Financial Accounting: Types of Business Transactions, Principles, Bank Reconciliation
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This document provides an understanding of financial accounting, including types of business transactions, fundamental principles, and bank reconciliation. It covers scenarios related to journal entries, ledger accounts, trial balance, and comparative analysis. The document also includes a case study on the business of Kate and Carol Andrew.
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HNBS 310 Financial Accounting 1
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Contents Contents...........................................................................................................................................2 INTRODUCTION...........................................................................................................................3 SCENARIO 1..................................................................................................................................3 Question 1: Analyse types of business transaction......................................................................3 Question 2: Business of Kate.......................................................................................................5 Question 3: Comparative analysis.............................................................................................11 Question 4: Fundamental principles of accounting...................................................................12 Question 5: Business of Carol Andrew.....................................................................................13 SCENARIO 2................................................................................................................................15 Question 1: Bank reconciliation................................................................................................15 Question 2: Control accounts.....................................................................................................16 Question 3: Suspense account...................................................................................................17 Question 4: Business of Mr. Akram..........................................................................................18 Question 5: Business of Milky..................................................................................................20 CONCLUSION..............................................................................................................................21 REFERENCES..............................................................................................................................22 2
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INTRODUCTION Financial accounting is a procedure of developing and analysing the financial statements of a business organisation. This process of accounting is a skilful set of multiple functions that includes vouching of transaction, recording to vouchers in journal books, classifying all the transitions in appropriate ledgers, development of final accounts and then finally analysing those final accounts(Phillips, Libby and Libby, 2011). The main aim of this report is to develop an understanding about various processes of financial accounting. In order to fulfil this aim, the present report is categorised into two financing scenarios. The first scenario will include development of journal entries leger accounts, trial balance and final accounts along with the theoretical descriptive of types of business transactions and the principles that are used in financial accounting. In the second scenario of this report, bank reconciliation statement will be developed along with control and suspense account. These practical statements will be developed along with their theoretical descriptions. SCENARIO 1 Question 1: Analyse types of business transaction Various types of business transaction A business transaction is the basic unit while undertaking a business; such transaction is an event of exchange of services, goods or money of business with certain parties. There are various types of business transaction which are categorised on different criterions. These criteria ofcategorisingbusinesstransactionsincludeinstitutionalrelationship,exchangeofcash, visibility and objective. Here, the criteria of institutional relationship are used according to which there are widely two types of business relationships that are internal and external(Porter and Norton, 2012). Internal transactions – These transactions are the events which are conducted between business and internal stakeholders of the organisation such as drawings, depreciation, salaries to employees and more. Drawing is a transaction when the owner of an organisations draws money from the business for personal use. Depreciation is a kind of transaction when organisation charges depreciation on their own assets to deplete the value of an asset. Lastly, salary or wage is a transaction in which organisation pays money to their employees who are the internal stakeholders against their contribution in the firm. 4
