ACCOUNTING AND FINANCE

ESSENTIAL STUDY GUIDE

CONTAINING UNIT 2 REVISION NOTES

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UNIT 2A

REVISION NOTES

SOLE TRADER BANK LOAN RENT PAYEE DRAWEE BANK OVERDRAFT

CAPITAL LEASE CHEQUE

MORTGAGE INTEREST DRAWER BANK STATEMENT

CHEQUE COUNTERFOIL CURRENT ACCOUNT

STARTING UP IN BUSINESS SOLE TRADER is the name given to a business that is set up and managed by one person. The money invested in it by its owner is called CAPITAL. Sole Traders make their own decisions, can keep any profits but must also suffer any losses. Premises will be required which could be purchased with a MORTGAGE (ie borrowing from a bank or building society) or if this is not possible other options are to RENT (pay monthly to the owner for use of the property) or LEASE (purchase for a fixed period only). In order to set up a business the sole trader may need to borrow money from a bank. A BANK LOAN is taken out for a fixed period of time eg 10,000 over a 5-year period. The whole amount is immediately available for use by the business. The loan has to be paid back in regular payments eg monthly, together with a rate of INTEREST as set by the Bank. Here is an example: LOAN TOTAL TO BE REPAID MONTHLY REPAYMENT 10,000 over 5 years with a 15% interest rate 10,000 + 1,500 interest = 11,500 11,500 60 months = 192 each month

The most common type of Bank Account used by businesses is a CURRENT ACCOUNT. Money is withdrawn from a Current Account by completing a CHEQUE. A cheque is a written order from the account holder (the drawer) to the bank (the drawee), to pay a specified amount of money from the holders account to the person or firm named on the cheque (the payee).
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ACCOUNTING AND FINANCE Going Solo The 3 parties involved in a cheque: 1 2 3

UNIT 2B

REVISION NOTES

The Drawer the person who writes out the cheque ie pays the money The Payee - the person or firm being paid The Drawee the drawers bank

Here is an example of a cheque it must show: the amount in words and figures the date on which the cheque is written the signature of the drawer
the drawee the payee
bank sort code
32 80 32

Tayside Bank

Tayside Bank

Pay
(Desk) 150 -

Frasers

One Hundred and Fifty Pounds only

150 ----------Jean

the drawer

000462351 0321

counterfoil

account no

cheque no

The CHEQUE COUNTERFOIL is the part that stays in the drawers cheque book after paying the cheque over and is a record of who, when, how much and what was being paid for eg a new piece of office equipment or a heating and lighting bill. The bank CURRENT ACCOUNT in the ledger will normally have a debit balance and is an asset in the Balance Sheet but when the amount paid out of the account is greater than the balance in the account, there is a BANK OVERDRAFT ie a credit balance and this is a liability in the Balance Sheet. It is possible for the account holder to pre-arrange with the bank to have overdraft facilities up to a certain limit, sometimes interest-free. If the overdraft limit is exceeded or has not been pre-arranged with the bank then interest will be charged on the amount overdrawn. The interest charged by the bank is an expense in the Profit and Loss Account. Each month the bank sends account holders a BANK STATEMENT detailing all money paid in and out of the account during the month.
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UNIT 2C

REVISION NOTES

INVOICE CREDIT NOTE RECEIPT CHEQUE PURCHASES

COPY INVOICE COPY CREDIT NOTE COPY RECEIPT VAT BANK STATEMENT CASH DISCOUNT SALES

THE LEDGER This is the section of a firm's books in which individual accounts are kept on a double entry basis. Each transaction generates a document which contains the information that is posted (entered) into the relevant accounts. An INVOICE is the bill sent by the seller to the buyer who has purchased on credit. It shows the date, quantity, description, unit price, total price, trade discount, VAT and the terms of payment for the PURCHASES of goods (stock) bought for re-sale. VAT is a tax paid on SALES by the buyer and is collected for the Customs and Excise by the seller. It is charged on sales after all discounts have been deducted. For VAT purposes it must be assumed that the customer will pay the account promptly enough to qualify for any CASH DISCOUNT offered as an incentive to pay on time. Example Terms 5% Cash Monthly:Goods Less 10% Trade Discount Net Goods Value Add VAT Total Value of Goods 120.00 12.00 108.00 17.96 125.96

VAT WORKINGS:
Net Good Value Less 5% Cash Discount Value on which VAT is charged VAT at 17.5% (102.60 x 17.5%) 108.00 5.40 102.60 17.96

