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Fundamentals of Auditing ACC 311

Lesson 09

BOOKS OF ACCOUNT & FINANCIAL STATEMENTS

Books of Account to be Kept by Company [SECTION-230]

A company should keep proper books of account in respect of:

Cash received and expended by the company;

Sales and purchases of goods by the company

All Assets and liabilities of the company; and

In case of a company engaged in production, processing, manufacturing, or mining

activities, a production record as may be required by the Commission through a general or

special order;

Books of account should be preserved for ten years;

Books of account are to be kept at the registered office of the company. If kept at any other place, the

registrar should be informed;

Books of account should give a true and fair view of the state of affairs of the company and should contain

explanation of transactions.

Directors can inspect the books of account during the business hours.

If company fails to comply with the above provisions a director, including chief executive and chief

accountant:

(a)

of listed company is liable to imprisonment for one year and a fine of not less than Rs.

20,000 not more than Rs. 50,000, and a further fine of Rs. 5000 per day during which the

default continues; or

(b)

of other companies is liable to imprisonment for six months and with a fine, which may

extend to Rs. 10,000

Accounting Cycle

· Transaction

· Document

· Voucher

· Books of original entry/journal/day book

· Books of secondary entry/ledger

· Financial statement

Transaction

Source Document

Sale

Invoice Issue

Purchase

Invoice Receive

Sales return

Credit Note Issued

Purchases return

Credit Note Received

Cash received

Receipt/Cash Memo Issue

Cash paid

Receipt/Cash Memo Received

Lease/Hire Purchase Agreement

Voucher

· Receipt voucher

· Payment voucher

· Journal voucher

· Petty cash voucher

Books of Original Entry

· Purchase journal

· Sale journal

· Purchase return journal

· Sales return journal

· Cash book (two/three column)

· Petty cash book

Fundamentals of Auditing ACC 311

· General journal/ transfer journal

Books of Secondary Entry

· Main ledger

· Subsidiary ledger

Financial Statement

· Balance sheet

· Income statement

· Statement of changes in equity

· Cash flow statement

· Notes to the accounts

Recording of Transactions from Source Documents

To enter into a transaction we need approval from our responsible managers. When, after having approval of

a manager, transaction takes place, such transaction should be evidenced by a document. Because, to record a

transaction into the books of account, a bookkeeper needs an evidence of proper approval of transaction

and authorization of documents, therefore, a voucher is prepared on which all of the descriptions of the

transaction are written up and with which all of the evidences of approvals and authorized document are

attached. Such voucher is finally authorized by accounts manager which is then recorded in the books of

accounts by a bookkeeper.

To have a more clear understanding of the above paragraph, lets have a step by step example of purchasing

an air conditioning plant for workshop.

1. Production manager will send a requisition to the general manager for air conditioning the workshop

to improve the working environment.

2. The general manager will approve the requisition (if he gets convinced that workshop is in real need of

air conditioning plant) and will send this approval to the purchase department.

3. The purchase department will call a tender and after having received several quotations the purchase

department will place a purchase order to the vendor quoting lowest rate. (All of the above procedure

is properly documented).

4. The vendor company (supplier) will send an invoice (purchase invoice) to the business along with the

air conditioning plant. Such air conditioning plant will be inspected by the expert and finally the invoice

will be approved for payment.

5. Now all of the documents along with the purchase invoice shall be send to the bookkeeping office

where a voucher will be prepared and will also be approved by the concerned manager for recording

this transaction in the books of accounts.

Source Documents:

Following are the few examples of source documents which

are required to support different types of

transactions.

Sr. No.

Transaction

Source Documents

Sales

Sales Invoice issued

Purchase

Purchase Invoice received

Sales Return

Credit Note issued

Purchase Return

Credit Note received

Cash received

Cash Memo/receipt issued

Cash paid

Cash Memo/receipt received

Leases/Hire purchase

Agreements

Staff Salaries

Approved Payrolls

Electricity, Gas, Water, Tele. Phone

Metered Bills/Invoices.

Recording in the Books

Approved voucher are recorded in the books of accounts, many businesses now a days use computers for

recording of transactions. However, an understanding of book of accounts is necessary whether

transactions are recorded manually or electronically.

Basically, there are two types of books of accounts which are used to record the business transactions

Fundamentals of Auditing ACC 311

1. Books of original entries.

2. Books of secondary entries.

These are further subdivided according to the needs of the business and/or complexity of the transaction.

Following diagram best describes the different books of accounts which are used in the business for

recording transactions.