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External stakeholders – These transactions are the exchange of goods, services or money betweenorganisationtoexternalstakeholders;suchtransactionsincludesale,purchase, borrowing and more. The transaction of sale is done between business and the customers in exchange money or credit. The transaction of purchase is done between business and suppliers in exchange of cash or credit where business procures raw material from suppliers. The transaction of borrowing is done between business and financial institutions where business borrows money in order to grow their organisational functions in exchange of interest(Porter, 2019). Defining single entry and double entry book keeping Book keeping system is the procedure of recording all the business transactions, there are two types of techniques of maintain book keeping which single entry and double entry. The single entry book keeping system includes two column ledger which all the business transactions are recorded individually without any reference of different ledger accounts due to which it is only appropriate for small business having less number of transactions. Double entry book keeping system is complex system which includes three column ledger in which every transaction has an impact on two accounts and is recorded into debit and credit columns. This system is appropriate for all types of organisations. In order to better understand these system, the example of format of such systems is represented below: Single entry book keeping Transaction descriptionAmount Purchase 100 books from ABC suppliers500 Double entry book keeping ParticularsDebitCredit Purchases accountDr.500 To ABC suppliers Ltd. account500 Explaining trial balance and its importance Trail balance is a financial statement which is mandatory to be developed by a business as it acts as base for the development of final statements. The trial balance is a summary of all the ledger account balances in which both the sides of trial balance which is debit and credit must be equal(Schroeder, Clark and Cathey, 2019). There are various points which can represent the importance of trial balance stated below: 5
ď‚·Trial balance is developed for every year and includes balances of all the accounts due to which it plays an important role in comparative analysis as an organisation can easily compare their yearly financial position. ď‚·Trial balance holds a significant position when it comes to audit as trial balance helps auditors to locate every disperancy to its original account and ultimately assist in giving a true and fair judgement for a business. ď‚·Another importance of trail balance is that it helps in checking arithmetic accuracy. As trial balance is developed using double entry book keeping system, it has become easier to check whether the financial reports of an organisation are appropriately developed or not by ensuring both sides of the trail balance are equal. Question 2: Business of Kate Journal entries 6
Ledger accounts 7
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Question 3: Comparative analysis Basis of differenceFinancial reportFinancial statement Definitionand meaning A financial report is a report of a businessorganisationthat includesmonetaryinformation regardingtheoperationsofthe organisation. These type of reports are prepared by an organisation at a regular interval such as once in a quarter or once in a year. A financial statement is a formal documentofabusiness organisationwhichincludes information about the operational financialpositionofan organisation. Thesetypeofstatementsare developedattheendofevery financial years and are regarded as formalfinancialevidenceofan organisation(Thornton, 2018). Why these reports are needed Financial reports are prepared by anorganisationinorderto communicatetheinformation regardingthecompanytothe public. Financial reports are the combinationoffinancial statementswhicharepublished by an organisation and required bytheorganisationtomake effective decisions. Financial statements are of various typesandeachofthemare prepared with their own purpose. The income statement is needed to identify the profit earned by the organisation so that investors and shareholderscandecidethat whether an organisation is worth investing or not. The statement of financial position is prepared to identify the level of liquidityofanorganisation.By whichcreditorsandsuppliers decidewhethertheyshould provide credit to the organisation not. Who are the different users Users of financial reports variates accordingtothenatureof On the other hand, all the financial statements of an organisation are 12
financial reports. Reports such as annual and quarterly are used by allthestakeholdersofthe organisationincluding employees,Boardofdirectors, suppliers,government,creditors andmore.Buttherearesome internal financial reports such as inventoryreportandaccounts ageing report which are only used andaccessedbytheinternal parties of the organisation such as managersandBODs(Zhang, Low and Seow, 2020). used by every stakeholder of the company.Internalstakeholders such as employees, managers and BODs use financial statements to developstrategiesregardingthe company.Externalstakeholders suchassuppliers,investors. Customers, public, creditors used financialstatementstomake informed decisions regarding their investment or potential investment in the company. ExamplesItmustbeconsideredthatall financial reports are not financial statements. Few examples of such reports are: ď‚·Quarterly financial report ď‚·Annual report Ontheotherhand,allfinancial statements are financial reports and few examples of such statements are: ď‚·Statementofchangesin equity ď‚·Income statement ď‚·Balance sheet ď‚·Cash flow statement ď‚·Statementof comprehensive income Question 4: Fundamental principles of accounting Every business organisation requiresto conduct financialanalysis of their business operations so that the financial information of the company can be communicated to the people. In order to bring effectiveness in this procedure, few principles are developed of accounting which are used by all the businesses of world in order to bring a uniformity; these principles are 13
