adding both sides of the account to determine the total for each side
ii) For example, the debit side of the account below adds up to 5,000,000 while the credit
side to 700,000
iii) Leave space after all the transactions have been posted for inserting in the end of period
balances.
iv) The Larger amount after adding both sides will become the total for both sides.
v) iv) Subtract the smaller total from the larger total (e.g. 5,000,000-700.000= 4,300,000)
vi) Enter the difference (4, 300,000) on the side with the smaller amount
and it is represented as balance carried down (bal c/d)
vii) Now both the debit and credit side will have the same total
viii) Double entry of the balances should be fulfilled by carrying down the balance to the
beginning of the next period.
ix) If the balance carried down is on the credit side of the account, then the balance
brought down will be on the debit side of the same account.

Normal Balances
Liabilities, capital and revenue accounts should have credit balances. Assets (apart from the
bank overdraft), expenses and drawings account should have a debit balance. If these accounts
have different balances from the normal, then the accounts were not properly prepared.

With this in mind, the ledger accounts for XYZ Ltd now appear as follows;

General ledgers for XYZ ltd

Cash A/C

Jan 1 Capital 2,000,000 Jan 3 Purchases 600, 000

7 Sales 300,000
20 Loan 80,000
31 Bal c/f 4,780,000
5,380,000 5,380,000
Feb 1 Bal b/f 4,780,000

Bank A/C

Jan 1 Capital 3,000,000 Jan 6 M.vehicle 1,500,000

31 Bal c/f 1,500,000
3,000,000 3,000,000
Feb1 Bal b/f 1,500,000

39
 Capital A/C

Jan 31 Bal c/f 3,000,000 Jan 1 Cash 2,000,000

1 Bank 3,000,000
5,000,000 5,000,000
Feb 1 Bal b/f 3,000,000

Purchases A/C

Jan 3 Cash 600,000 Jan 31 Bal c/f 1,400,000

15 Creditors (Tk) 500,000
29 Creditors (John) 300,000
1,400,000 1,400,000
Feb 1 Bal b/f 1,400,000

Motor vehicle A/C

Jan 6 bank 1,500,000 Jan 31 Bal c/f 1,500,000

1,500,000 1,500,000
Feb 1 Bal b/f 1,500,000

Debtors A/C

Jan 23 Sales 200,000 Jan 25 Cash 80,000

26 Sales 100,000 31 Bal c/d 220,000
300,000 300,000
Feb 1 Bal c/f 220,000

Creditors A/C

Jan 31 Bal c/f 800,000 Jan 15 Purchases 500,000

29 Purchases 300,000
800,000 800,000
Feb 1 Bal b/f 300,000

40
 Loan A/C

Jan 31 Bal c/f 3,000,000 Jan 20 Cash 3,000,000

3,000,000 3,000,000
Feb 1 Bal b/f 3,000,000

Sales A/C

Jan 31 Bal c/d 600,000 Jan 7 Cash 300,000

23 Debtor (Mary) 200,000
26 Debtor (Peter) 100,000
600,000 600,000
Feb 1 Bal b/f 600,000

XYZ subsidiary ledgers

Debtors’ subsidiary ledgers

The debtors for XYZ Ltd are Mary and Peter .We are going to have Mary and Peter
accounts separately.

Mary’s A/C

Jan 23 Sales 200,000 Jan 25 Cash 80,000

31 Bal c/f 120,000
200,000 200,000
Feb 1 Bal b/f 120,000

Peter’s A/C

Jan 26 Sales 100,000 Jan 31 Bal c/F 100,000

100,000 100,000
Feb 1 Bal b/f 100,000

41
 Note that the balance in the debtors’ account (220,000) should always be equal to the total
of all individual balances. In this example the total of individual balances (for Mary and
Peter is 120,000 + 100,000 = 220,000

Creditors’ subsidiary ledgers

The creditors for XYZ Ltd are John and TK ltd

TK Ltd A/C

Jan 31Bal c/f 500,000 Jan 15 Purchases 500,000

500,000
Feb 1 Bal b/f 500,000

Johns A/C

Jan 31 Bal c/f 300,000 Jan 29 Purchases 300,000

300,000 300,000
Feb 1 Bal b/f 300,000

Similarly, the balance in the creditors account in the General ledger (800,000) should always
be equal to the total of all individual creditors (i.e. of TK Ltd and John in this example)
(500,000+300,000 =800,000))

Exercise

Refer to journal of Kyeswa Ltd, post to the ledgers including the general ledger and
extract a trial balance

The trial balance always has to balance that is the debit side always has to be equal to the credit
side as shown in the XYZ ltd trial balance above.

Failure of the trial balance to agree implies that:

 Arithmetical errors may have been committed while balancing off the accounts
 The double entry rule was not properly observed .For example if goods were sold for
cash, the cash account has to be debited while the sales account credited. If the cash
account is debited but the sales account is not credited the trial balance will not agree
However the trial balance can agree when there still errors that have been committed. These
are referred to as errors that cannot be detected by the trial balance – trial balance will be
covered in details in the later chapters.

42
 Topic 5
The cashbook preparation

Learning objectives
By the end of the this topic, you will be able to;
To enter up and balance off a Cashbook under various columnar formats
To complete entries for discount allowed and discount received.
Write up and keep a petty cash book under imprest system.

Introduction
Cash and Cash transactions is an important and easy area to understand in accounting and
bookkeeping. Every business and indeed every person receives cash and makes payments.

All businesses and many people should keep records of all receipts and payments. It is
important to note that although cash is still used, most business receipts and payments are
made through the banking system.

Receipts and payments are recorded in a book called the cashbook. The cashbook therefore is
a book in which are recorded detailed particulars of all moneys received and paid. From the
beginning of the double entry bookkeeping, businesses have found that a very large number of
transactions consist of receiving and paying sums of money. Originally, these transactions
involved actual payment and receipt of cash. Hence the need to draw and keep a cashbook

In later times, while cash is still used, receipts and payments are also made by cheque through
a bank account. Other small and few cash transactions as do happen are recorded in the petty
cash book. Thus, a cashbook is now used to record bank transactions but it is still called the
cashbook.

Retail transactions for instance shops are still carried out using cash or more correctly a
mixture of cash and cheques. We still regard these as bank transactions as at the end of each
day the retailer will count the takings (Cash, cheques) and pay the lot into the bank.
Cash Book Types
Two cashbooks types are maintained by business firms i.e.
 Main cash book
 Petty cash book
Nevertheless, generally a cashbook is maintained in a columnar format particularly in a
manual accounting system. Thus a cashbook can be;
 Single column
 Two column
 Three column

Single Column Cash Book

This is a type of cashbook maintained where small business owners retain cash received for
use in the business and therefore the cash received is debited in the only cash column.
Moreover, where the money is paid out from cash, the entry is credited in the only cash
column.

43
This traditional type of cashbook is phasing out since almost every business owner operates an
account with the bank. Thus giving rise to a two-column cashbook.

Two Column Cash Book

This is the most commonly used format of the cashbook. It involves recording bank and cash
transactions.

Bank transactions are recorded in the bank column and cash transactions are recorded in the
cash column on Debit and Credit side respectively.

Three-Column Cashbook
Where a business entity frequently allows or receives cash discount, it is usually convenient to
use a three-column cashbook so as to include all the information relating to cash and balk
transactions in a single book. In this Topic emphasis is more on two and three column
cashbooks.

Drawing up a Cash Book

Already you have been told that in reality a cashbook is a ledger account, which for
convenience and also because of the multiplicity of the entries passing through it, it’s not
included in the ledger, but it’s bound as a separate volume.
It is important to note that cash transactions need not to be journalized because the cashbook
fulfils the functions both of a ledger account and book of “original entry” in which cash
transactions are recorded as they occur.

Now let us look at hypothetical example of how we design a cashbook. The example adopts a
two-column cashbook.

Date Details Cash Bank Date Details Cash Bank

2004
Oct 1 Bal b/f 10,000 2 Rent 1000
2 Cash sales 3300 10 Purchases 4000
3 Debtors 2500 11 Fuel 2000
9 Rent income 3000 19 Telephone 1500
30 Interest 20,000
Income 29 Payments
to 1200
suppliers
31 2800 26300
8800 30,000 Bal c/d 8800 30,000

Note the following: -

a) Receipts are on the left hand side and payments are on the right hand side of the
cashbook.
b) On the left side of the debit and of the credit side is the date for each transaction.
The cashbook is on going and may last for years, so this is very important
c) The receipts and payments could be by cash or by cheque

44
 The Bank column contains details of the payments made by cheque and of the money
received and paid into the bank account.
The bank will have a copy of the account in its own books. The bank will send a copy
of the account we know as the bank statement in its books to the firm or organization.
When the firm receives the bank statement, it will check it against the bank column in
its own cashbook to ensure that there are no errors.
d) As receipts are entered on the debit side of the cashbook, they are subsequently
posted to the credit side of the appropriate accounts in the ledger. Moreover, when
payments are entered on the credit side of the cashbook, they are subsequently
posted to the debit side of the appropriate ledger accounts. We do this to comply
with the principle of double entry.
The details column shows the entries against each item stating the name of the account
in which the completion of the double entry has taken place.

e) At the beginning of the period that is Oct 1 st 2004 the balance in the bank was
10,000 and this appears on the debit side.
At times, a firm may have both cash and bank balances. They should both appear on
the debit side of the cashbook at the beginning of the period. It is only on few occasions
that a cashbook will have Balance brought forward on the credit side in the bank
column. In addition, this is when a firm made an over draft in the previous period.

During the month, bankings were 20,000. The total in the bank would thus be 30,000 if
there had been no payments out. In fact, there were payments out of 3700. You can now
see that the balance left is 30,000 – 3700 = 26300. The custom is to put this on the
credit side with a description; Balance c/d (Carried down). The essence is to have both
debit and credit with 30,000. The procedure of finding and entering the balance at the
end is called balancing the account.
The procedure is the same for the cash column.
f) Finally, the closing balance forms the opening balance of the next period and it is
entered in the new period on the debit side.

Cash paid into the Bank

From our previous hypothetical example, the payments into the bank have been
cheques received by the firm that have been banked immediately. We must now
consider cash being paid into the bank.

A. Let us look at the position when a customer pays his account in cash, and later part
of this cash is paid into the bank. The receipt of the cash is debited to the cash column
on the date received, the credit entry being in the customer’s personal account. The
cash banked has the following effect needing action as shown.

Effect
1. Asset of cash is decreased
2. Asset of bank is increased.
Action
Credit asset account, that is the cash
account which is represented by the cash
column in the cash book
Debit the asset account, which is the bank
account, which is represented by the bank

45
 column in the cashbook.

For example, cash receipt of 10,000 from Kato on 3rd June 2004, later followed by the
banking on 5th June 2004 of 6000 of this amount. This would appear in the cashbook as
follows.

Cashbook
Date Details Cash Bank Date Details Cash Bank
2004 UGX UGX 2004 UGX UGX
June 3 Kato 10,000 June 5 Bank 6000
5 Cash 6000

The details column as we have said before shows entries against each item stating the name of
the account in which the completion of the double entry has taken place. Against the cash
payment of UGX 6000 appears the word “bank” meaning that the debit of UGX 6000 is to be
found in the bank column, and the opposite applies.

B. Where the whole of the cash received is banked immediately, the receipt can be
treated in exactly the same manner as a cheque received i.e. it can be entered directly in the
bank column.
C. If the firm requires cash, it may withdraw cash from the bank. This is done by making out a
cheque to pay itself certain amount in cash. The bank will give cash in exchange for the cheque
over the counter.
Here is the two-fold effect and the action required.

Effect
1. Asset of bank decreased
2. Asset of cash increased.
Action
Credit asset account, i.e. the bank column
in the cash book
Debit the asset account, ie the cash
column in the cashbook.

For example a firm made a withdraw from the bank on 4th August 2004 of UGX.75000/=.
In the cashbook, this transaction would appear as follows.

CASHBOOK
Date Details Cash Bank Date Details Cash Bank
2004 UGX UGX UGX UGX
August 4 Bank 75000 August 4 Cash 75000

Note: Both the debit and credit entries for this item are in the same book. When this happens
it is known as a contra item.

46
 The use of folio columns
As you have already seen, the details column in an account contains the name of the other
account in which double entry completed. Any one looking through the books would therefore
be able to find where the other half of the double entry was.

However, when many books are being used, just to mention the name of the other account
would not be enough information to find the other account quickly. More information is
needed, and this is given by using folio columns.
In each account and in each book being used, a folio column is added, always shown on the
left of the money columns.
In this column the name of the other book, in abbreviated form and the number of the page in
other book where double entry is completed is stated against each entry in the books.

An entry of receipt of cash from Kalisa whose account was on page 45 of the sales ledger and
the cash recorded on page 37 of the cashbook would use the folio column thus;
In the cashbook, the folio column would appear SL45.
In the sales ledger, the folio column would appear CB 37.

By this method full cross-reference would be given. Each of the contra items being shown on
the same page of the cashbook would use the letter “C” in the folio column.
The act of using one book as a means of entering the transaction to the other account so as to
complete double entry is known as “posting” the items.

Example 1
Enter the following transactions into a cashbook - Year 2005 , Month of Oct
Oct. 1. Kibonge started business with cash at bank amounting to UGX 940,000
2. Received a cheque from G.W Kato worth UGX 115000
4. Cash sales 102000
6. Paid rent by cash 3500
7. Banked 50,000 of the cash held by the firm
15. Cash sales paid direct into the bank 40,000
23. Paid by cheque to S. Forks 277000
29. Withdrew cash from bank for business use 120,000
30. Paid wages in cash 118000

CASHBOOK
Date Details Folio Cash Bank Date Details Folio Cash Bank
2005 UGX UGX 2005 UGX UGX
Oct 1 Capital GL1 940,000 Oct 6 Rent GL65 35000
“ 2 G.W. SL98 115000 Oct 7 Bank C 50,000
“ 4 Kato sales GL 102000 Oct 23 S. Forks PL23 277000
“ 7 Cash 87 50,000 Oct 29 Cash C 120,000
“ 15 Sales C 40,000 Oct 30 Wages GL39 118000
“ 29 Bank GL87 120,000
C Oct 30 Balances C/d 19000 748000

222000 1145000 222000 1145000

47
Nov Balances 19000 748000
1 B/d
The abbreviations used in the folio column are as follows: -
GL= General Ledger, SL = Sales Ledger, C = Contra, PL = Purchases Ledger

The folio column is not always an examination requirement and little emphasis is usually put
on this; but very important in practical writing up of books of accounts for any organisation
/firm.
Let us look at the comprehensive example

Exercise
The following balances were extracted from the books of O &M on 31/05/2005.
UGX
Cash 5000
Bank (credit balance) 3300
During the month of June 2005, the following transactions occurred.
June 1. Bought goods on credit for UGX 6500
2. Sold goods on credit for UGX 8000
4. Received a cheque from UGX 5000 from a debtor and banked it.
7. Paid creditors UGX 1500 cash and UGX 500 by cheque
10. Rejected and returned goods worth UGX 300 to a creditor
12 A debtor rejected and returned goods worth 100/=
14. Banked UGX 1500 cash
16. Paid rent UGX 400 cash and UGX 800 by cheque and electricity UGX 250 cash
20. Withdrew UGX 1000 from the bank and put it in the cash box for payment of
Cash expenses.
22. Paid UGX 2000 by cheque for retirement loan
25. Sold land inherited = from father for UGX 10,000 cash and the rest he put into
the business
27. Received cash of UGX 100 and cheque of UGX 2000 from a debtor and banked
both cash and cheque.
30. Used business cash UGX 300 for a social evening with his friend at a club
Required
Prepare O&M’s Cash Book for June 2005 properly balanced off as at 30 /6 2005.

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 Topic 6
Preparing bank reconciliation statements

Learning objectives
By the end of this topic, you will be able to;
Amend the cash book for any errors or omissions
Prepare a statement reconciling the amended cash book balance with the bank statement

Introduction
The cashbook records all transactions with the bank. The bank statement records all the bank’s
transactions with the business. A moment’s thought will suggest that the contents of the
cashbook are the same as the record provided by the bank in the form of a bank statement, and
therefore our records should correspond with the bank statement. This is in fact so, but with
two important provisos;
The ledger account maintained by the bank is the opposite way round to the cashbook.
This is because the bank records the balance in favor of an individual as a credit
balance that is a liability of the bank to the individual. From the individual’s point of
view, it is, of course, an asset, that is a debit balance in his cash book (or bank control
account in the general ledger)
Timing differences must inevitably occur. A cheque payment is recorded in the
cashbook when the cheque is dispatched. The bank only records such a cheque when it
is paid by the bank, which may be several days later.

The existence of the bank statement provides an important check on the most vulnerable of a
company’s assets – cash. However, the timing differences referred to above make it essential to
reconcile the balance on the ledger account with that of the bank statement. This reconciliation
takes the form of a bank reconciliation statement.

In this topic the relationship between the balance in the cashbook (or cash account), and the
balance on the bank statement will be considered. The likely reasons for any differences will
be investigated and a statement reconciling the two balances prepared.

Bank reconciliation is the process of bringing cashbook and bank statement balances into
agreement by adjusting an account balance reported by a bank to reflect transactions that have
occurred since the reporting date.

The process by which you compare the information in the company's records with the
statements provided each month by the bank for the bank account and deal with the difference
so that the bank's records and the company's records balance.

