Recording financial transactions

1.0 Introduction
Every time a transaction takes in an organization it has to be recorded on or in a document.
Transactions that take place in a business entity involve resources brought into or taken out of
the business entity. The accounting equation is shown below to show how resources are
accounted for in an organization.

2.0 The Accounting Equation

 Resources Supplied by the owner = Resources in the business

 The amount of resources supplied by the owner is called Capital. It is often called
owner's equity.

 The actual resources that are in the business are called assets.

 Therefore, Capital = Assets

 Liabilities: refers to amounts owing to other people rather than the owners to finance the
assets.

 The Accounting equation will change to Capital = Assets - liabilities

 To show the value represented by the resources in the business, the accounting equation
will change to:

 Assets = Capital + Liabilities

Resources: What they are = Resources: Who supplied them

(Assets) (Capital + Liabilities)

3.0 Source Documents

3.1 Definition

A source document is an individual record of a business transaction, for

example a sales invoice is a formal record of a sale having occurred.

3.2 Types of Source Documents

 Sales and Purchase orders

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A purchase order is an agreement to purchase goods/services from a business prepared by
the purchaser.

A sales order is an agreement to sell goods/services to a business prepared by the seller.

A sales or purchase order records an intended rather than actual transaction. Thus an
invoice is more important than the sales and purchase order in terms of recording
financial transactions.

 Invoices

When a business sells goods or services to a customer it sends a sales invoice to the
customer.

A sales invoice is a formal record of the amount of money due from the customer as a
result of the sales transaction. To the customer, the invoice represents a purchase and will
thus be referred to as a purchase invoice.

It is a essential document which provides the information which will be entered into the
accounting records of a business.

The invoice may contain the following information

o Name and address of seller and purchaser

o Date of sale

o Reference to the order

o Description of goods

o Amount due

o Terms of payment

o Vat number for a tax invoice

 Credit and debit notes

A credit note records goods returned by a customer or the reduction of monies owed by a
customer. The credit note is issued subsequently to a sales invoice and will refer to that
invoice. There are many reasons why the original sale may have been incorrect. Faulty
goods may have been supplied or the price charged on the invoice was incorrect.

A debit note is sometimes raised by a purchaser of goods and is a formal request for a
credit note to be issued by the supplier
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  Cheque tabs and Payment Vouchers

Cheque tabs record cheque payments by a business entity. They are used as a source
document to enter up the cash book particularly the bank column of the cash book.
Payment vouchers show the payments made by an organization to its suppliers and other
individuals it owes. It saves the same purpose as the cheque tabs, even though the
payment voucher may also record cash transactions.

 Other source documents

Source documents are not limited to the ones we have discussed above, for example offer
letters and loan deduction forms may be used as source documents to enter up the payroll
journal.

4.0 Accounting Records

Accounting records are any listing or book which records the transactions of a business in a
logical manner. Source documents are part of the accounting records of a business, but
information contained in them needs to be more clearly laid out. This is achieved by the use of
books of prime entry or day books.

The route by which transactions are recorded in the final output of the accounting system:
financial statements are as follows in order of the sequence.

 Transactions

 Day books (1st Store)

 Ledger accounts (2nd Store)

 Financial statements

1. Day books

Day books record the similar transactions of each day; they are used as the initial ‘store’ of
information of the business transactions prior to storing the information in the ledger
accounts. Their prime function is to list transactions of a common nature and these listings
will be used to make further entries in the accounting system. For example a sales day book
will list all the sales invoices raised by the business, and will contain sufficient information
about each sale so that further entries can be made at a convenient later date without having
to refer back to the sales invoices.

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2. Ledger account or T account

A ledger account or T account is where all transactions of a similar type are recorded, for
example all cash transactions or all purchases of fixed asset. All transactions affect the
accounting equation and could be recorded directly by drawing up a balance sheet, if we so
wished, though it is cumbersome in a practical in situation involving a large number of
transactions. The day books and ledger accounts are instead used to summarize all
categorizes of transactions so the balance sheet need only to be produced at intervals of, say,
twelve months.

3. The theory of double entry

Every transaction affects two items. Every time a transaction is recorded, both aspects must
be taken into account. Traditionally, one aspect is referred to as the debit side of the entry
(abbreviated to Dr) and the other as the credit side of the entry (abbreviated to Cr).

4. The double entry rules

A debit represents

 An increase in an asset

 A decrease in a liability

 An increase in an expense

 A decrease in income

 A loss

A credit represents

 A decrease in an asset

 An increase in a liability

 An increase in income

 A decrease in an expense

 A profit

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5.0 Recording transactions using the double entry rule

o Step one: since every transaction affects two items or accounts. The initial step is to
identify the two items or accounts affected by the transaction.

o Step two: the items affected need to be classified whether they are assets, liabilities,
expenses and or income.

o Step three; apply the double entry rule to record the transaction in the respective T
accounts identified.

