Chapter 4 - Ledger Accounting and Double Entry

Question 1

What is a nominal ledger?

Answer 1

Nominal ledger: The main accounting record in which financial transactions are recorded.

The nominal ledger contains details of assets, liabilities, capital, income and expenditure, and therefore profit and loss. It consists of a large number of different ledger accounts (T accounts), each account having its own purpose or ‘name’ and an identity or code.

Each items within the SOFP and SPL will have its own ledger account

Question 2

How is a ledger / T account presented?

Answer 2

T shape

Debit the left, credit on the right.

                                    £       |                                           £ Date  Narrative   ref              |  Date  Narrative   ref       
                                             | 
                               \_\_\_\_\_\_\_  |                                      \_\_\_\_\_\_\_
                               TOTAL  |                                      TOTAL

Question 3

What is double entry bookkeeping?

Answer 3

Each transaction has an equal but opposite effect. Every accounting event must be entered in ledger accounts both as a debit and a credit.

Central to this process is the idea that every transaction has two effects, the dual effect (also known as the duality concept).

Question 3

What is the format of a journal?

Answer 3

Date Debit Credit
£ £
Account to be debited X
Account to be credited X

A narrative explanation should accompany each journal entry. It is required for audit and control, to indicate the purpose and authority of every transaction.
A computerised accounting system will not allow a journal entry to be processed if the debit entries do not equal the credit entries.

Question 4

When do we use journals?

Answer 4

Journals can be used to record any type of financial transaction but are mainly used to record transactions that are one-off or unusual in nature.

A narrative explanation should accompany each journal entry. It is required for audit and control, to indicate the purpose and authority of every transaction.
A computerised accounting system will not allow a journal entry to be processed if the debit entries do not equal the credit entries.

Question 5

If we need to top up the cash float to the imprest amount for petty cash by a payment of £54.50 from the business bank account, what would the journal look like?

Answer 5

Date Debit Credit
£ £
Petty Cash 54.50
Cash at bank 54.50

Question 6

What is a receivables ledger? (2)

Answer 6

The receivables ledger is where the individual ledger accounts for each credit customer (personal accounts) are listed.

A total receivables account is held in the nominal ledger, called trade receivables.

Question 7

What is a payables ledger? (2)

Answer 7

The payables ledger is where the individual ledger accounts for each credit supplier (personal accounts) are listed.

A total payables account is held in the nominal ledger, called trade payables.

Question 8

NEED TO LOOK INTO

Memorandum accounts

Answer 8

Nominal ledger accounts relate to types of income, expense, asset, capital and liability – rent, sales, trade receivables, payables and so on – but do not record individual details relating to the person or business to whom the money is paid or from whom it is received. Therefore, there is also a need for personal accounts, most commonly for receivables and payables, and these are contained in the receivables ledger and the payables ledger. These are memorandum accounts only, in memorandum ledgers; they are not part of the double entry system. Instead trade receivables and trade payables accounts are kept in the nominal ledger which record the totals of the receivables and payables ledgers.

In a manual system of accounting, the receivables and payables ledgers would be updated separately from the nominal ledger. It was therefore possible that, due to errors, there would be differences between balances in the receivables and payables ledgers and the totals in the nominal ledger.
In a computerised accounting system, sales and purchase invoices, credit notes and payments are recorded in the receivables and payables ledgers which will then automatically update trade receivables and trade payables in the nominal ledger. The total of the individual accounts in the receivables ledger at any point in time will be exactly equal to the total included in trade receivables, and the same will apply to the individual accounts in the payables ledger and trade payables.

The receivables and payables ledgers are a key source of information for the purpose of understanding who an entity’s receivables and payables are and what the balance owed from and to them is. It is important for you to understand that whilst these accounts hold important accounting information, these are not part of the nominal ledger system.

Question 9

What is a trade discount? (3)

Answer 9

Trade discount: A percentage discount deducted from the list price of goods owing to the nature of the trading transaction.

It is always deducted from the list price in arriving at the sales/purchases figure for double entry purposes

Recorded net of discount

Accounting for trade discounts
* Purchases should be recorded net of trade discounts received from suppliers.
* Sales should be recorded net of trade discounts given to customers.
Trade discounts should be deducted before any early settlement discount is calculated.

Question 10

What is an early settlement discount?

Answer 10

Early settlement discount: A percentage reduction in the amount payable in return for payment within an agreed period.