Banks furnish a depositor with a bank statement once each month. Included with the statement
are usually the canceled cheques and any debit or credit memos that have affected the amount.
During any month, besides the cheques drawn, the bank may deduct from the account amounts
for service charges, returned cheques and for errors. The bank notifies the depositor of each
deduction with a debit memo. The bank may also add amounts to the depositor's account for

49
errors and interest. A credit memo is used to notify of any additions. A copy of each
memorandum should be included with the monthly statement.
Entries on the customer’s bank account in the bank
When a cheque or cash is deposited, the customer account will be credited in the bank. When
the customer withdraws cash or when payments are made out of the customer’s account, the
account is debited.
Entries in the customer’s cashbook (bank column)
The bank column of the cashbook shows the transactions of the customer with its bankers. A
customer who deposits money debits his cashbook and when a withdrawal is made, the
cashbook is credited.
Agreement of the cash and bank balances
When all receipts are deposited intact and all payments are made by check, the bank statement
becomes a device for proving the cash in bank account. The proof normally begins with the
preparation of a reconciliation of the bank balance. To simplify this process, request the cutoff
date of the bank statement to be the last working day of the month. Thus, if all credits in the
bank were also debited to the cashbook and all debits in the bank were credited in the cashbook
and vice-versa, the two balances would agree and there would be no need of bank
reconciliation. However, this is not always the case. The balance as per bank statement rarely
agrees with the balance as per cashbook and thus the need to prepare a bank reconciliation
statement.
Numerous things may cause the bank statement balance to differ from the cash balance
in the general ledger
i) Outstanding Checks/ Unpresented cheques:
These are checks that have been written and are listed on the cash disbursement
journal but have not cleared through the bank. They are drawn and credited in
the cashbook but not presented to the bank for payment. These cheques are not
debited to the bank statement.
ii) Unrecorded Deposits/ Uncredited cheques (also called Deposits in Transit):
Often deposits are made on the day following the last day of the month;
consequently, these deposits do not appear on the bank statement for that month
but they appear on the cash receipts journal. Deposited to the bank and debited
to the cashbook but not credited by the bank.
iii) Direct debits, Charges for Services and Non-Collectable Items:
A bank often deducts amounts from a depositor's account for services rendered and
for returned checks. The bank notifies you of each deduction with a debit memo.
These deductions should be recorded as soon as they are received. They are debits
in the bank statement not credited to the cashbook and payments effected by the
bank without requiring a cheque to be issued by the account holder. Since cheques
are not issued for such payments, they are not recorded in the cashbook yet debited
in the bank statement. They include the following.
Bank charges,
The bank, for services offered to the account holder, levies these charges; they
include ledger fees, commission and many others.

50
 Standing orders (SO)
These are arrangements where the account holder instructs the bank to make certain
routine and fixed type of payments directly to the payees on behalf of the account
holder. The account holder does not issue cheques for these types of payments.
Such transactions include; insurance premiums, paying utility organizations such as
water bills and telephone charges. Others include paying interest and amortizing
fixed installment loans.
If the deduction occurs close to the end of the month, it may not show on the bank
statement.
iv) Direct credits and Interest earned: (credits in the bank statement not debited to
the cashbook)
These are receipts that are directly credited to the bank statement without having
been debited to the cashbook. For instance, some debtors may clear their
indebtedness by paying directly to the payee’s bank account and some accounts
earn interest that is posted to the account by the bank at the end of the month
making the bank statement the only notification.

Credit advice notes (credit memo) and debit advice notes

A credit advice note (credit memo) and a direct debit note for direct credits and direct
debits are sent to the account holder and may not be included in the cashbook.
v) Clerical errors
Errors made in recording amounts or wrong postings in the cashbook or bank statement
make the cashbook and bank statement balances disagree. Regardless of care and systems
of internal control, both the bank and the depositor may make errors that affect a bank
balance. These errors are not discovered until the balance is reconciled.
vi) Dishonoured cheques
When a bank refuses to pay or recognize a cheque as an instrument for transferring money
from one person to another, such a cheque is a dishonoured cheque.

Why are cheques dishonoured?

 Lack of sufficient funds on the account
 Amount in words differing from amount in figures
 Drawer’s signature differing from specimen signatures held by the bank
 Expired cheques (cheques get stale or expire six months from the date on the
cheque).
 Alterations on the cheque not counter signed.
 If there is no account title on the cheque
 Where drawer’s confirmation is required by contract and cheques are not
confirmed.
 When the payee’s identity is doubted
 For some cheques, if payment vouchers are required and are not presented

51
Steps to follow reconciling account balances:
STEP ONE: Compare the deposits listed on the bank statement with deposits recorded in
the cheque register and the cash receipts journal. Identify any
differences and determine which is correct. List the deposits in transit
for each account on the reconciliation form.
STEP TWO: Compare the canceled checks listed on each bank statement. Note any
discrepancies. Review the previous month's reconciliation and check off
the cheques that cleared during the current month that were outstanding
last month. List any checks that are still outstanding. Verify all deposits
in transit that were listed last month to assure that they have been
recorded by the bank on the current statement.
STEP THREE: Compare each of the cheques with its entry in the cash disbursement
journal. Identify any corrections or discrepancies. List any outstanding
checks on the reconciliation form.
STEP FOUR: Determine if any debits or credits appearing on the bank statement need to
be recorded in the cheque register. Make general journal entries to record
them. Any corrections to deposits or cheques noted should be made by
general journal entries. Do not go back and change the cash disbursement
or cash receipts journals. Changes to those records must be made in the
following month through general journal entries. The purpose of
reconciling the bank statement is to verify balances per your chequebook
and to resolve discrepancies. If discrepancies or bank errors are found,
notify the bank immediately.
STEP FIVE: Compare each of the cheques with its entry in the cash disbursement journal.
Identify any corrections or discrepancies. List any outstanding checks on
the reconciliation form. Determine if any debits or credits appearing on
the bank statement need to be recorded in the cheque register. Make
general journal entries to record them. Any corrections to deposits or
cheques noted should be made by general journal entries. Do not go back
and change the cash disbursement or cash receipts journals. Changes to
those records must be made in the following month through general
journal entries. The purpose of reconciling the bank statement is to verify
balances per your chequebook and to resolve discrepancies. If
discrepancies or bank errors are found, notify the bank immediately.
Bank statement
This is a summary of transactions between the account holder and the bank. The transactions
include deposit and withdrawals to and from the account respectively. The bank statement also
shows the running balance after every transaction. Banks prepare bank statements for their
account holders at the end of each month or any time on request.

Relevance of Bank reconciliation

Bank reconciliation strengthens an organizations internal control system through detection
and prevention of fraud. When bank transactions are involved, manipulations in
the cashbook can be discovered.
It enhances accuracy of records.

52
 A mistake in either the cashbook or the bank statement can be discovered and
corrected during the process of bank reconciliation.

Methods of bank reconciliation

There are three major methods of bank reconciliation

i) You can begin with the cashbook balance, adjusting, updating or correcting the
cashbook and then preparing a bank reconciliation statement. The aim of this
method is to arrive at the bank statement balance.
ii) Beginning with the bank statement balance and working towards the cashbook
balance.
iii) Adjusting the cashbook balance and adjusting the bank statement balance. The aim
is to show whether the two adjusted balances agree.
As are a number of methods or ways by which a bank reconciliation can be prepared the
method adopted by this book is that prepare an adjusted cashbook (Bringing the cash book up
to date) and then proceeding to prepare a reconciliation statement.

A Simple illustration:
Mr. Bukenya runs a current account with Nile Bank. He has received a bank statement showing
his transactions with the bank in the month of December 2004 as follows.
M. Bukenya
Bank statement for the month of Dec. 2004
Date Particulars Dr. (UGX) Cr. (UGX) Balance (UGX)
1/12/2004 Balance B/f 1,600,000
Chq. No. 202 8,000,000√ 9,600,000
Chq. No. 1002 1,000,000√ 8,600,000
Chq. No. 204 500√ 9,100,000
Chq. No. 1003 2,000,000√ 7,100,000
Salary deposit 1,700,000 8,800,000
S.O-MTN (Airtime) 100,000 8,700,000
Bank charges 200,000 8,500,000

The following is an extract of his cashbook.

M. Bukenya’s Cashbook
Date Particulars Debit (UGX) Date Particulars Credit (UGX)
1/12/04 Balance b/f 1,600,000 Chq. No. 1001 500,000
Chq. No. 201 1,000,000 Chq. No. 1002 1,000,000√
Chq. No. 202 8,000,000√ Chq. No. 1003 2,000,000√
Chq. No. 203 4,500,000 Chq. No. 1004 2,500,000
Chq. No. 204 500,000√ Bal c/f 9,600,000
Total 15,600,000 Total 15,600,000

Note: Ignore Dates

Required: Reconcile the bank statement and cashbook balances

53
Solution
Step 1: Check off all the transactions that appear both in the cashbook and bank
statement with right amount on the right sides. (See items with the
symbol (√) in the question above).
Step 2: Prepare an adjusted cashbook as follows

M. Bukenya’s adjusted Cashbook

Date Particulars Debit (UGX) Date Particulars Credit (UGX)
1/1/05 Balance b/f 9,600,000 D. Dr. S.O-MTN (Airtime) 100,000
D. Cr. Salary 1,700,000 D. Dr. Bank charges 200,000
Bal c/f 11,000,000
Total 15,600,000 Total 15,600,000

Step 3: Prepare a bank reconciliation statement as follows

M. Bukenya’s Bank reconciliation statement

Illustration Balance as per adjusted cashbook 11,000,000

Two
Using the Add: Unpresented cheques
following Chq. No. 1001 500,000
information,
Chq. No. 1004 2,500,000 3,000,000
prepare a
bank 14,000,000
reconciliation Less: Uncredited cheques
statement for Chq No. 201 1,000,000
Goodshed Ltd Chq No. 203 4,500,000 (5,500,000)
for the month Balance as per bank statement 8,500,000
of august.
Extracts form Goodshed Ltd’s Bank reconciliation statement for the previous month
Bank charge 200,000
Commission 100,000
Uncredited cheques
Cheque No. 004 1,000,000
Cheque No. 623 4,500,000

Unpresented cheques
Cheque No. 10 500,000
Cheque No. 12 2,500,000

Cashbook error: cheque No. 14 1,700,000

Goodshed
Cashbook for the month of Aug. 2004
Dr. ((UGX)) Cr. (UGX)
Bal b/f 9,600,000 Cheque No. 20 800,000

54
Cheque No. 2515 1,000,000 Cheque No. 21 1,200,000
Cheque No. 1119 500,000 Cheque No. 22 2,000,000
Cheque No. 990 3,000,000 Cheque No. 23 600,000
Cheque No. 224 2,400,000 Cheque No. 24 200,000
Cash 900,000 Cheque No. 26 1,400,000
Cheque No. 414 1,800,000 Cheque No. 27 2,400,000
Cheque No. 666 700,000 Cheque No. 28 700,000
Cash 1,300,000 Cheque No. 30 1,800,000
Cheque No. 804 2,100,000 S.O-Insurance 900,000
Cheque No. 707 3,400,000
Cheque No. 31 1,300,000
C.M Peter 900,000 Bal. C/f 16,900,000
Total 28,900,000 Total 28,900,000

Goodshed
Bank statement for the month of august 2004

55
Additional information;
i) Any mistake in amounts was made in the cashbooks by an inexperienced
Dr. (UGX) Cr. (UGX) Balance (UGX)
Bal b/f 8,500,000
Cheque No. 22 2,000,000 6,500,000
24 200,000 6,300,000
623 4,500,000 10,800,000
990 3,000,000 13,800,000
C.M –Peter 900,000 14,700,000
Cheque No. 21 2,100,000 12,600,000
12 2,500,000 10,100,000
20 800,000 9,300,000
2515 1,000,000 10,300,000
1119 500,000 10,800,000
S.O –Insurance 900,000 9,900,000
Cheque No. 224 4,200,000 14,100,000
Cash 900,000 15,000,000
Cheque No. 26 1,400,000 13,600,000
27 2,400,000 11,200,000
6001 5,000,000 16,200,000
414 1,800,000 18,000,000
804 2,100,000 15,900,000
31 3,100,000 12,800,000
C.M –John 1,300,000 14,100,000
Cheque No. 28 700,000 13,400,000
Ledger fee 50,000 13,350,000
Dividend 1,500,000 14,850,000
bookkeeper.
ii) Cheque No. 31 and 804 were entered on the wrong sides of the cashbook and bank
statement respectively.

Solution
Goodshed
Adjusted cashbook
(UGX. 000) (UGX. 000)
Bal b/f 16,900 July 2004 D. Debits
Error on cheque No 224 1,800 Bank charge 200
Cheque No 6001(D. Credit.) 5,000 Commission 100
C.M (John) 1,300 Aug 2004 D. Debits
Dividend 1,500 Ledger fee 50
Error on cheque No14 1,700 Error on cheque No. 21 900
Error on cheque No. 31 4,400
Bal. C/f 22,550
Total 28,200 Total 28,200

56
 Goodshed bank reconciliation statement
(UGX. 000) (UGX. 000) (UGX. 000)
Balance as per adjusted cashbook 22,550
Add: Unpresented Cheques
Cheque No. 10 500
Cheque No. 23 600
Cheque No. 30 1,800 2,900
Less: Uncredited cheques 25,450
Cheque No.004 1,000
Cheque No. 666 700
Cheque No. 707 3,400 5,100
Uncredited cash 1,300
Bank error; Cheque No. 804 4,200 10,600
Balance as per bank statement 14,850

Exercise
The following information relates to the transactions of BRITT Ltd and its bankers for the
month of January 2005.
CASHBOOK
Details Dr. UGX (Millions) Details Cr. UGX (Millions)

Balance b/d 1300 Chq No. 400 150

Chq No. 650 2000 Chq No. 444 5000
Chq No. 256 1750 Chq No. 455 1000
Chq No. 181 3000 Chq No. 477 3700
Cash 3500 Chq No. 488 1700
Chq No. 555 4100 Chq No. 500 1100
Chq No. 284 550 Chq No. 511 1950
Chq No. 922 1650 Chq No. 544 600
Cash 2000 Chq No. 588 2800
Chq No. 805 7200 Chq No. 600 1900
Chq No. 695 6850 Chq No. 774 3900
Chq No. 885 3650 Balance c/d 13750
Total 37550 Total 37550

BANK STATEMENT

57
 Particulars Dr. (Millions) Cr. (Millions) Bal. (Millions)

Balance b/f 1300

Chq No. 411 100 1400
Chq No. 922 1650 (250)
Cash 2000 (2250)
Chq No. 477 37000 34750
Chq No. 511 1950 36700
Chq No. 495 4000 32700
Chq No. 905 4500 28200
Chq No. 544 600 28800
Chq No. 588 2800 31600
Minority interest dividends 400 32000
Cash 2500 29500
Chq No. 444 500 30000
Chq No. 455 1000 31000
Chq No. 181 300 30700
Cash 3500 27200
Chq No. 379 1800 25400
Chq No. 488 1700 27100
Chq No. 500 1100 28200
Chq No. 805 2700 25500
Chq No. 774 3900 21600
Chq No. 695 6850 14750
Bank charges 1000 13750
S.O-Interest 200 13550

Errors on cheques numbered 805 and 181 were made in the bank but any other errors are
cashbook errors, while the bank dishonoured chq No. 650.
Required:
Reconcile the cashbook and bank statement balances and determine whether there was any
fraud/undiscovered error and by how much?

Exercise 2
On 30/6/2004, the bank statement of MUBS Guild showed the bank account to have to have a
debit balance of UGX 715,400,000. However, on the same date, the cashbook
showed the bank account to have an overdraft of UGX 1,195,900,000.
A check of the bank statement against the cashbook revealed the following:
i) Cheques totaling UGX 3,168,400,000 paid to creditors had not been presented to the
bank for payment.
ii) An amount of UGX 150 Millions paid as contribution to assist the Tsunami Victims
was recorded as UGX 15 Millions.
iii) Cheques amounting to 2,574,500,000 Shillings banked in the month did not appear
on the bank statement.
iv) Bank charges of 13,750,000 Shillings had been recorded in the cashbook as
17,350,000.

58
 v) A cheque of 35 Million Shillings for drawing had been recorded as 53 million in the
cashbook.
Required:
a) Adjust MUBS Guild cashbook.
b) Reconcile the adjusted cashbook balance with the bank balance.
c) State four major reasons why the cashbook balance most often differs from the bank
statement balance as at any date.
d) There is normally no serious need for preparation of a bank reconciliation statement
Discuss.

59
 Topic 8
Accounting cycle and Year - end Adjustments

Learning objectives
By the end of this topic, you will be able to;
Demonstrate the accounting cycle
Explain the types and nature of the adjustments required in order to prepare financial
statements
Prepare schedules of end-of year adjustments.

Introduction
Regardless of the type of business or the accounting system used, it is not possible to keep all
accounts up to date at all times. At the end of each financial (accounting) year, certain accounts
must be updated by adjusting entries, to reflect the status of the organization and financial
statements can then be prepared.

The accounting cycle

After examining documents, journals, ledgers and the trial balance, we establish a sequence
known as the accounting cycle. The accounting cycle refers to the sequence in which data is
recorded and processed until the financial statements are extracted.