Example

N’gundu is sole trader. The following transactions took place in the month June 2008.

a. Cash amount of K150, 000,000 was introduced into the business by the owners.

b. Machinery worth K40, 000,000 was bought by cash.

c. Cash purchases amounted to K5, 000, 000.

d. The company sold goods worth K7, 000,000 by cash.

e. Cash purchases amounted to K8, 000,000.

f. The company incurred sundry expenses worth K100, 000.

g. Cash sales amounted to K15, 000, 000.

h. The owner of the business had taken out K600, 000 cash for personal use.

i. Credit sales amounted to 8, 000,000.

j. Credit purchases amounted to K7, 000,000

k. He paid suppliers K300, 000.

l. He received K300, 000 from customers.

Task

Enter the transactions above in different ledger accounts?

Solution

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 Accounts identified Reasoning Debit (Dr) Credit (Cr)

(K’000) (K’000)
Cash account Increase in asset 150,000

Capital account Increase in liability to the owner 150,000

Machinery account Increase in asset 40,000

Cash account Decrease in asset 40,000

Purchases account Increase in expense 5,000

Cash account Decrease in asset 5,000

Cash account Increase in asset 7,000

Sales account Increase in income 7,000

Purchases account Increase in expenses 8,000

Cash account Decrease in asset 8,000

Sundry expense a/c Increase in expenses 100

Cash account Decrease in asset 100

Cash account Increase in asset 15,000

Sales account Increase in income 15,000

Drawings account Decrease in liability to the owner 600

Cash account Decrease in asset 600

Debtors account Increase in asset 8,000

Sales account Increase in income 8,000

Purchase account Increase in expense 7,000

Creditors account Increase in liability 7,000

Creditors account Decrease in liability 300

Cash account Decrease in asset 300

Cash account Increase in asset 300

Debtors account Decrease in asset 300

This is not really applicable in an exam situation, it is meant to help us reason how the
double entry works. Refer to the steps stated on how to record the transactions using the
double entry rule.

Ledger accounts

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 Cash account
Debit Credit

K’000 K’000

Capital 150,000 Machinery 40,000

Sales 7,000 Purchases 5,000
Sales 15,000 Purchases 8,000
Debtors 300 Sundry expenses 100
Drawings 600
Creditors 300
Balance c/d 118,300

172,300 172,300
Balance b/d 118,300

Capital account
Debit Credit

K’000 K’000
Balance c/d 150,000 Cash 150,000

Balance b/d 150,000

Machinery account
Debit Credit

K’000 K’000
Cash 40,000 Balance c/d 40,000

Balance b/d 40,000

Sales account
Debit Credit

K’000 K’000
Cash 7,000
Cash 15,000
Balance c/d 30,000 Debtors 8,000
30,000 30,000

Balance b/d 30,000

Debtors account

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 Debit Credit

K’000 K’000
Sales 8,000 Cash 300
Balance c/d 7,700
8,000 8,000

Balance b/d 7,700

Purchases account
Debit Credit

K’000 K’000
Cash 5,000
Cash 8,000
Creditor 7,000 Balance c/d 20,000
20,000 20,000

Balance b/d 20,000

Creditors account
Debit Credit

K’000 K’000
Cash 300 Purchases 7,000
Balance c/d 6,700
7,000 7,000

Balance b/d 6,700

Sundry expenses account

Debit Credit

K’000 K’000
Cash 100 Balance c/d 100

Balance b/d 100

Drawings account
Debit Credit

K’000 K’000

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 Cash 600 Balance c/d 600

Balance b/d 600

6.0 Balancing the ledger accounts

Ledger accounts need to be balanced before a trial balance is drawn up. Where there are several
entries in a ledger account, ledger balances are computed and can be shown in the ledger account
by carrying down and bringing down a balance in each ledger account.

The procedure for balancing ledgers accounts is as follows:

1) Add up the total debits and credits in each account and make a note of the totals

2) Insert the higher total at the bottom of both the debits and credits, leaving one line for the
inclusion of a balance carried down (c/d)

3) Then again total the two sides and the totals should equal and they should be level with
each other and must be underlined both on top and also at the bottom.

4) Enter on the side which has the lower arithmetical total, the narrative should read
“balance c/d” and an amount which brings the arithmetical total to the total that has been
inserted under step 2 above.

5) The same figure is then shown on the other side of the ledger account but underneath the
totals. This is the balance brought down (b/d). The balance c/d is known as the closing
balance while the balance b/d is known as the opening balance.

7.0 The trial balance

A trial balance is a memorandum listing all the ledger account balances. In an accounting context
memorandum means that the listing is not part of the double entry.

Information from the trial balance is used to test the accuracy of the posting to the ledger
accounts. A large number of transactions recorded in ledger accounts increase the possibility of
error occurring. Periodically some assurance is required as to the accuracy of the procedures and
postings to the ledger accounts. The same information is also used to draw up the trading and
profit and loss account and also the balance sheet.

If the double entry procedures have been carefully followed, the trial balance should show that
the total of the debit balance agrees with the total of the credit balances. In other words, with
proper accounting entries, the trial balance should be able to balance as the debit totals should
agree with the credit totals in compliance with the rule of double entry.

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8.0 References

1) AT Foulks Lynch Ltd, (1997), Financial accounting, National Accounting Technicians.

2) Frank Wood & Alan Sangster, (2005), Business Accounting, Tenth Edition.

F.K.Musweu

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