BOOKS OF ACCOUNT

Books of Secondary

Entries (Ledger)

Books of Original

Entries (Journal)

To record credit transaction

To record cash transaction

Purchases

Returns

General

Sales Journal

Cash

Inward

Outward

Journal

Book

Journal

For credit

For sales

For

For all other

For cash

purchases

receipts &

purchases

sales

return

transactions

return

payments

Source Documents

Invoices

Credit

Credit Note

Depends upon

Cash

Note

the nature of

Received

Issued

Received

Memos

Issued

Transaction

Main Ledger

Subsidiary Ledger

To extract trial balance and to

prepare financial statements

Debtors

Creditors

Materials

Other

Ledge

Ledger

To keep memorandum

Figure 3.1

Just after analyzing a transaction or event for its debit and credit effects it is required to record them in a

systematic way. So the books of accounts in which Debit and Credit are initially recorded in a systematic

way are known as books of original entry (BOE). In accounting system of business concern books of

original entries possess a very important position.

Fundamentals of Auditing ACC 311

JOURNAL:

It depends upon the complexity of transactions and size of the business that what books of original entries

are required to record the transactions. For a very little business, having very few cash and credit

transactions, a general purpose journal is sufficient to record each type of transactions.

Journal is the very first book of account in which all of the business transactions and events are recorded. In

this book transactions and events are recorded in a chronological (date) sequence. Both of the accounting

effects (Debit & Credit) are recorded in it in a systematic way. Information recorded in the journal for a

transaction or an event is known as journal entry.

Sketch of a Journal & Journal Entry

Date

Particulars

Post

Debit

Credit

2003

Ref.

(Rs)

Jan. 10

Salaries Account (Debit)

50,000

Cash Account (Credit)

50,000

Cash

(Staff salaries paid in cash).

Memos

Figure 3.2

From the above illustration we can understand that on 10th January 2003, business paid cash Rs.50,000 as staff

salaries. It is customary that the accounting head analyzed as debit is written firstly in the particulars' column

and its amount is written in the debit column whereas the accounting head analyzed as credit is written under

the debit accounting head but after indenting a little space from the left side, its amount is written in the

credit column. The column of post reference cannot be very well understood without having knowledge of

Ledger, any how, the column post reference shows page numbers of the Ledger in which salaries and cash

accounts are posted. Words written within the parenthesis in the particulars column are known as

"Narration of a transaction or event"; it is an integral part of a journal entry. Narration explains the

accounting treatments to a layman.

Subdivision of Journal:

As discussed earlier in 1.2 that the journal is sub-divided based on complexity of the transactions or size of

business. This happens only when there are a number of cash transactions in a day and also there are so

many transactions for credit purchases and credit sales. This large numbers of transactions create a mess in

bookkeeping office; therefore, separate bookkeeping clerks are given responsibilities for separate types of

transactions along with separate journals. For example,

For cash transactions there is a separate cash office in which only cash transactions are analyzed and

recorded in a book named as cash book.

For purchases there is a purchase journal in which only and only credit transactions for purchases are

recorded. In the same way sales journal for credit transaction of sales is maintained. And if there are a large

number of returns then separate journals for sales return and purchase return are also maintained.

Now that, after having separate journals for credit sales, credit purchases, sales & purchases return and cash

transactions, all of the remaining transactions and events like sale and purchase of assets on credit, loss by

fire etc. shall be recorded in general journal.

To learn more about subdivision of journal, firstly have a re-look on figure 3.1.

SALES JOURNAL:

Need for Sales Journal

In case of a small business, there is very little number of transactions of credit sales. As we can have an

example of a barber's shop, a tailor, a retailer etc. they mostly sell their services or goods on cash terms. But

as business expands, the sales of it also grow in terms of cash as well as in terms of credit. The cash sales are

now recorded in the cash book as a receipt, and the credit sales are recorded in a separate journal named as

sales journal (sales day book). In sales journal, no other transactions are recorded except the transaction for

sales on credit terms.

Supporting Document:

As shown in the figure 3.1 the source document supporting credit sales is sale invoice. It is made up in

duplicate or triplicate (depending upon the accounting systems developed for the recording of credit sales)

Fundamentals of Auditing ACC 311

one of these copies is sent to the debtor (credit customer) along with the goods/services sold. A standard

format of sales invoice looks like below;

Name of Vendor Co.

Address of Vendor Co.

Sale Invoice No.

Date:

Name & Address of Customer

Purchase Order Ref. No.

Sr. No.

Particulars/Description

Quantity

Rate

Amount

***

Trade discount

(***)

Total

***

Settlement terms. 2/10, n/30

Figure 3.3

Purchase Order Reference No:

When a customer asks a vendor for supply of some goods, such order is evidenced through a purchase

order form. Purchase order form discloses the quantity and quality of goods ordered along with its rates and

discounts both trade and settlement. Each purchase order has its unique number which is put on the sales

invoice for reference.