The accounting cycle has the following stages:

i. Occurrence and documentation When transaction has occurred, the relevant
documents are prepared. These include invoices, receipts; good received notes,
payment vouchers, delivery notes, local purchase order etc
ii. Journalizing of the transactions Information from documents is recorded in the
journals. Journals are also referred to as the books of original entry. Examples of
journals are the general journal, sales daybook, purchases daybook etc
iii. Posting the transactions from the journals to the ledgers
Then we record the business transactions in the respective ledger accounts. Post the
information from the journals to the ledgers. Ledgers include; general ledgers and
subsidiary ledgers. Ledgers are books in which transactions concerning a particular
account are summarized. Balance off the ledger accounts are at the end of the
accounting period.
iv. Preparation of the trial balance
Extract from the ledger balances, the trial balance. The trial balance is a list of debit
and credit balances extracted from the ledgers. If the double entry rule is not complied
with, the totals of the debit and credit columns will be not equal
v. Adjustments of accounts
Adjustment of some accounts is need before the preparation of the financial statements.
The major adjustments include provision for bad debts, provision for depreciation,
incomes and expenses. You make these adjustments in the work sheet. After
incorporating the adjustments in the trial balance, the financial statements are prepared.
vi. Preparing the financial statements
Financial statements are the outputs of recording organization transactions. The
financial statements include the Income statement, Balance sheet, and Cash-flow

60
 statement, Statement of changes in equity and Notes to the financial statements.
Nominal accounts shown in the trial balance are taken to the income statement. Net
profit is added to the capital figure brought forward and any drawings are deducted to
find the adjusted capital figure. These adjustments take place in the balance sheet. The
remaining balances in the trial balance are taken to the balance sheet.

Year – end adjustments

Why is the adjustment necessary?

Profit for the period
The profit or loss of a business is calculated by deducting the expenses incurred within a
defined period from the income earned within that same period. The accountant is concerned
with income earned and expenditure incurred during the period and not the receipts and
payments actually made.

The matching concept

The adjustments for accruals and prepayments are the result of applying the matching
principle. You should recall that this states that cash received and cash paid should be adjusted
for any part period that does not relate to the overall period in question.

Accruals and Prepayments:

When the income statement is being prepared for a specific period, we must bring into
account:
a) All expenses relating to that period whether we have actually paid them or not.
b) All items of income and gains whether we have actually received them or not.

For this purpose, some adjustments are needed at the end of the accounting period relating to:

i) Accrued expenses – These are expenses, which are outstanding and have not yet been paid.
In order to ensure that the full expenses of the period have been included in the income
statement, the accountant must ensure that the expense accounts include not only those items
that have been paid for during the period but any outstanding amounts due for expenses.
Accrued expenses appear as current liabilities in the balance sheet.

The accounting entry is as follows;

Dr. Income statement or respective expense account
Cr. Accrued expense account
Illustration;
Salaries and wages paid during the year amounted to UGX 6,200,000=. Accrued wages as at
31st Dec. amounted to UGX 250,000=. Show the entries

Dr. Salaries and wages 250,000

Cr. Accrued Salaries and wages 250,000

61
 Income statement (extract) Balance sheet (extract)
Salaries and wages: Current liabilities:
Paid: 6,200,000 Accrued salaries and wages: 250,000
Add: accrued 250,000 6,450,000

ii) Prepaid expenses – These are expenses, which have already been paid but relate to the
following accounting period or the normal operating cycle. As well as ensuring that all of the
expenses incurred in the period appear in the income statement, the accountant must also
ensure that items of expense that relate to future periods, but have already been paid for, are
separated. Prepaid expenses appear as current assets in the balance sheet.

Accounting entry is as follows;

Dr. Prepayments account.
Cr. Income statement or respective expense account

Illustration
Insurance paid during the year amounted to UGX.380, 000 of which UGX.120, 000 was
prepaid as at 31/12. Show the entries as are necessary to bring this sum into account.

Dr. Prepayments account 120,000

Cr. Income statement or respective expense account 120,000

Income statement (extract) Balance sheet (extract)

Insurance: Current assets:
Paid: 380,000 Prepaid insurance: 120,000
Less: Prepaid 120,000 260,000

iii) Accrued income – This is income relating to the current accounting period or operating
cycle but has not yet been received. Accrued income is presented as a current asset in the
balance sheet.

Accounting entry is as follows;

Dr. Accrued income account
Cr. Income statement or respective income/gain account

Illustration
Rent received during the year amounted to UGX.650, 000. Accrued or owed rent as at 31/12
amounted to UGX.70, 000. Show the entries as are necessary to bring this sum into account.

Income statement (extract) Balance sheet (extract)

Rent receivable: Current assets:
Received: 650,000 accrued rent/rental income: 70,000
Add: Accrued 70,000
720,000

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iv) Income in advance / prepaid income – This is income which has already been received but
relates to the following accounting period or operating cycle. Prepaid income is treated as
current liabilities in the balance sheet.

Accounting entries is as follows;

Dr. Income statement/ respective income account

Cr. Income in advance/ prepaid income account

Illustration
Rent received during the year amounted to UGX.800, 000 of which UGX.80, 000 was received
in advance as at 31/12. Show the entries as are necessary to bring this sum into account.

Income statement (extract) Balance sheet (extract)

Rent receivable: Current liabilities:
Cash/Bank: 800, 0000 rent in advance: 80,000
Less: Rent in advance 80,000
720,000

Reserves
These are those amounts, which are set aside out of profits to retain assets in the business. The
motive may be to strengthen the financial position of the business. The Amounts transferred to
reserves are treated as under.

Accounting entry is as follows;

Dr. Income statement account

Cr. Reserves account

More specifically, however, these amounts are shown as appropriations within equity as shown
in the statement of changes in equity.

Provisions
Are those amounts which are set aside of profits for a specific purpose. For example;
a) Provision for bad debts,
b) Provisions for discounts allowed or received
c) Provisions for depreciation, etc.

These provisions are made in view of some expected events. Any expected future loss relating
to the current accounting period must be charged to the income statement of the current year.

Bad debts and provision for doubtful debts

Bad debts: Debts due from debtors are shown as an asset. When a debt becomes irrecoverable,
it must be written off as bad debt; otherwise, the balance sheet will not show a true and fair
view of receivables/debtors. Actually if a debt is considered uncollectible then it would be

63
prudent to remove it totally from the accounts and to charge the amount as an expense to the
income statement. The original sale remains in the books as this did actually take place. The
debt is however removed as it is now considered that the debt will never be paid and an
expense is charged to the income statement. This bad debt is regarded as a loss to the business.

We treat this as under:

Dr. Bad debts written off account
Cr. The Receivables/debtors account.

At the end of the year:

Dr. Income statement
Cr. Bad debts written off account
These entries effectively close the Bad debts written off account, create a charge to the income
statement and the Receivables/debtors restated to a recoverable figure (net).

Illustration
As at 31/12, UGX.200, 000 owing from P Bush was written off as bad debt. Show the
necessary entries in the ledger accounts.

P Bush
Dec 31 Bal b/f 200,000 31-Dec
B/debts W/O 200,000
200,000 200,000

Bad debts written off account

De 31 P Bush 200,000 31-Dec
Income statement 200,000
200,000 200,000

Bad debts recovered: Bad debts written off in the previous accounting periods may be
recovered at a later stage in some cases. In other words there is a possible situation where debt
is written off as bad in one accounting period, perhaps because the debtor has been declared
bankrupt, and the money, or part of the money, due is then unexpectedly received in a
subsequent accounting period. These recovered bad debts are regarded as gain and are treated
as under:
Step 1 Reinstate the debtor:
Dr. Receivables/debtors
Cr. Bad debts recovered

Step2 Record the receipt of cash or cheque:

Dr. Bank
Cr. Receivable/debtors
Note that this is the usual entry for cash received from a customer.

This double entry may be simplified to:

Dr. Cash account

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 Cr. Bad debts recovered account
As the debit entry and credit to the receivables account cancels out each other. However, it may
be useful to pass the transaction through the customer’s account so that the fact that the debt
was eventually paid, or partly paid, is recorded there.

Step 3
Dr. Bad debts recovered account
Cr. Income statement
This last entry effectively closes the Bad debts recovered account and recognizes income in the
income statement.

Note: In examinations, it is possible to circumvent the above steps by simply:

Dr. Bank/cash
Cr Income statement
As these will be the only accounts whose balances will be affected.

Provision for bad and doubtful debts: It is a matter of common experience that some part of
debts outstanding at the last date of the accounting period becomes irrecoverable later. In other
words, a doubtful debt is one about which there is some cause for concern but which is not yet
definitely irrecoverable. Therefore, although it is prudent immediately to recognize the
possible expense of not collecting the debt in the income statement, it would also be wise to
keep the original debt in the accounts in case the debtor does in fact pay up. This is achieved as
below.

The anticipated loss must be also taken into account for the computation of correct amount of
net profit. For this purpose, a provision for bad and doubtful is created and it is charged to the
income statement. This provision is credited to the provision for bad debts account and is
shown as a deduction from Total receivables/debtors in the balance sheet. The provision for
Bad debts may be computed in the following two ways.
i. Anticipated bad debts may be added up to a total figure for the provision for bad debts.
ii. A specific percentage of total receivables/debtors may be computed to get the provision
figure. This percentage depends upon debts not recovered in the previous periods and it
will be different for different firms.

The provision for bad debts is adjusted at the end of every year according to the total amount
owing from debtors. The creation of a provision for bad debts does not affect the personal
accounts of the debtors, since these debts have not yet become irrecoverable. The following
entries are made in this case:
Provision for bad debts:
(i) On creation;
Dr. Bad and doubtful debts expense
Cr Provision for bad debts account
(ii) To Increase:
Dr. Income statement (with increase)
Cr. Provision for bad debts account
(iii) To decrease:
Dr. Provision for bad debts account

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 Cr. Income statement (with the decrease)

Provision for discount allowed.

(i) On creation;
Dr. Income statement
Cr. Provision for discount allowed account.
(ii) To Increase:
Dr. Income statement (with increase)
Cr. Provision for discount allowed account
(iii) To decrease:
Dr. Provision for discount allowed account
Cr. Income statement (with the decrease)

Provision for Discount received:

(j) On creation;
Dr. Provision for discount received account
Cr. Income statement
(ii) To Increase:
Dr. Provision for discount received account)
Cr. Income statement (with the increase)
(iii) To decrease:
Dr. Income statement (with decrease)
Cr. Provision for discount received account.
The balance on the provision for discount received account is shown as a deduction from
creditors in the balance sheet

Depreciation:
All Tangible non-current assets except land depreciate. Depreciation is defined as the
allocation of cost of the depreciable amount of a tangible non-current asset to the years in
which benefit is expected from the use of that asset. (‘Depreciable amount’ means book value
less residual value). IAS 16: Property, plant and equipment; requires the depreciation method
used to reflect the pattern in the asset’s economic benefits are consumed by the enterprise.
(Depreciation accounting will be dealt with later in the text).

At the end of the year, depreciation must be provided on Tangible non-current assets. Here;
Dr. Depreciation expense account
Cr. Accumulated/provision for/aggregate depreciation account

At the end of the operating cycle/financial year,

Dr. Income statement (with the depreciation expense)
Cr. The asset account (with the aggregate depreciation)

Note: This entry is necessary as far as it is necessary to comply with the requirements of IAS
16: Tangible non-current assets to show the net book value of the asset in question.

Corporation tax:

66
If draft accounts of the business suggest that net profit is earned, a provision must be made for
corporation tax to be paid. Taxation is real. A provision for corporation tax therefore becomes
a liability in the balance sheet because it satisfies the definition of a liability; a present
obligation arising from past events, the settlement of which is expected to result in an outflow
of resources from the enterprise.
Thus the accounting entry required is:
Dr. Income statement (with the provision for corporation tax)
Cr. Corporation tax payable

Proposed Dividends:
Dividends are a reward to Shareholders. If profits are made, some of it must be appropriated to
shareholders as dividends. Where dividends have been proposed after the balance sheet date,
then only disclosure as a note to financial statements is required. This is only necessary to
comply with IAS 10: Events after the balance sheet. However, where the dividends are
proposed before the balance sheet date, then an obligation exists at the balance sheet date and a
provision that becomes a liability as per IAS 37 is required.
Thus;
Dr. Income statement Appropriation account (proposed dividend)
Cr. Dividends payable (Balance sheet item)

67
 Topic 9
Preparation of financial statements

Learning objectives
By the end of this topic, you will be able to;
Prepare a worksheet Including the adjustment of a trial balance
Draw up a set of financial statements from a trial balance plus additional information.
Incorporate the adjustments learnt from the previous topic

Introduction
The financial condition and the results of operations of business enterprises are of a major
interest to many groups including owners, managers, creditors, government agencies
particularly the tax body, employees and prospective owners and creditors. The financial
statements are the outputs of an accounting system. The principal financial statements,
together with supplementary statements and schedules, present much of the needed basic
information to make sound economic decisions regarding business enterprises.

In the previous tpics, the main areas of double entry bookkeeping that resulted in the trial
balance have been covered. Together with this, we looked at the most frequent end of year
adjustments. This Topic will bring together an assimilation of all such information and a
full set (except for cash-flow statements) of financial statements prepared

A complete set of financial statements includes the following components:

 Balance sheet
 Income statement
 A statement showing either:
o All changes in equity, or
o Changes in equity other than those arising from capital transactions with
owners and distributions to owners.
 Cash flow statement
 Accounting policies and explanatory notes.

As mentioned earlier, we shall restrict our selves to the income statement, Statement of
changes in equity and the balance sheet for purposes of this paper. The other ones we shall
come to later in the course.

INCOME STATEMENT
This statement discloses the financial performance of the enterprise during a given
year/operating cycle. That is whether the operations of the enterprise resulted in a profit or
loss. It is therefore a profitability statement that shows an organization’s revenues and
expenditures or costs in a particular period ended. This statement is normally prepared before
the balance sheet because the ending figure after subtracting expenditures from incomes (net or
retained profits/loss) connects the income statement and balance sheet.

Initially it is critical to appreciate that the income statement is part of the double entry book
keeping system, whereas the balance sheet is not.

68
 It is easy to be put off by the fact that the income statement is set out in vertical form,
whereas other ledger accounts are set out in ‘T’ account form. However, you must
remember that, although not presented as such, the income statement is a ‘T’ account
and the double entry principles apply therein as with any other such account. However
presented, the income statement is simply another ‘T’ account or ledger account.

The income statement takes the following format.

XYX Income statement for the year ended_________
Sales revenue xxxx
Less: Cost of goods sold
Opening inventory xxx
Add: purchases xxx
xxx
Less: Closing inventory xxx xxxx
Gross profit xxxx
Less: Operating expenses
Rent xxx
Electricity xxx
Salaries xxx
Etc xxx xxxx
Net profit before finance costs and taxation xxxx
Finance costs (xxx)
Net profit before taxation xxxx
Taxation (xxx)
Net profit for the year xxxx

The income statement has three components: The trading account that ranges from the sales
revenue up to the gross profit, the profit and loss account that ranges from gross profit up to
net profit after tax. Manufacturing companies have an additional account called the
Manufacturing account or manufacturing cost statement. This statement will be given its due
treatment later.

However, the Income Statement for service firms like National water and sewerage
Corporation are slightly different in format Thus;

XYX Income statement for year ended_________

Incomes/revenues xxxx
Less: Expenditures: xxxx
Net incomes before finance costs and taxation xxxx
Finance costs (xxx)

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 Net incomes/profit before taxation xxxx
Taxation (xxx)
Net incomes/profit for the year xxxx

Note: Finance costs include items of Interest on loans, overdrafts, debentures; Lease charges
and any other costs incurred in raising finances.

Statement of changes in equity

Illustrative Statement of changes in equity Format Based on IAS 1
Share Share Revaluation Translation Acc. Total
capital premium reserve reserve profit
Opening balance x X x x x x
Changes in accounting policies - - - - x x
Restated opening balance x X x x x x
Revaluations - - x - - x
Translation differences - - - x - x
Net gains or losses not recognized
in income statement - - x x - x
Net profit for the period - - - - x x
Dividends paid - - - - (x) (x)
Issue of share capital X X - - - x
Closing balance X X x x x x

A comparative statement for the prior period must also be published.

Adjustments to the opening balance figures for changes in accounting policy appear first. The
correction of a fundamental error would appear in the same position. The order of the
remaining items is significant. The order to remember is:
 Revaluations
 Subtotal of net gains and loses not recognized in the income statement
 Net profit/loss for the period
 Dividends paid in the period
 Issues or reductions of share capital

BALANCE SHEET
This statement shows the financial position of an organization at a particular date. The balance
sheet satisfies the Accounting equation of ASSETS = OWNER’S EQUITY + LIABILITIES.
The balance sheet is much more akin to the trial balance, being a balance of the ledger
accounts after double-entry has been completed, and requiring that debits thereon must equal
credits. It is an ordered list of all the ledger account balances remaining once the income
statement has been prepared.

As a minimum, the face of the balance sheet should include line items which present the
following amounts.
1. Items of property, plant and equipment eg. Land, Buildings, fixtures and fittings
Machinery, etc.
2. Intangible assets like Good will, Patents and trade marks, Development costs, etc.

70
 3. Financial assets (excluding amounts shown under 4,6 and 7)
4. Investments
5. Inventories
6. Trade and other payables like debtors etc
7. Cash and cash equivalents
8. Trade and other payables eg. Trade creditors
9. Tax liabilities and assets as required by IAS 12: Income taxes eg. Corporation tax
payable
10. Provisions
11. Non-current interest bearing borrowings
12. Minority interest
13. Issued capital and reserves.