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UNIT 2C

REVISION NOTES

COPY INVOICE is the document kept by the seller and entered into SALES account. CREDIT NOTE is the document sent by the supplier to the customer who has returned goods which are faulty or damaged. This is posted to the PURCHASES RETURNS ACCOUNT (also known as Returns Outwards Account). COPY CREDIT NOTE is the document kept by the supplier and used to enter into the SALES RETURNS ACCOUNT (also known as Returns Inwards Account). A RECEIPT is the document given to a customer paying in cash or by cheque. The Receipt is used to enter into the customer's CASH OR BANK ACCOUNT. COPY RECEIPT is the document kept by the supplier and posted to the supplier's CASH OR BANK ACCOUNT to summarise:SOURCE DOCUMENT Invoice Copy Invoice Credit Note Copy Credit Note Cheque Cheque Counterfoil Receipt Copy Receipt Till Roll KIND OF TRANSACTION Credit Purchase Credit Sale Purchases Returned on credit Sales Returned on credit Payment Received Payment out of Bank Payment out of Cash/Bank Received Cash/Bank Cash Sales POSTING TO ACCOUNTS Dr Purchases Dr VAT Cr Creditor Dr Debtor Cr Sales Cr VAT Dr Creditor Cr Pur Returns Cr VAT Dr Sales Returns Dr VAT Cr Debtor Dr Bank Cr Debtor Dr Creditor or Expense Cr Bank Dr Creditor or Expense Cr Cash/Bank Dr Cash/Bank Cr Debtor Dr Cash Cr Sales Cr VAT

TRIAL BALANCE The accuracy of the double entry in the ledger should be checked on a regular basis (eg weekly) by transferring the ledger account balances to a Trial Balance. The total of the debit balances should equal the total of the credit balances. In the trial balance the following types of accounts have:
DEBIT BALANCES Asset accounts Expense accounts Purchases account Sales Returns account Debtors' accounts Discount allowed account Drawings Accounts VAT (debit balance) CREDIT BALANCES Gains accounts Sales account Purchases Returns account Creditors' accounts Discount Received account Capital account Bank Overdraft VAT (credit balance)

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UNIT 2D

REVISION NOTES

TRADING AND PROFIT AND LOSS ACCOUNT TRADING ACCOUNT GROSS PROFIT PROFIT AND LOSS ACCOUNT NET PROFIT RETURNS IN CARRIAGE IN BAD DEBTS DISCOUNT ALLOWED DRAWINGS FINAL ACCOUNTS Once the balances have been gathered together in the Trial Balance, this provides the information to complete the Trading and Profit and Loss Account and Balance Sheet these 2 statements together comprise the final accounts which, by law, must be prepared at least once a year. A TRADING AND PROFIT AND LOSS ACCOUNT is a statement in which the profit made from buying and selling (trading) goods over a period of time is calculated. The TRADING ACCOUNT is the section where all the figures relating to trading (buying, selling and returning) goods go. It is where the cost of the goods sold to customers (COST OF SALES) is deducted from the amount charged to customers, to leave GROSS PROFIT ie the profit before paying EXPENSES (the regular bills that firms have to pay). In the PROFT AND LOSS ACCOUNT we add on to Gross Profit, any GAINS ie items received by the firm eg COMMISSION RECEIVED on sales and rent received from someone you sub-let part of your premises to, before deducting all expenses for the period.
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COST OF SALES EXPENSES GAINS NET LOSS RETURNS OUT CARRIAGE OUT COMMISSION RECEIVED DISCOUNT RECEIVED