Sales should be recorded net of early settlement discounts taken by customers. However, at the point of invoice, when the sale is recorded in the accounting system, the business does not know whether or not the customer will take the early settlement discount offered. Therefore, when the sale is recorded, the business should determine whether they expect the customer to take the discount, or not, based on their knowledge of the customer and whether the customer has previously taken advantage of such discounts, and record the sale accordingly.
If, when payment is made, the customer does not behave as expected, eg, does take a discount when they were not expected to, the accounting records are adjusted to reflect the full gross value of the goods sold.

Question 11

Summary of accounting treatment for early settlement discounts (see table)

Answer 11

Summary of accounting treatment for early settlement discounts (see table)

Question 12

What is VAT?

Answer 12

Value added tax (VAT) is an indirect tax on the supply of goods and services.

Tax is collected at each transfer point in the chain from prime producer to final consumer. Eventually, the consumer bears the tax in full and any tax paid earlier in the chain can be recovered by a registered trader who paid it.

Question 13

How does a computerised accounting system help with VAT? (2)

Answer 13

Standing data in computerised accounting systems will include a business’ VAT registration number and applicable VAT rates. This information is used to automatically calculate and record VAT on invoices.

A computerised accounting system will also support accurate record keeping for VAT purposes.

Question 14

What is output VAT?

Answer 14

VAT on Sales

VAT on sales (output VAT) is debited to receivables and credited to the VAT control account (it is owed to HMRC).

Question 15

What is input VAT?

Answer 15

VAT on purchases

VAT on purchases (input VAT) is debited to the VAT control account (it is due from HMRC) and credited to payables.

Question 16

How is VAT collected? (4)

Answer 16

Although it is the final consumer who eventually bears the full VAT, the sum is collected and paid by the traders who make up the chain, provided they are registered for VAT.

Each trader must assume that his customer is the final consumer:

• They must collect and pay over VAT at the appropriate rate on the full sales value (known as output tax) of the goods sold.
• They are normally entitled to reclaim VAT paid on his own purchases of goods, expenses and non- current assets (known as input tax) and so makes a net payment to the HMRC equal to the tax on value added by himself.

Question 17

How does VAT impact traders whose sales (outputs) are below a certain level?

Answer 17

Traders whose sales (outputs) are below a certain level need not register for VAT although they may do so voluntarily.

Question 18

How does VAT impact unregistered traders?

Answer 18

Unregistered traders neither charge VAT on their outputs nor are entitled to reclaim VAT on their inputs (assets/expenses). They are in the same position as a final consumer.

Question 19

How does VAT affect registered businesses? (2,3)

Answer 19

If they are conducting exempt activities - they can not charge (output VAT) or recover (input VAT)

If they are conducting taxable activities they can recover input and output VAT. Chargable at 3 rates:

1. Zero rate (printed books, newspapers, eggs, cakes)
2. Reduced rate (5% on domestic fuel)
3. Standard rate 20% (e.g. CDs, furniture)

Question 20

How often should businesses prepare a VAT return? (3)

Answer 20

Businesses prepare a VAT return which is submitted to HMRC. The frequency with which businesses prepare a VAT return and make payments to/reclaim amounts from HMRC depends on the amount of the taxable sales of the business, alongside other conditions such as the type of business, the history of preparing VAT returns on time and the history of making payments on time.

• The most usual position is to have to pay the net balance to HMRC (when output tax exceeds input tax) ie, the amount owed to HMRC is a payable.
• A trader who makes zero-rated supplies will have paid more input tax than it has received output tax, so will recover cash from HMRC, ie, the amount due from HMRC is a receivable.

Question 21

When is VAT irrecoverable? (3)

Answer 21

Where the trader suffers irrecoverable VAT as a cost, as in the following cases, VAT should be
included as an expense (it cannot be claimed as input tax).
* Traders not registered for VAT will suffer VAT on inputs as a cost. This will increase their expenses and the cost of any non-current assets they purchase.
* Registered traders who also carry on exempted activities may suffer VAT on certain inputs. This will increase the expense in respect of these inputs.
* Non-deductible inputs will be borne by all traders.
– VAT on cars purchased and used in the business is not reclaimable (VAT on a car acquired new
for resale, ie, by a car trader, is reclaimable).
– VAT on business entertaining is not deductible as input tax other than VAT on entertaining staff.
Where VAT is not recoverable it must be regarded as part of the cost of the items purchased and included in the statement of profit or loss or statement of financial position as appropriate.