The balance sheet can take the following format.

XYX Balance sheet as at ___________
ASSETS
Acc. Net book
Tangible Non-current assets: Cost Depn. value
Land xxxx nil Xxxx
Motor vehicles xxxx xxxx Xxxx
Equipment xxxx xxxx Xxxx
xxxx xxxx Xxxx
Intangible assets Xxxx
Financial Assets Xxxx
Investments Xxxx
Current assets:
Inventories xxxx
Trade and other receivables (net of bad debts) xxxx
Prepayments xxxx
Cash and cash equivalents xxxx Xxxx
Total assets Xxxx
EQUITY AND LIABILITIES
Capital and reserves:
Share capital xxxx
Accumulated profits (net of drawings if any) xxxx
Other reserves xxxx Xxxx
Minority Interests** Xxxx
Non current Liabilities:
Bank loans xxxx
Debentures xxxx
Preference shares (redeemable) xxxx Xxxx
Current liabilities:
Trade and other payables e.g. creditors xxxx

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Short term borrowings e.g. overdrafts xxxx
Taxation xxxx Xxxx
Total equity and liabilities Xxxx
** This item is dealt with in the third year of study.

Example 1
The following balances were extracted from the books of Elgon Heights Ltd at year-end 31
Dec.2002.
Account Title UGX’ 000s
Share capital 75,000
Creditors 22,472
Inventory 31.12.2001 41,415
Debtors 28,560
Bank 16,225
Machinery at cost 28,000
Accumulated depreciation – Machinery 18,000
Accumulated depreciation – Motor vehicle 12,600
Sales 97,500
Purchases 51,380
Motor expenses 8,144
Maintenance 2,308
Utilities 1,076
Wages and salaries 11,372
Directors remuneration 6,200
Retained earnings 6,138
General reserve 8,000

The following information is also relevant to the company for the period for which the
balances were extracted.
i) Stock at December 31 was UGX.54,300,000
ii) Motor expenses of UGX.445,000 were not paid or recorded anywhere in the books
iii) Utilities of UGX.500,000 were prepaid
iv) A dividend of UGX.7,500,000 was proposed on 28th Dec. but is not paid
v) A transfer of UGX.2,000,000 to the general reserve was approved but not made
vi) Depreciation on non current assets to be provided at the rate of 20% using the
reducing balance method
Required
Prepare Journal entries, Income statement, statement of changes in equity and the balance sheet
for the company.

Solution

Elegon Heights General journal showing adjusting entries

i) Closing inventory 54,300,000

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 Trading account 54,300,000
ii) Motor vehicle expenses 445,000
Accrued motor vehicle expenses 445,000
iii) Prepaid utilities 500,000
Utilities expense account 500,000
iv) Retained earnings 7,500,000
Dividends payable 7,500,000
v) Retained earnings 2,000,000
General reserves 2,000,000
vi) Depreciation expense – motor vehicle 3,080,000
Accumulated depreciation – Motor vehicle 3,80,0000
Depreciation expense – Machinery 5,400,000
Accumulated depreciation – Machinery 5,400,000

Elgon Heights
Income statements for the year ended 31.12.2002
(Amounts in UGX’000s)
Sales 97,500
Less:Cost of sales
Opening stock 41,415
Add: Purchases 51,380
Goods available for sale 92,795
Less Closing Stock 54,300
Cost of goods sold (38,495)
Gross profit 59,005
Less: Operating expenses
Motor expenses 8,589
Maintenance 2,308
Utilities 576
Wages and salaries 11,372
Directors’ remuneration 6,200
Depreciation: Motor vehicle 3,080
Machinery 5,400 (37,525)
Profit for the year 21,480

Elgon Heights Statement of changes in equity

(Amounts in UGX’000)

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 Share capital General Acc. profit Total
reserve
Opening balance 75,000 8,000 6,138 89,138
Net profit for the - 21,480 21,480
period
Transfer to G. reserve 2,000 (2,000)
Dividends payable – (7,500) (7,500)
Ordinary
Closing balance 75,000 10,000 18,118 103,118

Elgon Heights
Balance sheet as at 31.12.2002
(Amounts in UGX’000s)

ASSETS Cost Acc. Depn WDV

Non-current assets:
Motor vehicle 28,000 15,680 12,320
Machinery 45,000 23,400 21,600
73,000 39080 33,920
Current assets
Inventory 54,300
Debtors 28,560
Prepayments 500
Bank 16,255 99,615
Total assets 133,535

EQUITY AND LIABILITIES

Share capital and reserves:
Share capital 75,000
General reserve 10,000
Retained earnings/accumulated profits 18,118 103,118
Current liabilities
Trade creditors 22,472
Accrued motor vehicle expenses 445
Dividends payable 7,500 30,417
Total equity and liabilities 133,535

Example 2
The Bookkeeper of Mwenge Company prepared the following trial balance at the end of its
financial year on 31 December.

Trial balance as at 31/12

74
 Dr. CR.
(UGX.'000) (UGX.'000)
Cash at hand 2,000
Cash at bank 4,000
Land, cost 100,000
Motor vehicle, cost 10,000
Accumulated depreciation - motor vehicle 2,000
Equipment, cost 20,000
Accumulated depreciation – equipment 4,000
Inventory 1/1 (Opening inventory) 1,000
Payables (debtors) 5,000
Provision for bad debts 2,000
Trade creditors 3,000
Sales 200,000
Purchases 110,000
Discount allowed 2,000
Discount received 1,000
Purchases returns (Returns out wards) 5,000
Sales returns (Returns inwards) 10,000
Carriage inwards 6,000
Salaries 8,000
Salaries payable (accrued salaries) 15,000
Rent 1,800
Electricity 7,000
Bad debts 1,200
Capital 26,000
Long-term Bank Loan 30,000
288,000 288,000

You ascertain the following

(a) Closing Inventory at the end of the year was valued at UGX.20,000,000
(b) Salaries of UGX.2,000,000 accrued or remained outstanding at the end of the year and
was not recorded in the trial balance
(c) Half of the rent paid is for the forthcoming financial year
(d) Depreciate Tangible non-current assets by 20% on cost at the end of the year
(e) 20% of trade debtors are expected to default; a provision against bad debts needs to be
made.
Required:
As the company’s Accountant, prepare Mwenge Company’s Income statement for the year
ending 31/12 and the balance sheet as at that date. Be sure to journalize adjusting entries.

Solution:

75
Mwenge Ccompany. General Journal for the period ending 31/12
DR. CR.
(a) Closing inventory 20,000,000
Trading account 20,000,000
(b) Salaries expense 2,000,000
Salaries payable 2,000,000
(c) Rent prepaid 900,000
Rent expense account 900,000
(d) Depreciation expense account (motor vehicle) 2,000,000
Accumulated depreciation account 2,000,000
Depreciation expense account (Equipment) 4,000,000
Accumulated depreciation account 4,000,000
(e) Bad debts expense 1,000,000
Bad debts provision 1,000,000

MWENGE COMPANY
INCOME STATEMENT FOR THE YEAR ENDED 31/12
(Amounts in thousands of shillings)
Sales revenue 200,000
Returns in wards (10,000) 190,000
Cost of sales:
Opening inventory 1,000
Purchases 110,000
Returns out wards (5,000)
Carriage in wards 6,000
Closing inventory (20,000) (92,000)
Gross profit 98,000
Other (miscellaneous) incomes – discount received 1,000
Less: operating incomes:
Depreciation – Motor vehicles 2,000
_ Equipment 4,000
Bad debts (1000 + 1200) 2,200
Discount allowed 2,000
Salaries: Paid 8,000
Accrued 2,000 10,000
Rent: Paid 1,800
Prepaid (900) 900
Electricity 7,000 (28,100)
Net profit for the period 70,900

MWENGE COMPANY
BALANCE SHEET AS AT 31/12
(Amounts in thousands of shillings)
ASSETS

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Tangible Non-current assets: COST AGG.DEPN NBV
Land 100,000 Nil 100,000
Motor vehicle 10,000 4,000 6,000
Equipment 20,000 8,000 12,000
130,000 12,000 118,000
Current assets:
Inventory 20,000
Trade receivables 5,000
Provision (2000 + 1000) (3,000) 2,000
Prepayments – Rent 900
Cash and cash equivalents (2000 + 4000) 6,000 28,900
Total assets 146,900

EQUITY AND LIABILITIES

Equity and reserves:
Capital 26,000
Accumulated profits 70,900 96,900
Non-current Liabilities:
Long term loan 30,000
Current liabilities:
Trade creditors 3,000
Salaries payable (15,000 + 2000) 17,000 20,000
Total equity and liabilities: 146,900

Exercise 1
The trial balance of Futi Bitangwa Ltd had the following transactions for the year ending 31st
Particulars Debit Credit
10% preference share Capital (redeemable) @1000 50,000,000
Ordinary share capital @ 1000 80,000,000
Income statement balance 31.12.2003 26,800,000
Inventory 1.1.2004 99,000,000
Sales revenue 886,000,000
Returns in wards 42,000,000
P++.-u02/rchases 328,600,000
Salaries and wages 118,000,000
Debenture interest 46,800,000
Directors’ remuneration 97,000,000
Bad debts 7,000,000
Legal and audit fees 43,000,000
Returns outwards 68,000,000
Freehold property, cost 180,000,000
Cost of plant and machinery 350,000,000
Cost of motor Vehicles 62,000,000
Cash and bank balances 31,000,000
Trade debtors 36,000,000

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Debentures (redeemable in 5 years) 239,000,000
Provisions for bad debts 15,000,000
Accumulated depreciation – Motor Vehicles 8,000,000
_ Plant and machinery 35,000,000
Trade creditors 36,600,000
Interim preference dividend 4,000,0000
1,444,400 1,444,400
You ascertain that;
a. Inventory value on 31.12.2004 was UGX.33,000,000
b. Depreciation is charged at a rate of 10% on motor Vehicles and 5% on Plant and
Machinery all on cost.
c. Legal and Audit fees of UGX.13,000,000 relate to the year starting on 1.1.2005
d. UGX.2, 000,000 accrued on salaries and wages while 1,200,000 accrued on
debenture interest.
e. The directors agreed to pay the remaining amount of preference dividends at the
close of the year. They also proposed to pay a dividend of 200= per share to
ordinary shareholders on 29th Dec.2004.
Required:
i) Show the journal entries for all the above adjustments.
ii) Prepare the income statement, statement of changes in equity and balance sheet of the
company at the end of the year 2004.

Exercise 2
The Accountant of Smart Partnership Ltd. prepared the following trail balance for the financial
year ended 31/8/99.
Dr. UGX. Cr. UGX.
Land, cost 150,000,000
Machinery, cost UGX.60,000,000 54,000,000
Cash 15,000,000
Bank 3,000,000
Trade payables and receivables 8,000,000 6,800,000
Inventory, 1/9/1998 5,000,000
Sales revenue 200,000,000
Purchases 100,000,000
Returns 5,000,000 10,000,000
10% treasury bills 60,000,000
Electricity 1,000,000
Bad debts 500,000
Salaries 6,500,000
Rent 2,000,000
Prepaid rent 4,800,000
Accumulated losses, 1/9/98 2,000,000
Bad debts provision 4,000,000
4 year UDB loan 40,000,000
Ordinary share capital Issued and

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fully paid shares of UGX.50,000 @ 150,000,000
413,800,000 413,800,000

Other relevant information:

1. Inventory on 30\8\1999 had a net realizable value of UGX.8, 000,000 and a cost of
UGX.7, 000,000.
2. Depreciate machinery by 10% on reducing balance.
3. The company made an investment in Treasury bills Bank of Uganda. Interest for the
three months accrued.
4. During the year, prepaid rent of UGX.2, 000,000 expired and Salaries of UGX.1,
500,000 accrued at the balance sheet date. No adjustments have been made so far for
these items in the accounts.
5. The trial balance has not been adjusted for the payment of the overdraft by cash.
6. The UDB Loan was obtained on 1/3/99 and it is at an interest rate of 20% pa
7. An emergency reserve of 30% of net profit after tax needs to be made.
8. The company’s Directors proposed a Dividend per share of UGX.2,000,000 on 25/8/99
Required:
Ignoring Taxation effects, prepare the company’s Income statement, a statement of changes in
equity and a Balance sheet at the end the financial year on 31/8/99. No Journal entries are
required but the adjustments must be incorporated in the financial statements.

Exercise 3
The following trail balance was extracted from the ledger of Nyabushozi Plc at the end of its
financial year on 28/2/1999.

Dr.UGX. Cr.UGX.
'000 '000
Ordinary share capital (40,000 shares) 40,000
Preference Share Capital (10,000 shares) 20,000
Machinery cost 30,000
Motor vehicles cost 20,000
Land, cost 63,000
Patent 5,000
Receivables 4,000
Payables 6,000
Cash Balance 14,000
Bank balance 2,000
10% Treasury bills 3,000
Trading Inventory 1/3/1998 2,500
General expenses 1,400
Sales 200,000
Returns in wards 1,500
Bad debts 100
Purchases 150,000
Discounts 1,000

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Carriage inwards 3,500
Returns outwards 6,500
Salaries 4,200
Insurance 1,800
Aggregate depreciation:
Machinery 6,000
Motor Vehicles 8,000
Interim preference dividends 1,500
Bad debts provision 1/3/98 500
5 year's bank loan acquired on 1/9/98 at interest of 20% pa 10,000
Accumulated profits 7,500
306,500 306,500

The following information is also relevant.

1. Trading Inventory on 28/2/1999 was valued at UGX. 4,000,000
2. Interest on Treasury bills and bank loan accrued.
3. Machinery is to be depreciated by 10% and Motor Vehicles by 20% on reducing
balance method.
4. The provision for bad debts should be increased to 20% of debtors.
5. In addition to the interim dividend paid on preference shares, a further dividend of
UGX.200 per Preference Share, was proposed on 3/3/2000
6. An amount of UGX.2, 000,000 was appropriated to Plant replacement reserve.
Ignore Taxation

Required:
(a) Journalize adjusting entries
(b) Prepare the company’s Income statement for the year ended 28/2/99, a statement of
changes in equity and a balance sheet as at that date.

+-
-*
.

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 Topic 10
Suspense Accounts and correction of errors

Learning objectives
By the end of the topic you will be able to;
Describe the errors not detected by the trial balance
Correct the errors
Describe the reasons why suspense accounts are established
Prepare a statement of corrected net profit
Restate the balance sheet after the correction of errors

Introduction
A suspense account is a temporal account. It is an account in which debits or credits are held
temporarily until sufficient information is available for them to be posted to the correct
accounts. There are two situations where a suspense account might be needed.
 The bookkeeper knows in which account to make the debit entry for a transaction but
does not know where to make the corresponding credit entry. Until the mystery is
sorted out, the credit entry can be recorded in a suspense account. A typical example is
when the business receives cash through the post from a source which can not be
readily determined. The double entry in the accounts would be a debit in the cash book,
and a credit to a suspense account. Similarly, when the bookkeeper knows in which
account to make a credit entry, but for some reason does not know where to make the
corresponding debit, the debit can be posted to a suspense account.
 When a trial balance is prepared and it fails to balance. The difference by which it fails
to balance is temporarily recorded in a suspense account until the errors are discovered
and can be corrected.

Recall that the purpose of the trial balance is to check the accuracy of the books. Specifically it
detects whether;
The principles of double entry were followed or not
The arithmetic errors were made in balancing off the ledger accounts.

When entries are made in the books of account, some wrong postings or calculations are
possible and these are known as errors. When discovered, the necessary correcting entries must
be made in the accounts. The errors may be of two types;
 Those when made, do not affect the trial balance
 Those when made, will affect the trial balance
Once these errors are found, they must be corrected; and, for the correction of these errors, the
necessary journal entries are made. The use of the journal for the correction of errors is a
common feature.

Therefore, these errors relate to incorrect additions, subtractions, or entries on the wrong side
of the books. For the correction of these errors, a suspense account is opened and the
difference in the trial balance is posted in this account. If the debit side of a trial balance is
smaller then this amount is debited in the suspense account and when the credit side is smaller,

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then this amount credited to the suspense account. When those errors affecting the trial balance
are discovered, they are corrected in by the double entry through the suspense account. As we
shall see later, when all these errors are discovered and corrected, the balance on the suspense
account is eliminated. In this case;
 Dr. Respective A/C if Omitted
Cr. Suspense account
 Dr. Suspense account
Cr. Respective account if omitted
 If any debit entry has been made on the credit side then to correct it, double amounts must
be debited and vice versa.

Typically, there are two main reasons why suspense accounts may be created:
1) On the extraction of the trial balance, the debits are not equal to the credits and the
difference is put to a suspense account
2) Of course, the other one is when the bookkeeper performing double entry is not sure
where to post one side of an entry he may debit are credit a suspense account.

Note: The rule for correcting these errors (that is those that do and do not affect the agreement
of the trial balance) is; The entry which was made correctly, make that entry into the suspense
account and the entry which was not made previously, make that entry in the respective
account.