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known as fundamental principles that are given by IFRS and GAAP. Some of these principles are identified and assessed below: Cost principle – This is the most basic principle of accounting which is often regarded as historical cost principle. Under this principle, an asset is recorded in books of accounting with a price at which it was acquired. This price is not changed with the changing market value of that asset. Also, no inflation or deflation impact is considered on the amount of the asset(Langevin and Mendoza, 2013). Going concern principle – This fundamental principle states that an organisation must operate with an assumption that their business will no matter what will continue till the completion of the accounting year. Considering this, all organisations must continue to imply same techniques or methods for whole accounting year which the once started to use. Full disclosure principle – According to this principle, every organisation must provide access to their financial information to viable stakeholders in terms to provide full disclosure. It is mandatory to share true and fair financial information for all business organisation. Revenue recognition principle – This fundamental principle of accounting is similar to the principle of prudence under which a revenue or gain in the organisation is only recognised or recorded when it is actually received by the company by this the organisation will never over estimate its gains. Under this principle, an organisation is required to be record its revenue only when they are received and must record their losses or expenses as soon as they are intimated. Matching principle – This is also a most fundamental principle of accounting under which the net balance of all the revenues must be equal or matching with the net balance of all expenses. This principle is aligned with double book keeping system under which one account always impact the other account. This principle of matching is applied on trial balance and balance sheet. Debit and Credit sides of trial balance must be equal and the Assets and Liabilities side of balance sheet must also be equal. All principles which are assessed above are the fundamental and basic concepts of accounting that are required to be used and followed by all business organisations in order to ensure that the financial statements of all organisation are developed in a uniformity of International financial reporting standards. Question 5: Business of Carol Andrew Profit and loss account for 31 December 2017 14
ParticularAmount Revenue125000 Less:sales returns1500 Total Revenue123500 Less: Cost of goods sold83500 Discount received1000 Rent received in advance4850 Gross profit45850 Expenses: Rent & rates expenditure1500 Telephone expenses900 Insurance expenses7500 Bad debts1200 Depreciation5000 Wages and salaries13200 Provision for bad-debts (934) Less: Bad debts written off (650)284 Outstanding expenditure340 Net profit15926 Balance sheet LiabilitiesAmountAssetsAmount Capital120800Bank balance10594 Less: Drawings5150115650Cash in hand340 Creditors3900Debtors12500 Rent received490Motor expenses25000 Reserves balance15926less: Depreciation540019600 Suspense account7489Prepaid insurance411 Loan provided100000 143455143445 15
SCENARIO 2 Question 1: Bank reconciliation A bank reconciliation is a procedure in which an organisation attempts to match their balances of cash records with the statement of bank. This procedure is conducted to ensure that correct balances are recorded in organisational statements(Marginson, 2013). An organisation undertakes this procedure by developing a bank reconciliation statement which helps to balance both cash and bank book along with ensuring that any fraud can be immediately detected. There are various purposes due to which the procedure of bank reconciliation is undertaken by an organisation. One of the most important purpose is to detect frauds. When an organisation receives a payment by cheque they record it in company’s cash book but if the cash and bank’s book are not balancing equal, then it means the payment is not received by the cheque due to low balance or other reasons and by this fraud in payments can be detected. Another purpose of conducting bank reconciliation is to identify the reasons due to which there is a deviation in cash and bank book as these reasons can direct towards the charges charged by bank and issues in cheque. Another purpose of conducting bank reconciliation is to develop a document which will testify the fairness of accounting records at the time of annual audit. In order to achieve the state of bank reconciliation, it is required to prepared bank reconciliation statement. There is a set process having multiple steps which can help an organisation to achieve bank reconciliation and prepare BRS. These steps are mentioned below: The first step in the procedure of achieving bank reconciliation is the collect the bank and organisation records so that the both documents can be checked to identify deviations. To identify the variances in both the records, it is first required to check all the amount value of transactions so that any transaction having different values can be identified. Secondly all deposits made in the bank are checked in order to identify whether all the deposits recorded in cash book are equal with the bank book or not. In next step, accountant of an organisation identifies the number of checks which are deposited in bank but are not cleared(Obigbemi, 2013). And lastly, all bank charges in bank statement and identified and then recorded in the cash book. 16