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UNIT 2D/E

REVISION NOTES

EXPENSES (such as Heating & Lighting, Wages, Salaries and Carriage Out) are paid for out of gross profit leaving NET PROFIT (profit after expenses). If total expenses are higher than gross profit then a NET LOSS is recorded. RETURNS IN, otherwise known as Sales Returns, is the value of the goods brought back by customers because they are faulty, damaged or not as ordered. This is deducted from Sales to give Net Sales in the Trading Account. RETURNS OUT, otherwise known as Purchases Returns, is the value of the goods returned to suppliers because they are faulty, damaged or not as ordered. This is deducted from Purchases to give Net Purchases in the Trading Account. CARRIAGE OUT is the cost of transporting goods sold to customers. This is an expense in the Profit and Loss Account. CARRIAGE IN is the cost of delivery charged on Purchases and is added to the cost of Purchases in the Trading Account ie it is part of the Cost of Sales. (CASH) DISCOUNT ALLOWED is a reduction given to debtors to encourage them to pay promptly and is treated as an expense in Profit and Loss. (CASH) DISCOUNT RECEIVED is a reduction given by creditors to encourage us to pay them promptly. BAD DEBTS are debtors who, after all attempts have been made to collect what is owed by them, still fail to pay, their debt is eventually written off. This involves crediting their account in the ledger to close it down and debiting the Bad Debts Account. The balance of the Bad Debts Account is an expense in Profit and Loss. COMMISSION is money paid to encourage higher sales. When it is paid to the firm's salespeople then it is an expense. COMMISSION RECEIVED is when the firm is given a reward for selling more of the manufacturer's products. It is a Gain and therefore added to Gross Profit in the Profit and Loss Account. CASH DISCOUNT This is a financial incentive to pay promptly. It benefits firms who trade on credit to collect the money owed to them quickly as this allows the firm to pay its creditors on time. Terms can be offered eg 5% monthly, which means if a firms pays its debt before the end of the following month, they will get another 5% off their bill. It is important that when VAT is calculated for the Invoice it is on the cost of goods after both Trade and Cash Discounts (it has to be assumed that customers will pay in time to qualify for the Cash Discount also).
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UNIT 2D

REVISION NOTES

CASH BUDGET CLOSING BALANCE

OPENING BALANCE

A CASH BUDGET is a statement prepared to forecast how much cash will be left at the end of the coming week, month or year. It shows the OPENING BALANCE (the amount in the Bank at the beginning of the period) plus all cash coming in, less all cash going out, to arrive at the CLOSING BALANCE (the amount in the Bank at the end of the period). Reasons for preparing a Cash Budget are to: calculate how much is expected to come in during the coming week/month/year calculate how much cash is expected to be spent during the coming week/month/ year show how much cash is likely to be left at the end of the coming week/month/year plan future spending predict the likelihood of running short of cash (liquidity problems) tell how long it will take to reach a certain target for the bank balance help judge if items of spending or borrowing can be afforded. CASH BUDGET Jan Opening Balance Add Receipts: XXX XXX Total Receipts Receipts + Opening Bal Less Payments: XXX XXX Total Payments Closing Balance
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Feb

Mar

Apr

May

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UNIT 2F

REVISION NOTES

BREAK EVEN ANALYSIS VARIABLE COSTS BREAK-EVEN POINT

FIXED COSTS TOTAL COSTS CONTRIBUTION

VARIABLE COSTS BREAK-EVEN POINT ROYALTIES

BREAK-EVEN ANALYSIS is used to show the level of sales required to just cover all the costs, making neither a profit nor a loss. FIXED COSTS are those that remain the same regardless of the level of sales and which must be paid even if no sales are made eg rent. VARIABLE COSTS vary directly with the level of sales eg Roylaties. ROYALTIES are paid to the owner of a design or name for using it. TOTAL COSTS is Fixed Costs plus Variable Costs. BREAK-EVEN POINT is the number of sales at which neither a profit nor loss is made. CONTRIBUTION is the selling price minus the variable cost per unit. BREAK EVEN CHART: It is a line graph plotting Sales Revenue and Total Costs - the break even point is indicated where the two lines cross. This shows the level of sales needed to cover all costs. May not give as accurate a reading as the formula method.

BREAK EVEN CHART

1200 1000 800 600 400 200 0 1 3 5 7 NO OF UNITS
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COSTS AND REVENUE

Sales Revenue Total Costs

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UNIT 2F

REVISION NOTES

BREAK EVEN FORMULA: Break Even Point (in units) = Total Fixed Costs Contribution per unit (ie Selling Price-Variable Cost) Break Even Point (sales revenue) = Break Even Point in units X Selling Price BREAK EVEN SCHEDULE: This is a table which lists units, fixed costs, variable costs, total costs and sales revenue The break even point is the number of units at which total costs = sales revenue
Units 0 1,000 2,000 3,000 4,000 5,000 Fixed Costs 3,000 3,000 3,000 3,000 3,000 3,000 Variable Costs 0 2,000 4,000 6,000 8,000 10,000 Total Costs 3,000 5,000 7,000 9,000 11,000 13,000 Total Sales Revenue 0 3,000 6,000 9,000 (this is break even point) 12,000 15,000

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