Errors that cannot be detected by the trial balance

Specifically, the following errors do not affect the agreement of the trial balance.

i. Errors of Omission .This is when a transaction is completely omitted from the books
of account. For example if goods were sold Sarah for 300,000 cash but it is not
recorded anywhere the trial balance will agree
ii. Errors of Commission; This type of error occurs when the correct amount is entered in
wrong persons account. It is important to note that here double entry is observed. For
example if the company sold goods to Martha Tendo on credit but by mistake Marias
Tendo account is debited.
iii. Errors of Original entry. These are errors made on the original documents when a
transaction is being recorded. The double entry is observed but the original figure is not
correct. For example goods for 1,500,000 cash are sold but by mistake 5,100,000 is
recorded on the receipt, the wrong amount will be transferred to the journal, ledgers
and trial balance
iv. Errors of Principle This error occurs when transactions are entered in the wrong types
of accounts. For example a computer (fixed asset) is sold and credited to the sales
account the trial balance will agree. Such a transaction is supposed to be recorded in the
disposal account
v. Errors of Complete reversal of entries This type of error occurs when correct amounts
are recorded on the wrong sides of the account. For example if a cash sale is made the
cash account is supposed to be debited while sales account credited, but the reverse is
done by debiting the sales account and the crediting the cash account.
vi. Compensating errors

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 This is occurs when the same error made on the debit is made also on the credit side
which implies errors cancel out each other. For example if the cash account was over
debited by 200,000 UGX at the same time the sales account was over credited by the
same figure then such errors will cancel out and the trial balance will agree.

We emphasize again that even if the above errors do not affect the agreement of the trial
balance, once detected or found out, they must be corrected and must still follow the dual
concept.

Now let us look at an example involving the correction of errors (using the journal) that
do not affect the trial balance.

The Audit of Banyanga’s books for the year ending 31/12/2004 revealed the following errors;
i. A machine purchased for UGX.1.2M had been debited too the purchases account
ii. Goods purchased from Bukenya for UGX.0.15M were credited to the account of
Bakanya
iii. An invoice from Orobia for UGX.0.27M was omitted
iv. Goods sold to Akileng for UGX.0.175M were entered in the sale day book as
UGX.0.157M
v. The Salaries and wages account was over-added by UGX.0.035M and rent receivable
account had also been over-added by UGX.0.035M
Required: Show by means of journal entries how the following errors should be corrected in
the books of Banyanga.

Solution
Date Particulars folio DR CR
Dec.31.2004 Machinery account 1,200,000
Purchases account 1,200,000
(Being the correction of error as
machinery debited to purchases account)
-do- Bakanya 150,000
Bukenya 150,000
(being a Transfer of amount incorrectly
credited to Bakanya)
-do- Purchases account 270,000
Orobia 270,000
(Being purchase of goods previously
ommited)
-do- Akileng 18,000
Sales account 18,000
(Being adjustment for under charge of
sales)
-do- Rent receivable account 35,000
Salaries and wages account 35,000
(Being an adjustment for overcharge)

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Illustration 1
You are the accountant of BBA Ltd. When you come to prepare the accounts for the year ended
31 Dec. 2005, you find that the bookkeeper has raised a suspense account with a credit balance
of UGX.80, 530. On further investigation you ascertain that this balance is made up of the
following items;
1. Proceeds from an issue of shares (at nominal value) during the year amounting to
UGX.50,000;
2. Proceeds from sale of land, shown in the books at a cost of UGX.20,000, amounting to
UGX.30,000;
3. An excess of the total of the debit side over the credit side of the trial balance due to:
a) Salaries of UGX.690 being incorrectly entered as UGX.960
b) Cash received from a debtor, Eric, amounting to UGX.130 which was
incorrectly debited to his account.
Your job is to clear the suspense account, showing the transfers to the relevant accounts.

Solution
The journals for the correction of the above entries may look as follows
Account titles Account debited Account credited
1 Suspense account 50,000
Capital account 50,000
2 Disposal account 20,000
Profit on disposal 10,000
Suspense account 30,000
3 Suspense account 270
Salaries 270
3 Suspense account 260
Debtors – Eric 260

Notes:
1. The share capital is the proprietor’s capital in a limited company. A new share issue raises
cash of UGX.50, 000 and adds UGX.50, 000 to capital. Presumably in this example, the
cash account has been debited correctly, but the share capital account has not yet been
credited.
2. The UGX.30, 000 received from the sale of the land in the suspense account indicates
that the disposal has not been recorded in the accounts at all. Not only should the disposal
of land account be credited with UGX.30, 000, but also the Non-current assts account
should be credited and the disposal account debited with the cost of the land, to complete
the ledger entries.
3. The error of transposition in 3 (a) and error of commission in 3 (b) are corrected in the
ways described earlier.

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 Suspense account

31/12/05 Share capital 50,000 31/12/05 Bal B/f 80,530

Disposal of Land 30,000
Salaries (over
Statement) 270
Debtors (130 + 130) 260
80,530 80,530

Share capital

1/1/05 Balance b/f X

31/12/05 Suspense 50,000

Land (cost)

1/1/05 Balance 20,000 31/12/05 Disposal of land 20,000

Disposal of land

31/12/05 Land 20,000 31/12/05 Suspense 30,000

Profit on sale 10,000
30,000 30,000

Salaries

31/1/05 Balance X 31/12/05 Suspense 270

Debtor - Eric

1/1/05 Balance 130 31/12/05 Suspense 260

Cash (incorrect) 130
260 260

Illustration 2
JALIA LTD is an old fashioned firm with a handwritten set of books. A trial balance is
extracted at the end of each month, and an income statement and balance sheet are computed.
This month however the trial balance will not balance, the credits exceeding debits by UGX.1,
536,000

You are asked to help and after inspection of the ledgers discover the following errors;

85
 1. A balance of UGX.87, 000 on a debtors account has been omitted from the schedule of
debtors, the total of which was entered as debtors in the trial balance.
2. A small piece of machinery purchased for UGX.1, 200,000 had been written off to
repairs.
3. The receipts side of the cashbook had been under cast by UGX.720,000
4. The total of one page of the sales day book had been carried forward as
UGX.8,154,000, whereas the correct amount was UGX.8,514,000
5. A credit note for UGX.179, 000 received from a supplier had been posted to the wrong
side of his account.
6. An electricity bill in the sum of UGX.152, 000, not yet accrued for, is discovered in a
filing tray.
7. Mr. Magadu whose past debts to the company had been the subject of a provision, at
last paid UGX.731, 000 to clear his account. His personal account has been credited but
the check has not yet been entered in the cash book.

You are required to;

a) Write up the suspense account to clear the trial balance difference; and
b) State the effect on the accounts of correcting each error.

Solution
(a)
Suspense account
Opening balance 1,536,000 Debtors – balance omitted 87,000
Sales – under-recorded 360,000 Cashbook – receipts under cast 720,000
Creditors – credit note posted to
Wrong side 358,000
Cash book: Mr.Magadu’s debt paid
But cash receipt not recorded 731,000
1,896,000 1,896,000
Notes;
i. Error no.2 is an error of principle, whereby a non-current asset item (capital
expenditure – see the Topic on depreciation) has been accounted for as revenue
expenditure. The correct will be logged in the journal, but since the error did not result
in an inequality between debits and credits, the suspense account would not have been
used.
ii. The electricity bill has been omitted from the accounts entirely. The error of omission
means that both debits and credits will be logged in the Journal, but the suspense
account will not be involved, since there is equality between debits and credits in the
error.

(b)
1. The error means that debtors are understated. The correction of error will increase the
total amount for debtors to be shown in balance sheet.
2. The correction of this error will add UGX.1, 200,000 to fixed assets at cost (balance
sheet item) and reduce repair costs by UGX.1, 200,000. The Income statement will
therefore show an increased profit of UGX.1, 200,000, less any depreciation now
charged on the fixed asset.

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 3. The undercasting (i.e. under-adding) of UGX.720,000 on the receipts side of the cash
book means that debits of cash will be UGX.720,000 less than they have been. The
correction of the error will add UGX.720, 000 to the cash balance in balance sheet.
4. This transposition error means that total sales would be under-recorded by UGX.8,
514,000 – UGX.8, 154,000 = UGX.360, 000 in the sales account. The correction of the
error will add UGX.360, 000 to total sales, and thus add UGX.360, 000 to the profits in
the income statement.
5. The credit note must have been issued for a purchase return to the supplier by the
business. It should have been debited to the creditor’s account, but instead has been
credited. Assuming that the purchase returns account was credited correctly, the effect
of the error has been to overstate total creditors by 2*UGX.179, 000 = UGX.358, 000,
and this amount should be credited from the suspense account and debited to the
creditors account. The effect will be to reduce the total for creditors in the balance sheet
by UGX.358, 000.
6. The electricity bill, when entered in the accounts, will increase creditors by UGX.152,
000, assuming that none of this cost is a prepayment of electricity charges.
7. Since the cheque has not yet been recorded in the cash book, the correction of the error
will add UGX.731, 000 to the cash balance in the balance sheet. At the same time, the
provision for doubtful debts can be reduced. This will increase the net amount for
debtors in the balance sheet by UGX.731, 000 (i.e. debtors less provision for doubtful
debts, although the reduction in gross debtors by UGX.731, 000 has already been
accounted for, due to the cash received) and increase in profits by UGX.731,000
(because the bad debt was a previous business expense).

Note: The above answer means that we can now correct the balance sheet that previously had
suspense and correct a net profit that is wrong because of such errors.
Assignment: Get a hypothetical balance sheet with a suspense account of UGX.1, 536,000 on
the assets side and income statement. Be sure you can now restate the statements after
correcting the above errors.

Exercise 1
Friday, having been unable to balance his trial balance at 31 Dec. opened up a suspense
account and entered in it the amount he was out of balance. The debits had exceeded the
credits by UGX.736, 000

The following errors were subsequently discovered;

a) A discount of UGX.265,000 to a debtor, Monday, was entered in his account as
UGX.256,000
b) The total of the discount received column in the cashbook for the month of December
UGX.237,000 had net been posted
c) UGX.500, 000, representing the sale proceeds of a machine scrapped, had been passed
through the sales revenue account.
d) A balance of UGX.268,000 owing by a customer, Tuesday, had been omitted from the
list of account balances at 31 December
e) The bank overdraft of UGX.313,000 had been entered in the list of balances as
UGX.331,000

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 f) Sale of goods for UGX.1,000,000 to Wednesday on credit had been completely missed
from the books
g) Discounts received balance of UGX.379,000 had been entered in the list of account
balances as UGX.397,000 (debit balance)
Show;
The suspense account after the rectification of all errors and to state the entries to be made to
correct the errors which do not pass through the suspense account.

Exercise 2
The following trial balance was drawn by Bamwine enterprises on 28/2/05.
Account tittles Dr (UGX) Cr (UGX)
Vehicles 20,000
Cash 5,000
Bank 6,000
Opening inventory 3,000
Purchases 14,910
Sales 36,360
Trade creditors 5,226
Trade debtors 7,500
Discounts 560 35
Returns 50 121
Drawings 1,400
Bad debts 150
Rent 500
Capital 18,883
Salaries 1,500
Suspense 55
60,625 60,625

The following errors were revealed after thorough examination of the books.
i. An invoice for UGX.130 was entered in the purchases day book as UGX.310
ii. Discount allowed and received of UGX.34 and UGX.58 respectively had been posted
to the wrong sides of the discounts accounts
iii. A credit note for UGX.81 issued to January was credited to Jenuario account in the
purchases ledger and also credited to returns outwards account and no other entry was
made.
iv. A cheque for UGX.450 received from a debtor was correctly entered in the debtors’
control account but was recorded by mistake in the discount allowed column of the cash
book as UGX.540
v. The sales day book on 10/2/05 had been incorrectly cast. The correct amount should
have been UGX.11, 360 and not UGX.11, 330 which was recorded
vi. Goods taken by Bamwine for his own use costing UGX.600 had not been recorded in
the books.
vii. A debtor who owed UGX.186 died insolvent. This amount was written off his
account but no other entry was made
viii. The debit side of the cashbook column was over-added by UGX.150

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ix. A creditor who sent an invoice of UGX.500 promised a discount of 1% for early
payment. He was fully settled by cheque less the amount. The bookkeeper debited the
creditor’s account by UGX.505 and credited the book by UGX.500
x. No record was made for Bamwine’s personal vehicles value at UGX.4,000 which was
surrendered to the business.

Required
a) Journal entries to correct all the errors
b) Suspense account
c) The amended trial balance after the correction of the errors.

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 Topic 11
Depreciation accounting & disposal of tangible
Non-current (fixed) assets
Learning objectives
By the end of this topic, you will be able to
Define and explain the process of depreciation
Illustrate the different methods of computing depreciation
Explain the accounting treatment of disposals of tangible non-current assets.

Introduction
A tangible non-current asset is acquired for use within a business with a view to earning
profits. Its life extends over more than one accounting period, and so it earns profits over more
than one period. With the exception of land held on freehold or very long leasehold, every
tangible non-current asset eventually wears out over time. Machines, cars and other vehicles,
fixtures and fittings, and even buildings do not last forever. When a business acquires a non-
current asset, it will have some idea about how long it’s useful life will be, and it might be
decided either;
 To keep on using the asset until it becomes completely worn out, useless, and
worthless; or
 To sell off the non-current asset at the end of the useful life, either by selling it as a
second-hand item or as scrap – this gives rise to the idea of disposal of the non-current
assets

Since Non-current asset has a cost, and a limited useful life, and its value eventually declines,
it follows that a charge should be made in the income statement to reflect the use that is made
of the asset by the business. This charge is called depreciation.

Definition of depreciation:
There are as many definitions of depreciation as almost the authors in accounting, nevertheless
the following need emphasis.
Depreciation is the allocation of the depreciable amount of an asset over its estimated useful
life.
It is a measure of the wearing out, consumption or other loss of value of a depreciable asset
arising from use, efflux ion of time or obsolescence through technology and market changes. It
is the allocation of the cost of the asset to the years in which benefit is expected from its use. It
is a method of spreading the loss in value of a capital asset over several periods

Depreciation is commonly defined as wear and tear, but in accounting this definition is
inadequate or inappropriate because wear and tear is just one of the causes of
depreciation.
Some terms such as depletion, amortization etc. may sometimes be used instead of
depreciation.

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Note that some intangible assets such as patent, copyright, trademark goodwill etc also do lose
value except that different terms other than depreciation are used for the loss of their value for
stance amortization of goodwill

For simplicity in accounting, depreciation of capital assets is usually determined at the close of
each fiscal year and the depreciation expense( a portion of the expired cost of the asset) for the
accounting period is charged to Income statement in accordance with the matching concept.

Important Definitions, Terms and Issues in Depreciation

There are some important definitions, terms and issues that need to be grasped at this stage to
enhance the understanding of the subsequent contents in this Topic. They include but are not
limited to the following.
1. Depreciable assets. These are assets which are expected to be used during more than one
accounting period with a limited useful life and are held by an enterprise for use in the
production or supply of goods and services, for rental to others, or for administrative purposes
and not for the purpose of sale in the ordinary course of business.
2. Useful life. This is either the period over which a depreciable asset is expected to be used by
the enterprise, or the number of production or similar units expected to be obtained from the
use of the asset by the enterprise. It is also called the life span of the asset.
3. Depreciable amount. Depreciable amount of a depreciable asset is its historical cost, or
other amount substituted for historical cost in the financial statements, less the estimated
residual value.
4. Historical cost. Historical cost of a depreciable asset represents its money outlay or its
equivalent in connection with its acquisition, installation and commissioning as well as
additions to or improvements thereof. Capital assets are recorded at historical cost or, if
donated, at their estimated fair market value.
5. Residual value. This is the net amount, which the enterprise is expected to obtain from an
asset at the end of its useful life after deducting the expected costs of disposal. It is otherwise
called the scrap value or the residual value or the salvage value.
6. All non current assets (fixed assets) other than land depreciate to zero or almost zero book
values. Normally land and some types of improvements on it are not depreciated because in
most cases do not deteriorate due to use and the passage of time.
7. Some intangible assets such as patent, copyright, trademark, goodwill, mineral resources etc
do lose value except that different terms other than depreciation are used for the loss of their
value for stance amortization of goodwill depletion of the resources etc.

Consistency and Disclosure Requirements

Once a depreciation method is selected for a particular asset, it becomes an accounting policy.
It is a requirement that it should be used consistently and that similar items are treated using a
similar method.

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The method of depreciation should be applied consistently so as to enhance the comparability
of the results of the operations of the enterprise from period to period.

Changing depreciation methods is discouraged as it creates distortions in financial reporting,

nevertheless a change from one method can be made only if the adoption of such a method is
required by statute or for compliance with an accounting standard or if it is considered that the
change would result in a more appropriate preparation or presentation of the financial
statements of the enterprise, but even then the effect of such a change on the reported net profit
and balance sheet position must be disclosed.

It is pertinent to note that a change in the method of depreciation is treated as a change in an

accounting policy and therefore should be disclosed accordingly.
It is a requirement that the depreciation methods used, the total depreciation for the period for
each class of assets, the gross amount of each class of depreciable assets and the related
accumulated depreciation be disclosed in the financial statements along with the disclosure of
other accounting policies. But depreciation rates or the useful lives of the assets are disclosed
only if they are different from the principal rates specified in the statute governing the
enterprise.

Capital Expenditure and Revenue Expenditure Distinguished

It is very important to make a distinction between capital expenditures and revenue
expenditures for depreciation purposes because capital expenditures are depreciated whereas
revenue expenditures are not.