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The procedure of bank reconciliation and BRS holds primary importance in an organisation due to which it is considered as highly necessary, there are various points which can showcase the importance of bank reconciliation and why it is necessary; these points are stated below: The procedure of bank reconciliation is necessary for every organisation as it helps in detecting any fraud which has been conducted by internal or external parties so that the loss from fraud can be detected. BRS identifies the signs of fraud and detect it before it’s too late. Another point of significance which can mention why BRS is necessary is that it helps in preventing administrative problems which result inefficient cash management issue in business. BRS helps in identifying the amount which is required to be made available in bank accounts, so that issued checks must not be bounced. Also it helps in determining the fees and charges charged by bank so that bank must be maintained in bank account accordingly. The procedure is necessary for organisation as it helps in developing a statement of bank reconciliation which is required for the organisation to present it with their financial statements which can act as an evidence that all the information of the organisation is fair and true(Shapiro and Hanouna, 2019). Question 2: Control accounts A control account is general ledger account which keeps all detailed and aggregated balances of transactions of individual accounts recorded in subsidiary ledger. A control account is often referred as totalling or summarised account as it includes detailed transactions of an account so that only the final balance can appear in general ledger which will keep the general ledger clean and free from chaos. Control accounts plays significant role in financial management. Some of roles played by control accounts are as explained: Control account have role of keeping general accounts clean addition to properly recorded without any details, yet includes accurate balances that are to be used within financial statements. Control accounts also divides working of financial accounting among ledger keepers which leads to work specialisation (Shapiro and Hanouna, 2019). 17
ď‚·In financial management, control accounts facilitate in preparing interim addition top final accounts and assist in derivation of sales, debtors, creditors and purchase figures. ď‚·This type of account summarises subsidiary accounts and control balances which are reported in ledger. It provides internal check facility resulting in higher accuracy of records and financial accounts. ď‚·It removes excess details within general ledger and minimises likelihood situations of frauds while managing financial accounts. ď‚·Control accounts dictate what have to appear in general ledger as well as what is reported within financial statements (Khemani, 2016). Question 3: Suspense account Suspense account refers to catch all sections within general ledger that is used by businesses for recording ambiguous entries which needs clarification. It is general ledger accounts wherein amounts are recorded in temporarily manner for the transactions which cannot be recognised. It is located within general ledger and recorded amounts are required to be properly investigates as well as posted in correct account. When organisations open accounting suspense account then such transaction is taken in suspense. It also holds information related to discrepancies while collecting huge number of data (Young and Legister, 2018). The other name for suspense account is holding account till the duration until error is identified or unknown transaction is discovered. Following are main reasons to draft suspense accounts: Matching both sides of trial balance: trial balance is said to an account which is calculates at end on financial period. Suspense account is drafted as when two sides of trial balance so not match then the difference are recorded in suspense account till the duration errors are discovered and are transactions are corrected. In case, when debit side is more that credit then financial managers records the difference in credit. However, when credits are greater than debits, then differences are recorded in debits so to match the both in trial balance. Managing uncertainty related to payment makers: the other reason to draft suspense account is to manage uncertain situations concerned with payment makers. When financial managers fail in matching payments from specific client with balance of account receivables then they draft suspense account and park the payment in order to match outstanding of client due with payments together with cross verify with client. 18
Uncertain about classifying transactions: In general ledger, wide number of tractions or account exist. When financial managers are unsure about particular account in which they have to place specific transaction then they find best to draft suspense account and put the transaction into it. Before doing this, they consult with accountant and then draft suspense account (Holynskyy, 2017). Question 4: Business of Mr. Akram Bank reconciliation statement as on 28th February 2010 Difference between direct debit and standing order, Bank charges, Dis-Houner Cheque Basisof differentiation Direct debitStanding orderBank chargesDis-Honer Cheque DefinitionDirect debit refers tofinancial transaction whereinan organisation withdraws financial resourcesfrom bankaccountof Standing order is definedasan instructiongiven by a customer top thebanking institutionfor makingpayment offixedamount withinregular Bankcharge referstoall charges as well as fees that are made bybanking institutionsto theirkey customers. Dis-Honer cheque is defined to that chequewhichis returned by bank due to insufficient amountin account of payer topayforthe money written on 19