Capital expenditure is simply defined as that expenditure incurred in acquiring a fixed asset.
This also includes the expenditure that lengthens the life span of an asset and improves the
efficiency and ability of the asset to earn more income. Such an expense is debited to the
appropriate fixed asset account i.e. such expenditure is capitalized. . Any addition or extension
to an existing asset which is of a capital nature and which becomes an integral part of the
existing asset is depreciated over the remaining useful life of that asset.
Examples of capital expenditure include:
 Purchase of machines
 Installation costs
 Freight costs incurred in transporting a fixed asset
 Building an extension to a house
 Trial runs
 Commissioning
 Etc

Revenue expenditure on the other hand, is that expenditure that is incurred in the maintenance
and repair of fixed assets and operating expenditures necessary to carry on the business e.g.
rent, rates, salaries and wages etc.
Note that revenue expenditure does not increase the value of the asset of a business and
therefore cannot be depreciated but rather is debited to appropriate expense account and
written off at the end of the accounting year in the profit and loss account.

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Reasons for Providing For Depreciation
 Depreciation is a cost that has to reduce profits. If depreciation is not provided for,
income will be overstated and tax liability is also overstated. Therefore since fixed
assets are used to generate revenue it follows that the part of the cost of the asset used
in earning that revenue should be charged to the profit and loss account so as to get a
realistic figure of net profit.
 To portray a true and fair view of the state of affairs of a business by subtracting the
accumulated depreciation from the cost of the asset. This enables disclosure of book
values in the balance sheet to be fairly accurate.
 It guides policy for planning maintenance and replacement of the assets

Factors Considered In Determining/Calculating Depreciation

The assessment of depreciation and the amount to be charged in respect thereof in an
accounting period are usually based on the following three factors:

1. The historical cost of the asset or any other amount substituted for the historical cost of the
depreciable asset when the asset has been revalued. The historical cost includes the purchase
cost plus transportation costs, installation costs, taxation, trial runs and all other costs that put
the asset in a serviceable or usable state and therefore which should be capitalized.

2. Estimated salvage/scrap/residual value. This is the estimated amount that the owner of the
fixed asset expects to recover at the time of disposing off the asset less any cost of disposal.

3. Estimated useful life. This is the estimated time period during which benefit or service is
expected from use of a non-current asset. Such an estimated time period is often in form of
years however it can also be in terms of months, hours, units of production etc.

Causes of Depreciation
1. Physical deterioration
a) Wear and tear; this refers to the wearing out of fixed assets after having been in use for a
number of years.
b) Rust, rot and decay; Materials in vehicles or machines eventually rust, wood eventually rots
or decays after having been used for some time – hence depreciation of that asset.
c) Accidents; may cause depreciation of fixed assets through physical damage say by fire,
explosion etc.

2. Economic factors
a) Obsolescence; this refers to the fixed assets becoming outdated. E.g. due to changes in
technology. E.g. typewriters have been depreciated by computers, record players by radio
cassettes or CD players etc. Since they are out dated, they are no longer useful.
b) Inadequacy; this arises when an asset is no longer used because of the growth or changes in
the size of the firm.

Methods of Computing Depreciation

There are various methods of calculating depreciation and the method employed may vary
from one asset to another. The depreciation method chosen by management depends on the
company’s policy and its relevancy to the asset in question.

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When a method is selected for a particular asset, it should be used consistently and similar
items should be treated using a similar method i.e. in accordance with the consistency concept
(as already seen). Changing methods is discouraged as it creates distortions in financial
reporting, nevertheless where change is justifiable, the effect of the change on the reported net
profit and balance sheet position must be disclosed as earlier discussed.

The following methods may be used for computing depreciation;

 Straight-line method (SLM)/Fixed installments method.
 Reducing balance method (Diminishing balance method)
 Sum of years’ digits method
 Units of output method
 Hourly rate method
 Revaluation method

Straight Line Method (SLM)

This is otherwise called fixed installments method or fixed percentage method. It is the
simplest and most widely used method. It is based on the simple average principle. i.e it
involves dividing the total cost by an estimate of how many years we think the asset will
remain usable and apply the result year in year out. We also need to estimate any residual or
salvage value that we can reclaim at the end of the asset’s working useful life. This method is
especially good for assets that are used uniformly from year to year. However it is not realistic
by assuming constant depreciation over the lifetime of an asset. It is given as:

Depreciation per annum (p.a) = Cost – Scrap/salvage/residual value

Estimated Number of years of useful life
For example, it is 1/1/99 and we have just bought a new asset for shs 100,000 that we estimate
will have a useful life of 5 years; and that we think we will be able to dispose of for shs
20,000.
Required:
a. Calculate the annual depreciation provision for the asset.
b. Show the depreciation schedule for this asset.

Solution
Depreciation per annum (p.a) = Cost – Scrap/salvage/residual value
Estimated Number of years of useful life
= 100,000 – 20,000
5
= 16,000 per year

Depreciation Schedule
YEAR Depreciation expense Accumulated Depreciation Net Book Value

1 16,000 16,000 84,000

2 16,000 32,000 68,000
3 16,000 48,000 52,000
4 16,000 64,000 36,000
5 16,000 80,000 20,000

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Example:
An equipment was purchased from England at CIF Namanve at a value of UGX 10,000,000.
The installation cost was UGX 2,000,000 while trial runs and commissioning amounted to
UGX 2,600,000.The equipment is expected to be useful for 6years after which it is estimated
to have a salvage value of UGX2,600,000.
Required:
Calculate the depreciation expense for each year and accumulated depreciation up to year6.

Solution
Calculation of the cost of the equipment;

Cost up to Namanve (CIF) 10,000,000

Add installation cost 2,000,000
Trial runs and commissioning 2,600,000
Total cost of the equipment 14,600,000
Salvage value 2,600,000
Number of years of useful life= 6 years

Depreciation expense p.a. = Cost – Salvage/Scrap/residual value

Estimated Number of years of useful life

 14,600,000 - 2,600,000
6
=2,000,000

Depreciation Schedule
YEAR Depreciation expense Accumulated Depreciation Net Book Value

1 2,000,000 2,000,000 12,600,000

2 2,000,000 4,000,000 10,600,000
3 2,000,000 6,000,000 8,600,000
4 2,000,000 8,000,000 6,600,000
5 2,000,000 10,000,000 4,600,000
6 2,000,000 12,000,000 2,600,000

Note that depreciation p.a can be expressed as a percentage of depreciable cost as follows:

2,000,000 x 100 =16.667%

12,000,000

Reducing Balance Method

This is otherwise called diminishing or declining balance method. Under this method, more
depreciation is allocated to the earlier years than to later years of the asset i.e. depreciation
charge or allocation reduces as the asset gets older. This method is suitable for assets that are
more useful in earlier years than in later years like automobiles. Under this method

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depreciation charge is on the book value at the beginning of the year and not the original cost.
This method has two types:
 Normal reducing balance method
 Double declining balance method

Normal Reducing Balance Method

Under this method, annual depreciation is calculated as;

Depreciation p.a = Book value x Depreciation percentage

= (Cost – Accumulated depreciation) x Depreciation percentage

R
But depreciation percentage= (1  n ) x 100%
C

Where: n = estimated number of useful life

R = Residual or scrap value
C = Cost
Example
For an asset costing sh1,000,000 with a 5-year life and small residual value (say shs 30,000)
n = 5 years
C = shs 1,000,000
R = shs 30,000

30
Depreciation rate = (1  5 ) x 100% = approx 50%
1,000

To prove that the rate is 50% you will need a scientific calculator or a suitable computer
package.

Calculation of reducing balance depreciation

Year Annual Accumulated Net book

depreciation depreciation value at end of
year
50% of NBV(shs) (shs) (shs)
1 500,000 500,000 500,000

2 250,000 750,000 250,000

3 125,000 875,000 125,000

4 62,500 937,500 62,500

5 31,250 968,750 31,250

96
DOUBLE DECLINING BALANCE METHOD

Under this method depreciation percentage is got by doubling the rate (Depn %ge) on Straight
Line method i.e.

Depr. percentage = 2 x Depreciation percentage using Straight-Line Method (SLM)

Remember:
Depr. Expense p. a
Depr. Rate (SLM) = x 100
Depreciable cost

However; Depreciable cost = Cost – Salvage value.

Therefore:

Cost - Scrap value

No. of years x 100 x2

Depr. percentage =
Cost - Scrap

Depreciation p.a.(SLM)
DDBM Depr percentage = x 100 x2
Depreciable cost

Sum Of Years’ Digits Method

Under this method, depreciation is computed by dividing the number of years remaining in the
useful life of the asset (counting from the beginning of the year) by the sum of years of useful
life. The rate of depreciation got is then multiplied by the depreciable cost (Cost – Salvage
value).

Remaining useful life (Years)
Depr. Expense = X Depreciable cost
Sum of years’ digits

Example:
An equipment was bought at a cost of UGX 50,000,000. It has an estimated useful life of 5
years at the end of which the residual value is estimated to be UGX 5,000,000=.

Required:

97
Calculate the depreciation expense for each year using the sum of years’ digits method.
Solution:
Year Depreciation rate Depreciation Expense
1 5
= 5/15 (5/15) X (50000000-5000000 = 15000000
1+2+3+4+5
2 4/15 (4/15) X 45000000 = 12000000
3 3/15 (3/15) X 45000000 = 9000000
4 2/15 (2/15) X 45000000 =6000000
5 1/15 (1/15) X 45000000 = 3000000

NOTE:
Reducing balance method and sum of years’ digits method are called accelerated depreciation
methods because higher depreciation charges or allocations are made in the earlier years than
in the later years.
These two methods are used as tax incentives in some countries because they act as a tax relief
since they lead to a lower reported net profit in the earlier years when an investment is still
infant.

Units of Output Method

Here depreciation is computed in proportion to the use of the asset for production i.e. it is
based on the number of units estimated to be produced by the asset in its useful life.

Units produced during the year

Depr. Expense p.a. = X Depreciable cost
Estimated units to be produced in the useful life

Example:
A machine is expected to produce 400,000 units in its useful life. It produces 75,000 units in its
1st year of existence. If the machine was bought at 5,500,000= and its salvage value is
estimated at 500,000=.
Calculate the depreciation in the 1st year using the units of output method.

Units produced during the year = 75,000

Estimated units to be produced in useful life = 400,000
Cost = 5,500,000
Salvage value = 500,000

75,000
Depn. Expense = x (5,500,000 –500,000)
400,000

= 0.1875 x 5,000,000

= 937,500

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Working Hours Method (Hourly Rate Method)
This method takes into account the running time of the machine for depreciation purposes.
Depreciation is computed basing on the number of hours the asset is expected to run in its
useful life.
Number of hours worked in the year
Depn. Expense = X Depreciable cost
Estimated working hours in useful life

Example:
A machine is expected to work for 100,000 hours during its useful life. It ran for 40,000
hours during its 1st year of use. It had been bought at 22,000,000= and estimated to have a
salvage value of 2,000,000= at the expiry of 100,000 hours.
Required:
Calculate the depreciation expense in year 1 using the working hours method.
Solution:
Hours worked in year 1 = 40,000
Estimated No. of hours during the lifetime = 100,000
Cost = 22,000,000=
Salvage value = 2,000,000=

40,000
Depr. Expense = x (22,000,000 – 2,000,000)
100,000

= 0.4 x 20,000,000

= 8,000,000

Revaluation Method
Under this method professional valuers or Experts are used to value the non current
assets/fixed assets such as land and buildings, livestock, packages, loose tools etc. At the end
of the year the value of the asset is compared with the value at the beginning of the year and
the difference is depreciation expense.
This method is discouraged in accounting because of the subjectivity involved and the
historical cost concept except where all other methods cannot be used conveniently.

NOTE:
If the value of the asset at the end of the year is greater than at the beginning of the year, then it
is appreciation and not depreciation though in most cases depreciation is expected.

Example:
KAK Construction ltd had UGX 12,000,000 worth of loose tools at the beginning of 2004 and
during the year more loose tools worth UGX 7,000,000 were bought. At the end of the year the
valuers established the value of the tools at UGX 13,700,000, there was no disposal during the
Year.
Required:

99
Compute the depreciation expense for the year:

Solution:
Tools at the beginning of the year 12,000,000
Tools purchased during the year 7,000,000
19,000,000

Less the value of tools at the end of the year 13,700,000

Value of the tools used during the year 5,300,000

(Depreciation)

Disposal or Retirement of Fixed Assets

When fixed assets are worn out, become obsolete or useless, they are disposed off (sold off).
Note that disposing off of an asset is not like an ordinary sale of goods because it is not routine
but incidental and for that matter it should not be credited to the sales a/c but rather the cost of
the asset is transferred to an account called Disposal a/c (debit side).
The accumulated depreciation a/c is also closed off to the disposal a/c so as to determine
whether there is either a gain or loss on disposal. If there is a gain on disposal, it is credited to
the profit and loss account as miscellaneous income and if there is a loss on disposal then it is
debited to the profit and loss account as an expense.

Accounting Entries required for the Disposal of Fixed Assets.

i. To transfer the cost of the asset to the disposal account, open a non current asset (fixed
asset) disposal account and debit it with the cost of the fixed asset disposed off as you
credit the fixed asset account i.e.
Dr Disposal A/C xxxx
Cr Non current asset/Fixed asset A/C xxxx
ii. Transfer the accumulated depreciation of the asset being disposed off to the disposal
account i.e.
Dr Accumulated depreciation A/C xxxx
Cr Disposal A/C xxxx
iii. On sale of the asset, record the receipt of cash by debiting the Cashbook (Cash A/C or
Bank A/C) as usual and crediting the disposal account i.e.
Dr Cash/Bank A/C xxx
Cr Disposal A/C xxx
iv. On closing the disposal account to the Profit and Loss Account, the balancing figure is
either a gain or a loss on disposal i.e.
a. Gain on disposal
Dr Disposal A/C xxx
Cr Profit and Loss A/C xxx
b. Loss on disposal
Dr Profit and Loss A/C xxx
Cr Disposal A/C xxx

100
NOTE:
Alternatively gain or loss on disposal can be computed by deducting the net book value of the
disposed asset from the proceeds received upon disposal. For instance;

1. Travellers’ Choice Ltd sold off one of its buses, which had become old and could not cope
up with the high conditions. Its cost/carrying value was 200,000,000/=. It was sold for
100,000,000/= and it had an accumulated depreciation of 125,000,000/=. You are required to
compute the profit/gain or loss on disposal.

Solution:
UGX UGX

Proceeds received upon disposal 100,000,000

Less NBV:
Carrying value 200,000,000
Less Acc Depn 125,000,000
75,000,000
Gain on disposal 25,000,000

2. Travellers Choice Ltd sold off another bus, which had become economically unviable. Its
cost/carrying value was 250,000,000/=. It was sold for 70,000,000/= and it had an accumulated
depreciation of 150,000,000/=. You are required to compute the profit/gain or loss on disposal.
Solution:
UGX. UGX

Proceeds received upon disposal 70,000,000

Less NBV:
Carrying value 250,000,000
Less Acc Depn 150,000,000
100,000,000
Loss on disposal 30,000,000

Illustration 1
A computer was brought on 1st Jan 1991 at shs 2, 000,000/=. It was then sold or disposed off
31/12/93 at shs 1,200,000/-. The computer was expected to last for a period of 10 years at the
end of which it would have zero salvage value. Using the straight line method of depreciation.
It is the company policy to ignore depreciation in the year of disposal.
Prepare:
a) Computer account
b) Computer Disposal account
c) Accumulated depreciation of computer account

Solution:
Depreciation expense = cost – salvage value

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 No. of years of useful life

= 2,000,000 – 0
10

= 200,000

ֶֶ Accumulated depreciation = 200,000 x 2 years = 400,000

Dr Computer A/C Cr

1993 Shs 1993 Shs

Jan 1 Bal b/d 2,000,000 Dec 31 Disposal 2,000,000

2,000,000 2,000,000

Dr Computer Disposal A/C Cr

1993 Shs 1993 Shs

Dec 31 Computer 2,000,000 Dec 31 Acc Depr 400,000
Cash 1,200,000
Loss on Disposal 400,000

2,000,000 2,000,000

Dr Acc Depreciation for Computer A/C Cr

1993 Shs 1993 Shs

Dec 31 Disposal 400,000 Jan 1 Bal b/d 400,000

400,000 400,000

Illustration 2
A company purchased a pick up costing shs 25,000,000/ on 1 st Jan 1999, and then sold it at shs
18,000,000/ on 31st Dec 2000. It is the company’s policy to provide for depreciation at 10% on
a straight line basis. Ignore depreciation in the year of disposal
Required: Prepare:

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  Pick up account
 Pick up disposal account
 Accumulated depreciation for pick up account
Solution:
Depreciation expense: 10% x 25,000,000 = 2,500,000

ֶֶ Accumulated depreciation = 2,500,000 x 1 year = 2,500,000

Dr Pick up A/C Cr

2000 Shs 2000 Shs

Jan 1 Bal b/d 25,000,000 Dec 31 Disposal 25,000,000

25,000,000 25,000,000

Dr Pick up Disposal A/C Cr

2000 Shs 2000 Shs

Dec 31 Pick up 25,000,000 Dec 31 Acc Depr 2,500,000
Cash 18,000,000
Loss on Disposal 4,500,000

25,000,000 25,000,000

Dr Acc Depreciation for Pick up A/C Cr

2000 Shs 2000 Shs

Dec 31 Disposal 2,500,000 Jan 1 Bal b/d 2,500,000

2,500,000 2,500,000

Illustration 3
A computer was purchased on 1st Jan 1991 at Shs 2,000,000/. It was then sold or disposed off
on 31/12/93 at Shs 1,200,000/. Provision for depreciation is 10% on reducing balance method.
A full year’s depreciation is charged in the year of acquisition and none in the year of disposal.
Required: prepare;
 Computer account
 Accumulated depreciation for computer account
 Computer disposal account

103
Solution
Cost = Shs 2,000,000
Year Depr expense Accum depr Net book Value
1991 200,000 200,000 1,800,000
1992 180,000 380,000 1,620,000

Note: when using reducing balance method, depreciation for the 1st year is determined as the
provision rate x cost of asset. In the subsequent years, the depreciation expense is the rate x net
book value.

Dr Computer A/C Cr

1991 Shs 1991 Shs

Jan 1 Cash 2,000,000 Dec 31 Bal c/d 2,000,000

2,000,000 2,000,000
1992 1992
Jan 1 Bal b/d 2,000,000 Dec 31 Bal c/d 2,000,000
2,000,000 2,000,000

1993 1993
Jan 1 Bal b/d 2,000,000 Dec 31 Disposal 2,000,000
2,000,000 2,000,000

Dr Acc Depreciation for computer A/C Cr

1991 Shs 1991 Shs

Dec 31 Bal c/d 200,000 Dec 31 Depreciation 200,000
200,000 200,000
1992 1992
Jan 1 Bal b/d 200,000 Jan 1 Bal b/d 200,000
Dec 31 Depreciation 180,000
380,000 380,000

1993 1993
Dec 31 Disposal 380,000 Jan 1 Bal b/d 380,000
380,000 380,000

Dr Computer Disposal A/C Cr

1993 Shs 1993 Shs

Dec 31 Computer 2,000,000 Dec 31 Acc Depr 380,000
Cash 1,200,000
Loss on Disposal 420,000

104
 2,000,000 2,000,000

Exercise 1
Mercury Computers Ltd owns a computer consultancy firm. It has many computers some of
which have got old due to changes in technology.
The following information relates to some computers.
The first computer was bought on 2/3/1998 at UGX 4,000,000 , the second computer on
4/6/1999 at UGX 6,000,000 and the third computer on 30/9/2000 at UGX 8,000,000.

The first computer that was bought on 2/3/1998 was sold (disposed off) on 5/10/2001 for
UGX.2,400,000 and the second computer that was bought on 4/6/1999 was sold on 10/1/2002
for UGX 3,600,000.

All computers are expected to last for 10 years at the end of which they have zero scrap values.
It is the company’s policy to charge full depreciation in the year of purchase and none in the
year of disposal (sale) using the straight-line method of depreciation. The financial year runs
from January 1st to December 31st. All transactions were on cash basis.

You are required to prepare the following accounts:

a. I) Computers Account
ii) Disposal of Computers Account
iii) Accumulated depreciation Account
b. Show the extract of the Profit and Loss Account and the Balance sheet at the end of each
year.

Exercise 2
The following information regarding Akright Projects Ltd was obtained.
Extract from 31.12.2002 Balance sheet

NON CURRENT ASSETS COST ACC. DEPR. NBV.

UGX (000) UGX (000) UGX (000)
Equipment 25,000 10,000 15,000

On 2 Feb 2003, an additional equipment was bought at a cost of 2,500,000/=. Due to expansion
in the market for serviced plots, another equipment was bought on 24 th June 2003 at a cost of
3,750,000/=. However an equipment which had been acquired at a cost of 2,000,000/= on 7 th
April 2000 and was expected to have a useful life of 5 years and a scrap value of 125,000/=
could not cope up with bigger projects efficiently. On 5th July 2003, Management disposed it
off at 750,000/=

Another equipment which was bought on 20 th May 2000 at a cost of 4,000,000/= and was
expected to have a salvage value of 250,000/= at the end of the tenth year broke down and was
disposed off at 1,750,000/= on 3rd September 2003.

105
The company’s policy is to charge full depreciation in the year of purchase and none at all in
the year of sale (disposal).
The company followed double declining method of depreciation but changed to charge
depreciation at a rate of 10% on cost for the equipment, which was available by the end of 31
December 2003. All transactions were by cheque.
Required:
Show how the following accounts will appear at 31 December 2003.
(i) Equipment A/C
(ii) Equipment Disposal A/C
(iii) Accumulated depreciation- Equipment’s A/C

106
 Topic 12
Preparing Manufacturing Accounts
Learning objectives:
By the end of this topic, you will be able to:
Define the costs that form a manufacturing cost statement
Prepare financial statements for Manufacturing concerns

Introduction
Despite the diversity of enterprises which jointly make up what is commonly called ‘the
commercial world’, in this Topic we are concerned with those which are involved in the
manufacture, during which materials and labour are utilized in the production of articles for
sale. (Depending on the types of enterprises, products may range from raw materials or
components for use by other manufacturing or producing organizations, to finished products
ready for eventual sale to users or consumers).

Manufacturing firms unlike retailing firms Incur costs of transforming raw materials into
finished goods. This cost of goods manufactured becomes part of the cost of sales in the
trading account. For this reason, a preliminary statement/Account called the manufacturing
statement/Account, which is an extension of the trading account, is prepared to determine the
cost of goods completed/fully manufactured

Divisions of Costs in a Manufacturing Account/Statement

For convenience of comparison and analysis the items making up the total cost are broadly
divided in the manufacturing account as direct (Prime) and Indirect (Overhead) Costs.

A) Prime /Direct Costs

These are costs that can be specifically and exhaustively identified with a particular cost
Centre or cost unit for example a Department or process. They consist of direct material (Raw
material) cost; direct labour cost (direct wages) and direct expenses.

Direct Material
It is material that can be specifically and exhaustively identified with a particular product (Cost
unit) and cost Centre and becomes part of the finished product, for example the cost of timber
in the furniture industry. it can be identified with a particular item of furniture say a particular
chair, desk etc

Direct lab our cost (Direct Wages)

Direct labour is traceable to a particular cost Centre. Wages paid to workers who are directly
involved in the manufacturing process are called direct wages. If a worker’s Wage can be
associated with only one cost Centre say a Department, process, machine etc, and then it is a
direct wage. For example wages paid to the carpenter and the hiring charge of the machine
using for making furniture. The cost of glue and varnish used in the furniture, wages paid to a
watchman etc are indirect/overhead.

107
Direct expenses
These are expenses that are traceable or can be linked to specific cost Centre for example
royalty costs

B) Overhead/Indirect Costs.
Factory overhead costs are all those costs which occur in the factory where production is being
done but which cannot easily be traced to the items being manufactured
Indirect costs, or overhead costs are composed of indirect material costs, indirect labour costs
and indirect expenses. Since overhead costs cannot be linked to one particular cost Centre e.g.
Department, process, program etc, they must be apportioned to those cost centers and
thereafter to cost units by use of suitable bases

NOTE: Ability to trace a cost to a cost center or cost unit determines whether a cost is direct or
indirect

Stock in trade of a manufacturing firm

At any given time, a manufacturing concern may have stocks in three forms, namely
 Raw materials
 Work in progress. These are partly finished goods at any time during the accounting
period. Opening Work in progress is that at the beginning of the accounting period
while closing stock is that at the end
 Finished goods
Manufacturing firms disclose all these stock items as current assets in the balance sheet

Manufacturing cost statement /Manufacturing Account

It shows the cost of the manufactured goods. Expired Costs not related to the manufacture are
not shown in this account but in trading and profit and loss account

Elements of the Manufacturing account/statement

The elements of this account are as follows

A) PRIME COST. (The total of direct materials, direct labour and direct expenses)
I) Cost of raw materials consumed/used.
It is arrived at as follows
Opening stock of raw materials x
Add: Purchases of raw materials x
Carriage inwards x
X
Less: Discounts (If any) x
Returns x
X
X
Less: closing stock x x
Cost of raw materials x

108
(Discounts received could as well be added to the gross profit instead of being subtracted from
purchases)
ii) Direct labour cost/wages
This is added to the cost of raw material consumed
iii) Direct expenses concerned with production including royalties on production are added to
cost of raw material consumed and direct labour cost (Direct wages)
B) Factory overheads are added to the prime cost. Factory overheads include but are not
limited to the following:
a) Rent and rates of the factory
b) Factory power
c) Factory lighting
d) Depreciation of plant and machinery
e) Supervisors, wages and salaries
C). Opening work-in-progress
The value of opening work-in-progress is added to costs already collected as
described above.
vi). Closing work-in-progress
The cost of closing work-in-progress is subtracted in arriving at the cost of goods
completed or fully manufactured.

PROFORMA MANUFACTURING ACCOUNT/COSTSTATEMENT

PRIME COST
Raw-material (Direct material cost)
Opening stock xxx
Add: Purchases xxx
Xxx
Less: Closing stock xxx
Cost of raw materials consumed xxxx
Add: Direct labour cost (direct wages) xxxx
Direct expenses xxxx
xxxx
Add: FACTORY OVERHEAD COSTS:
Rent xxx
Insurance xxx
Depreciation xxx
Etc. xxx
xxxx
xxx
Add: OPENING W.I.P xxx
xxx
Less: CLOSING W.I.P xxx
COST OF GOODS COMPLETED/FULLY MANUFACTURED) xxx

109
The figure for cost of goods completed or fully manufactured is transferred to the
trading account to constitute cost of goods sold.
Manufactured Goods may be transferred either at
 Cost price or
 Cost plus markup (This will be discussed later)

Elements of a Trading and Profit and Loss Account Part

This account includes:
 Cost of goods fully manufactured /Production cost brought down from the
manufacturing account. This replaces the purchases
 Opening and closing stocks of finished goods
 Sales
In other words, the trading account of a manufacturing firm is similar to that of a retailing
firm in many aspects. The only difference is that the cost of goods manufactured replaces
the purchases figure
The gross profit is carried forward to the Profit and loss part

Elements of a Profit And Loss Account

This account includes operating expenses, which are not related to the manufacture.
Manufacturing firms categories these expenses as office and administration expenses, selling
and distribution expenses and financial charges.
Examples of office and administration expenses
a) Office salaries
b) Administrative allowances
c) Office rent
d) Telephone
e) Postage and stationery
f) General expenses
Examples of selling and Distribution Expenses
a) Advertising
b) Show room expenses
c) Delivery van Insurance
d) Depreciation of delivery vans
Examples of financial charges
a) Bad debts
b) Bank charges
c) Interest on loans
d) Debenture interest
e) Discount allowed
f) Legal fees
g) Audit and consultancy fees
h) Mortgage interest.

110
PROFORMA TRADING AND PROFIT AND LOSS ACCOUNT OF A
MANUFACTURING FIRM

Sales xxxx
Less: Cost of goods sold:
Finished goods opening stock xxxx
Cost of goods completed (fully manufactured) xxxx
Xxxx
Less: Finished goods closing stock xxxx
Cost of goods sold xxxx
Gross profit xxxx

Less: Office and administration expenses

Office salaries xxx
Postage and stationery xxx
e.t.c xxx xxxx

Selling and distribution expenses

Advertising xxx
Sales commission xxx
Carriage out wards e.t.c xxx xxxx
Financial charges
Bank charges xxx
Interest on loans e.t.c xxx xxxx xxxx

NET PROFIT/INCOME xxxx

111
WHERE MANUFACTURED GOODS ARE TRANSFERRED AT THEIR COST PRICE

EXAMPLE

Roof clad Ltd manufactures Iron Sheets and sells them to the final users. The following
balances were extracted from its ledger on 31/12/2004.
(UGX.000)
Sales 1,200,000
Purchases of raw materials 50,000
Wages of crane Drivers 45,000
Factory direct wages 40,000
Manufacturing expenses 15,000
General expenses 21,000
Promotion expenses 20,000
Discount allowed 3,000
Discount received (on raw material purchases) 2,000
Salesmen commission 14,000
Head office salaries 15,000

Carriage outwards 13,000

Electricity-Factory 14,000
-Office 17,000
Ground rent (factory) 3,000
Bad debts expense 4,000
Insurance
-Office buildings 6,000
- Factory premises 3,000
Depreciation
-Office buildings 1,000
-Factory machines 7,000
Legal fees 1,000

The Stock taking exercise revealed the following balances

Stock at cost 1/1/2004 31/12/2004
(UGX 000) (UGX 000)
Raw-materials 8,000 7,000
Work-in-progress 4,000 3,000
Finished goods 9,000 8,000

Required:
Prepare the company’s manufacturing, trading and profit loss account for the year ended
31/12/2004

112
SOLUTION

ROOFCLAD LTD
MANUFACTURING, TRADING AND PROFIT AND LOSS ACCOUNT
FOR THE YEAR ENDED 31/12/2004
(UGX 000) (UGX 000) (UGX 000)
Raw materials
Opening stock (1/1/1999) 8,000
Add: Purchases 50,000
58,000
Less: Discount on raw materials 2,000
56,000

Less: Closing stock (31/12/1999) 7,000

Cost of raw materials consumed 49,000
Add: Other direct costs
Factory direct wages 40,000
PRIME COST 89,000

Add: Factory (Manufacturing) overhead costs

Wages of crane Drivers 45,000
Manufacturing expenses 15,000
Depreciation of factory machines 7,000
Factory insurance 3,000
Electricity (Factory) 14,000
Ground rent (Factory) 3,000 87,000
176,000

Add: Opening W.I.P (1/1/2004) 4,000

180,000

Less: Closing W.I.P (31/12/2004) 3,000

Cost of goods completed 177,000

(Fully manufactured c/d)
Sales 1,200,000
Less: Cost of goods sold
Finished goods opening stock 9,000
Add: Cost of goods completed b/d 177,000
186,000
Less: Finished goods closing stock 8,000
Cost of goods sold 178,000
Gross profit 1,022,000
Less: Office and administration expenses
General expenses 21,000
Head office salaries 15,000
Insurance 6,000

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Office electricity 17,000
Depreciation-Office 1,000 60,000
Selling and distribution expenses
Promotion 20,000
Carriage outwards 13,000 33,000
Financial charges
Discount allowed 3,000
Legal fees 1,000
Salesmen’s commission 14,000
Bad debts 4,000 22,000 115,000

Net profit 907,000

NOTE: Manufacturing expenses are always taken to be overheads unless stated

Otherwise

MANUFACTURED GOODS TRANSFERRED TO THE TRADING ACCOUNT AT

THEIR CURRENT MARKET VALUE AND THE TREATMENT OF THE ARISING
UNREALISED PROFIT

The Illustration above (Roof clad Ltd) is a simple one where goods are transferred from the
manufacturing account to the trading account at their cost price (UGX 177,000). However,
finished goods are sometimes transferred from the manufacturing account to the trading
account at an inflated price, which is their current market value rather than their cost price. The
current market value is what competitors would charge for the same goods .For example in the
Roof clad illustration, if competitors can charge 194,700 for similar goods; this is the current
market value. Roof clad would transfer the goods at an inflated price of 194,700 UGX instead
of the cost of 177,000 UGX.
The difference between the current market value of 194,700 and the cost of
177,000 UGX is 17,700UGX.This figure is called a markup.

Why transfer at current market value (cost plus markup) rather than the cost price?

This is done to show the factory profit. This is what the firm gains as a result of manufacturing
the goods itself rather than buying the same goods from other sources. In the Roof clad
example, the factory profit is the markup of UGX 17,700, which the firm gains as a result of
producing at a cost of UGX 177,000 instead of buying the same goods from competitors at
UGX 194,700
The Factory/manufacturing profit is carried to the profit and loss account and is added to the
gross profit. However, the factory profit is on goods not yet sold. Disclosing such a profit in
the trading and profit and loss account as part of the overall profit and transferring
manufactured goods at an inflated price contravene the realization and historical cost
conventions.

How is the unrealized profit on unsold goods eliminated from the Profit and loss account?

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A provision account is used to eliminate the unrealized profit on the unsold items. If the
provision for unrealized profit on closing stock exceeds the provision on opening stock then
the profit and loss account will be debited (subtracted from profits). If on the other hand the
provision on closing stock decreases below the provision on opening stock, then the profit and
loss account is credited (added to profits).