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otherpersonor company (Sweeting, 2017). intervalthatis weekly,monthly, quarterlyor annually. the cheque. ControlOrganisationor individualperson havefullcontrol on direct debit as theydecidethe amounttobe collectedfrom customers.They canalsomake certain changes in amountaddition tofrequencyof collection without more authentication from others. Standingorder aresetand controlledby customers.They selectthe frequency togetherwith amount as well as canalsomake changesor cancelsthem withoutany notificationsto banking institution. Banking institution are the onethathave controlonbank charges.They makecertain changes on bank chargesfor makingprofits togetherwith payingoperating expenses.These arecharged againstthe servicesthatare providedby banks to clients or general public. Banks control dis- Hounercheques aswhenany chequeis dishonouredthen draweebank issuesCheque ReturnMemoin immediate time to bankerofpayee (Hienand Mariani, 2017). It includesreason fornotmaking payment. Further, payee'sbanker givesDis- Honoured cheque addition to memo to payee. ExampleFormaking paymentof electricity,gas and other regular bills,Direct Debitsisused To pay for rents andother expensesin instalment, standingorders are opted. Bankcharges includescharges for services such asopening account, overdraft service or others. Hid-honour check includes a fee that is charged by the payeebank againstthe chequewhichis 20
(Dewi, 2017).dis-honouredand itisgivento payer. Question 5: Business of Milky Journal entries 21
Suspense account 22
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CONCLUSION The report concludes that financial accounting is defined to specialised accounting branch that covers procedures related to recording, summarising together with reporting myriad of transactions that are outcomes of business operations over time period. Internal transactions and external stakeholders are kinds of transactions performed in business. Trial balance is important as it ensures that all the transactions or entries recorded in general ledger are balanced in proper manner. It checks arithmetical accuracy, helps in rectifying errors, comparative analysis, decision making related to budgets, preparing audit reports and making adjustments in accounts. Fundamental accounting principles are going concern principle, matching principle, full disclosure principle, cost principle and revenue recognition principle. Bank reconciliation is required for matching balances in organisational accounting records related to cash account with corresponding information within bank statement. It must be completed in regular durations for all accounts related to banks. It ensures that cash records of business are accurate. Control account plays multiple roles in financial management. It records balances on diverse subsidiary accounts as well as provides cross check on each of them. 23
REFERENCES Books and Journals Dewi, R. S., 2017. Pengaruh Financial Attitude, Financial Knowledge, Pendidikan Orang Tua danParentalIncomeTerhadapFinancialManagementBehaviorpadaMahasiswa Universitas Sumatera Utara. Hien, K. S. and Mariani, F. I., 2017.Financial Management Canvas. Elex Media Komputindo. Holynskyy, Y., 2017. The importance of financial management principles in the State budget execution.Annals of Spiru Haret University. Economic Series.17(4). pp.19-28. Khemani, M. P. D., 2016.How to Check Integrity of Fiscal Data. International Monetary Fund. Langevin, P. and Mendoza, C., 2013. How can management control system fairness reduce managers’ unethical behaviours?.European Management Journal.31(3). pp.209-222. Marginson, D., 2013. Budgetary control: what’s been happening?. InThe Routledge Companion to Cost Management(pp. 21-43). Routledge. Obigbemi, I.F., 2013. Employee Participation in Budgeting and Effective Budgetary Control a ToolforEnhancingOrganizationalPerformance.TactfulManagementResearch Journal,1. Phillips, F., Libby, R. and Libby, P.A., 2011.Fundamentals of Financial Accounting. New York, NY: McGraw-Hill Irwin. Porter, G.A. and Norton, C.L., 2012.Financial accounting: The impact on decision makers. Cengage Learning. Porter, J.C., 2019. Beyond debits and credits: Using integrated projects to improve students’ understanding of financial accounting.Journal of Accounting Education.46. pp.53-71. Schroeder,R.G.,Clark,M.W.andCathey,J.M.,2019.Financialaccountingtheoryand analysis: text and cases. John Wiley & Sons. Shapiro, A. C. and Hanouna, P., 2019.Multinational financial management. John Wiley & Sons. Sweeting, P., 2017.Financial enterprise risk management. Cambridge University Press. Thornton, S.C., 2018. A Collection of Case Studies on Financial Accounting Concepts. Young, J. H. and Legister, A. P., 2018. Project-based learning in internationalfinancial management.Journal of Teaching in International Business.29(1). pp.76-87. Zhang, T., Low, L.C. and Seow, P.S., 2020. Using online tutorials to teach the accounting cycle.Journal of Education for Business.95(4). pp.263-274. 24