EXAMPLE
Mukwano LTD, a manufacturing company had the following finished goods stock balances at
cost
1/1/2004 31/12/2004
(UGX) (UGX)
Finished goods at cost 2,500,000 4,000,000
During the period the cost of goods completed amounted to UGX 30,000,000. The company
transfers goods at cost plus a mark-up of 10% to cater for factory profits.
Required prepare
 A provision for unrealized profit account
 Manufacturing statement extract
 A trading and profit and loss Account extract
Solution
Note: When the cost of goods manufactured is inflated, stocks must also be inflated by that
same percentage.
Profit for unrealized profit =2,500,000 x 110% - 2,500,000
On opening stock
= UGX 250,000

Provision for unrealized

Profit on closing stock =4,000,000 x 110% -4,000,000
= UGX 400,000

Provision for unrealized profit A/C

Bal. b/d 250,000

P & L A/C 150,000
Bal c/d 400,000
(Increase in provision)
400,000 400,000

Transfer value of Finished goods = 30,000,000 x 110%

UGX 33,000,000.
Manufacturing account (extract)

Cost of goods manufactured/fully completed 30,000,000

Add markup (10%of 30,000,000) 3,000,000
Transfer value of goods manufactured 33,000,000

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Note
a) It is the Inflated (transfer) value of UGX 33,000,000 , not the cost of 30,000,000 that
is transferred to the trading account
b) When goods manufactured are transferred at an inflated value, the finished goods
opening and closing stocks are also inflated as shown in the trading account extract

Trading and profit and loss account (Extract)

Sales xxxxxxxxx
Less: Cost of goods sold
Finished goods opening stock 2,750,000
(Cost x 110%)
Value of goods completed or
Manufactured (transfer price or value) 33,000,000
35,750,000
Less: Finished goods closing stock 4,400,000
(Cost x 110%)
31,350,000
Gross profit xxxxxxxx
Add: factory profit 3,000,000
Less: Increase in provision for unrealized profit
150,000

ILLUSTRATION TWO

The following information was extracted from TRI STAR manufacturers

Debit side of the cash book (receipts) UGX

Receipts from debtors 60,000,000

Cash sales 650,000,000
Interest received 9,000,000

Credit side of the Cash book (Payments)

Direct factory wages 30,000,000

Electricity 5,700,000
Sales promotion expenses 900,000
Royalty costs 5,000,000
Indirect material 12,000,000
Payment to creditors 45,000,000
Accountancy fees 2,400,000
Discount on raw materials bought on credit 1,500,000
Raw material cash purchases 32,000,000
Office equipment 150,000,000

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Bank charges 400,000
Carriage inwards 18,000,000
Rent 15,000,000
Raw material returns 1,000,000
Carriage outwards 3,000,000
Manufacturing expenses 20,000,000
Salaries 16,000,000

The records of the manufacturers also showed the following

Stocks at cost (UGX) 1/1/2003 31/12/2003

Raw materials 10,000,000 14,000,000
Work-In-Progress 4,000,000 3,000,000
Finished goods 34,000,000 24,000,000
Other balances (UGX)
1/1/2003 31/12/2003
Trade Debtors 14,000,000 20,000,000
Prepaid electricity 500,000 200,000
Accrued promotion expenses 1,200,000 900,000
Trade creditors 12,000,000 16,000,000
Additional information
1. Of the manufacturing expenses, 50% are direct
2. Office equipment is depreciated at 10% on cost p.a
3. Rent is apportioned on the basis of the floor area as follows

Factory Administration Sales

Area (Square metres) 70 20 10
Apportionment of Other
Overheads
Salaries ½ ¼
Electricity 50% 30%
4. Manufactured goods are transferred from the factory to the sales department at
manufacturing cost plus a mark up of 20% for factory profit. Finished goods stocks are
inflated by the same percentage.
Required

Prepare TRI-STAR Manufacturing, trading and profit and loss account for the year-
ended 31.12.2003.

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SOLUTION

TRI STAR
MANUFACTURING, TRADING AND PROFIT AND LOSS A/C
FOR THE YEAR ENDED 31.12.2003(UGX 000)
Raw materials
Opening stock of raw materials 10,000
Add: Purchase of raw materials 82,500
Carriage on raw materials 18,000
100,500
Less: Raw material returns 10,000 99,500
109,500
Less: Closing stock of raw materials 4,000
Cost of raw materials consumed 95,500
Add: Direct factory wages 30,000
Add: direct expenses
Royalty 5,000
Manufacturing expenses 10,000 15,000
PRIME COSTS 140,500
Add: FACTORY OVERHEADS
Manufacturing expenses 10,000
Indirect material 12,000
Factory rent 10.500
Electricity 3,000
Salaries 8,000 43,500
184,000
Add: opening work in progress 4,000
188,000
Less: Closing Work in progress 3,000
Cost of fully manufactured goods 185,000
Add: Mark-Up/Factory profit (20%of 185,000) 37,000
Transfer value of finished goods 222,000

Sales 716,000
Less: Cost of sales
Finished goods opening stock 40,800
Transfer value of goods manufactured 222,000
Value of goods available for sale 262,800
Less: Finished goods closing stock 28,800
Cost of sales 234,000
Gross profit 482,000
Add: Factory profit 37,000
Interest received 9,000
Decrease in provision for unrealized profit 2,000
Discount on raw material purchases 1,500

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 531,500

Less: Operating expenses

Office and administration expenses
Rent 3,000
Electricity 1,800
Salaries 4,000
Depreciation-office equipment 15,000 23,800
Selling and distribution costs

Carriage outwards 3,000

Sales promotion 600
Rent 1,500
Electricity 1,200
Salaries 4,000 10,300
Finance charges

Bank charges 400

Accountancy fees 2,400 2,800 36,900
Net profit 494,600

Provision for Unrealized profit

Decrease in provision Bal b/d 6,800,000

For unrealized profit 2,000,000

Bal c/d 4,800,000

6,800,000 6,800,000

Trade debtors

Bal b/f 14,000,000 Cash 60,000,000

Credit sales 66,000,000 Bal c/f 20,000,000

80,000,000 80,000,000

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 Trade Creditors

Cash 45,000,000 Bal b/f 12,000,000

Discount 1,500,000

Bal c/d 16,000,000 Credit purchases 50,500,000

62,500,000 62,500,000

Note:
Total purchases=Cash purchases+ credit purchases
Total Sales = Cash sales + credit sales.
Discount on raw materials purchased could as well be subtracted from the purchases
figure in the manufacturing account/Statement

Exercise
Mukwano Group manufactures and Retails Cooking Oil; the following balances were
extracted from its ledger on 31st December
2003
(UGX 000)
Sales 7,000,000
Sales returns 100,000
Purchases of raw materials 50,000
Carriage inwards 2,000
Carriage out wards 1,000
Factory direct wages 60,000
Royalty costs 50, 000
Production manager’s commission 3,000
Manufacturing expenses 40,000
Plant maintenance 30,000
Insurance
-Production machines 25,000
-Delivery vans 15,000
Head office salaries 10,000
General expenses 2,000
Sales promotion 1,500
Depreciation of Office buildings 1,000
Salesmen commission 800

The stock records disclosed the following balances

1/1/2003 31/12/2003
(UGX.000) (UGX.000)
Raw materials 4,000 3,000

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Work in progress 3,000 4,500
Finished Goods 100,000 150,000

Required
Prepare the Company’s manufacturing, trading and profit and loss account for the year ended
31st December 2003

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 Topic 13
Control accounts and reconciliations

Learning objectives
By the end of this Topic, you will be able to:
Explain the nature and function of control accounts
Illustrate typical entries in a control account
Prepare control accounts proving the accuracy of the accounts receivable and accounts
payable ledgers.

Introduction

The whole process of bookkeeping revolves around the idea that the records ‘balance’; every
debit has a credit and the total of the debits equals the total of the credits. In other words, if
there are no errors in the records, the trial balance will balance.

If the trial balance does not balance, the difference has to be found. In a system that is not
computerized, it may take a lot of expensive time and effort to find the difference. However,
there is a technique which simplifies the process considerably – balancing sections of the
bookkeeping system separately.

Earlier in the text, we saw that the ledger is broken down into three parts: accounts receivable
ledger, accounts payable ledger and the general ledger. In most businesses, by far the greatest
volume of entries passes through the accounts receivable and payable ledgers. It is fairly easy
to prove the accuracy of the accounts receivable ledger and the accounts payable ledger
separately. The techniques of doing so are the subject of this Topic.

A control account is defined as a summary account appearing in the general ledger for the
purpose of controlling all the detailed entries in the ledger to which it relates – in short, it is an
account in which a record is kept of the total value of a number of similar but individual items.
Control accounts are used chiefly for debtors and creditors.

Examples of control accounts include;

 Debtors control a/c or Accounts receivable control a/c
 Creditors control a/c or Accounts payable control a/c
 Etc

Note; The balance of the control a/c should be the same as the sum of all individual ledger
balances to which it relates e.g. X ltd had the following debtors for the year ended 31.3.2004
Peter 200,000/=
Joy 300,000/=
Therefore at the year-end 31.3.2004, the debtors control a/c would have a balance of 500,000/=

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Control account reconciliations
The objective we have in this Topic is to establish a technique for proving the correctness of a
section of the bookkeeping system. Let us take the accounts receivable ledger/debtors ledger
first.

Proving the accuracy of the debtor’s ledger entries

The total of the debtor’s ledger balances is the key to the operation. We can establish,
independently of the accounts receivable ledger, a control total with which the total of these
balances can be agreed.

The entries in the accounts receivable ledger come predominantly from:

Sales journal -credit sales
Cashbook -Cash received from customers
Cashbook discount column -Discount allowed

There will be some other minor items like bad debts written off and, of course, the balances
brought forward from the previous period. It is possible to obtain the totals of these items
without reference to the accounts receivable ledger as all the information will be readily
available. Fore example;

Item Source of total

Opening balances List of last month’s balances
Credit sales Total of sales journal
Cash from customers Accounts receivable ledger (debtors’ ledger) column in the cash book
(We mean the analyzed cash book
Discounts allowed Discounts columns in the cash book

All these items are put together in a ledger account in the general ledger – the Account
receivable/debtors’ ledger control account. An example of the format appears below

Sales ledger or Debtors’ control A/c

Bal b/f xx Returns in wards xx
Credit Sales xx Cash/cheques received from debtors xx
Debtors’ cheques dishonored xx Discounts allowed xx
Debtors’ refund for over payments xx Bad debts written off xx
Bal c/f xx
x xx xxx

Note that the items appear on the same side as that on which the individual items appear in the
accounts receivable ledger. We have include the position of the returns inwards/ sales returns –
it would of course, be obtainable from the sales returns journal.

The balance c/f would then be agreed with the total of the accounts receivable ledger balances

One important point has been cleared up. We have introduced a third entry into our double
entry system. The debtors/accounts receivable ledger balances total (Bal.c/d), and the control
account does also. Only one of them features in the list of account balances (trial balance). So

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now, which is within the double entry system and which is the memorandum?. It is possible to
regard the control account as the double entry record, and the accounts receivable ledger as the
memorandum or vice versa.

Proving the accuracy of the accounts payable (creditors) ledger

Exactly the same process is followed to agree the accounts payable ledger by preparing an
accounts payable ledger control account which leads to a balance with which the total of the
accounts payable ledger balances can be agreed.

As well as the items covered so far, several others can appear:

Accounts receivable ledger control account Accounts payable ledger control account
Cash refunds to customers Cash refunds from suppliers
Bad debts written off

One other additional item appears in most examination questions on control accounts – the
Contra. A contra is a transfer between two ledger accounts for the same person. It sometimes
happens that a customer in the debtors’ ledger is also a supplier in the creditors’ ledger. In
many cases, the accounts are settled by each party paying the other in full for the goods
supplied. However, it is possible to set off the balances and for the party with the greater
balance to pay the difference (see the question in the exercises for such a scenario).

The most important point to grasp about contras is that they must appear in both the accounts
receivable ledger and accounts payable ledger, and therefore must necessarily be in both the
accounts receivable ledger control account and accounts payable ledger control account.

A format for the Purchases ledger (accounts payable) control account now appears

Purchases ledger (creditors) control A/c

Returns outwards xx Bal b/f xx
Payments to creditors xx Credit purchases xx
Discounts received xx Cheques written to creditors dishonoured xx
Bal c/f xx Refunds from creditors for over payment xx
xxx xxx

Reconciling Items
In practice (and in examination questions) the balance on the control account may not agree
with the total of the ledger accounts, and in such an instance the causes of the difference must
be identified and adjustments made where necessary. Such differences may be caused by:
Errors in the accounts receivable or accounts payable ledger control accounts
Errors in the accounts receivable or accounts payable ledger
Errors in both the control accounts and the ledger accounts

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Advantages of control accounts
1. Detection of fraud;
Control a/cs are usually prepared by responsible officials who have the responsibility of
controlling fraud, and since all entries pass through these accounts,
management/officials will be able to identify the fraud committed by manipulation of
accounts in the ledger. This helps to strengthen the organization’s internal control
systems.
2. Checking errors;
Since the balance of the control a/c has to reconcile with the total of individual
ledger balances, any mistake will be easily detected or located and corrected.
3. Improving management efficiency;
Control accounts enhance management efficiency because creditors’ and debtors’
balances can be obtained at first glance on a duly balanced-off (closed) control account.
This saves time that would have been wasted in balancing off and adding up individual
debtors and creditors balances.
4. Enhancing decision making;
Decisions relating to how much should be sold on credit, provisions to be made for bad
& doubtful debts on these sales, and how much to be bought on credit are easily
reached by looking at the outstanding balances on the Debtors’ and Creditors’ control
accounts.
5. Determination of credit sales and credit purchases;
In single entry & incomplete records, and in receipts and payments a/c, the credit sales
and credit purchases are often missing. These figures can be determined by
constructing control a/c

Illustration 1
The following details were extracted from the books of a company for the year ended
31.12.2003. (UGX)
Debtors balance 1.1.2003 1,600,000
Creditors balance 1.1.2003 2,300,000
Cash paid to suppliers 7,000,000
Cash received from debtors 15,000,000
Credit purchases 12,000,000
Discounts received 670,000
Bad debts written off 140,000
Sales returns 490,000
Purchases returns 590,000
Debtors cheque dishonoured 450,000
Discount allowed 650,000
Credit sales 26,500,000
Required; Draw up the debtors’ and creditors’ control accounts.

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Solution
Debtors control A/c
Bal b/d 1,600,000 Cash 15,000,000
Debtors cheque dishonored 450,000 Bad debts written off 140,000
Sales returns 490,000
Discount allowed 650,000
Credit sales 26,500,000 Bal c/d 12,270,000
28,550,000 28,550,000

Creditors’ control A/c

Cash paid to suppliers 7,000,000 Bal b/d 2,300,000

Discount received 670,000 Credit purchases 12,000,000
Purchases returns 590,000
Bal c/d 6,040,000
14,300,000 14,300,000

Agreement of the control account balance with the sum of the balances on the underlying
accounts

Example
The following example illustrates the types of problem likely to arise in such a system. Full
explanations of the amendments are given – such explanations would not normally be
necessary in the examination question. This illustration and the entries to correct the errors are
based on the accounts payable ledger control account being in the double entry system.

Kagutema’s accounts payable ledger control account is an integral part of the double entry
system. Individual ledger account balances are listed and totaled on a monthly basis, and
reconciled to the control account balance. Information for the month of March is as follows;
1. Individual ledger account balances at 31 March have been listed out and totaled as
follows;
Total of debit balances GX.1, 012,000
Total of credit balances UGX.20, 778,000
2. The accounts payable ledger control account balance at 31 March is UGX.21, 832,000
(net).
3. On further examination the following errors are discovered;
The total of discount received for the month, amounting to UGX.1, 715,000,
has not been entered in the control account.
On listing-out, an individual credit balance of UGX.205,000 has been
incorrectly treated as a debit

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 A petty cash payment to a supplier amounting to UGX.63,000 has been
correctly treated in the control account, but no entry has been made in the
supplier’s individual ledger account
The purchases journal total for March has been under-cast (understated) by
UGX.2, 000,000.
Contras (set-offs) with the accounts receivable ledger, amounting in total to
UGX.2,004,000, have been correctly treated in the individual ledger accounts
but no entry has been made in the control account.

Required
a) Prepare the part of the accounts payable ledger control account reflecting the above
information.
b) Prepare a statement reconciling the original total of the individual balances with
corrected balance on the control account.

Solution

The way to approach the question is to consider each of the above five points in turn and ask to
what extent they affect (a) the accounts payable ledger control account and (b) the listing of
accounts payable ledger balances.
Step 1
The total of discount received in the cash book is dealt with by debiting accounts payable
ledger control account and crediting discount received. Thus, if the posting has not been
entered in either double entry account it clearly should be.

As the individual ledger accounts in the accounts payable ledger are posted individually from
the cash payments book, the total of discount received will not feature in any postings to the
accounts payable ledger; hence no amendment is required.
Step 2
Individual credit balances are extracted from the accounts payable ledger. Here, this error
affects the totals of the debit and credit balances of the ledger account balance. No adjustment
is required to the control accounts.
Step 3
The question clearly states that the error has been made in the individual ledger accounts.
Amendments should be made to the list of balances. Again, no amendment is required to
control accounts.
Step 4
The total of the purchases journal is posted by debiting purchases and crediting accounts
payable ledger control account. If the total is understated, the following bookkeeping entry
must be made, posting UGX.2, 000,000 under-statement
Dr. Purchases
Cr. Accounts payable ledger control
As the individual ledger accounts in the accounts payable ledger are posted individually from
the purchases journal, the total of the journal being understated will not affect the listing of the
balances in the accounts payable ledger.
Step 5

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Here it is clear that the error affects the control account, not the accounts payable ledger.
Correction should be made by the bookkeeping entry:
Dr. Accounts payable ledger control
Cr. Accounts receivable ledger control
Accounts payable ledger control account

Discount received (S1) 1,715,000 1 March Balance (Net)

21,832,000
Accounts receivable ledger control (S5) 2,004,000 Purchase (S4) 2,000,000
Balance c/d 20,113,000
23,832,000 23,832,000

Reconciliation of individual balances with control account balance

DR (UGX.) CR(UGX.)
Balances extracted 1,012,000 20,778,000
Credit balance incorrectly treated 2*205,000 (S2) 410,000
Petty cash payment (S3) 63,000
1,075,000 21,188,000
1,075,000
Net total agreeing with control account 20,113,000

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