Trade Discount:

Amount of trade discount is not required to be recorded in the books of accounts. Actually it is the

discount which is agreed before entering into the transaction of sales or purchase, therefore, it is just

formally show on the face of the invoice, otherwise it has no other financial effects.

Settlement Terms:

It is also known as prompt payment terms. These terms are in fact offered to lure the customer for having

more discounts by making payment for the invoice earlier. In this term, for example 2/10, n/30, the first

part 2/10 contemplates that if customer pays cash within 10 days of the invoice, he will be offered a

discount of 2%, the second part of it n/30 contemplates that after 10 days there will be no discount offer

but the customer has to pay the amount of invoice net of trade discount within the thirty days of the date of

invoice.

This term sounds as two ten net thirty (2/10, n/30).

Brain Storming

How this will sound 5/20, n/60 and what do you understand by this term?

Entering the Transaction of Credit Sales in Sale Journal:

In case of credit sales the business is very much interested in the name and addresses of the credit customer

(Debtor), therefore, sales journal is so designed to cover following information;

Date---------------------

Date of invoice

Name of Debtor -------Mentioned in the invoice

Invoice number ------- It helps to trace the other details of invoice.

Post reference ---------Page number of subsidiary ledger (will be discussed later on)

Amount of invoice ---- Net of Trade Discount

Fundamentals of Auditing ACC 311

Sketch of Sales Journal

Date

Name of Debtor

Invoice

Post.

Amount

No.

Ref.

Rs.

You would have noticed in the sales journal, there is only one column for amount. It might have created

confusion in your mind that why we are not having two columns for amount, one for debit and other for

credit, like in journal. Remember, here in sales journal all of the transactions are of same nature (credit sales)

and the purpose of sales journal is just to avoid over working for recording the debits and credits of each

transaction again & again. So, the role of sales journal in an accounting system is to precise all of the credit

transactions of sales for a month or so and give effect of debit to debtors and credit to sales with total

amount of such period.

Purchase Journal:

Need for a Purchase Journal

After knowing the need of sales journal (as discussed in previous section) it will be very easy to understand

that for a large business having frequent transactions of credit purchases it is necessary to maintain a

separate book for recording the transactions of purchases on credit terms. This book is named as purchase

day book. Obviously like a sales journal no cash transactions relating to purchase shall be recorded in this

book.

Supporting Document:

As shown in the diagram the supporting document for transactions of credit purchases is purchase invoice.

It is exactly the same document as we looked into the diagram of previous section. Purchase invoice is in

fact the copy of sales invoice in the hands of customer. It is issued to the purchaser by the

seller/vendor/supplier. So from the stand point of a purchasing business, the business after having received

the invoice will put an internal number on it and will file it as evidence of the transaction and also for the

purpose to remember that amount of this invoice is still outstanding for payment according to the

settlement terms as discussed in section.

Entering the Transaction of Credit Purchases in Purchase Journal:

The basic contents of a purchase journal are exactly the same as discussed in the case of a sales journal with

the exception of one thing that now in the second column there is the name of Creditors instead of

Debtors. Obviously, we remember the person from whom goods are purchased on credit is creditor of the

business.

Sketch of Purchase Journal

Date

Name of creditor

Inv.

Post.

Amount

No.

Ref.

A purchase journal is a list of all credit purchases in a stipulated time period. All of the credit purchases

recorded in a purchased journal during a period is totaled and then for such total amount debit effect is

given to the purchases account and credit effect is given to the creditors account. You noticed here that the

rules of debit and credit remain same all the time.

Sales Return Journal: (Returns Inward Journal)

Need for Sales Return Journal

As the business expands the number of complaints and returns inwards also increases. Such return inwards

can be recorded in the sales journal as a negative entry if these are very little in number. But because of its

reverse nature it is recommended to maintain a separate journal to record sales return. Here one very

Fundamentals of Auditing ACC 311

important concept should be remembered that in sales return journal only the returns against credit sales

(from Debtors) are recorded. Normally, it doesn't happen that return of goods sold against cash are

accepted by a business because certainly against such return the business would have to make refund of

money already received. That's why in coming practice you will not find any such transaction. But obviously if

you have any example of such transaction in your business, it will be recorded in cash book as a payment.

Supporting document:

When a business receives back its sold goods it issues a "credit note" to the debtor returning goods, which

evidences that we have received the returned goods and accept that money for such sales will not be

received in future. A "credit note" issued is an evidence of reduction in sales income and also in the amount

of debtors. It is also said that a "credit note" is a reversal document of an "invoice" which cancels the effect

of it. Like an "invoice", a credit note is also given a number and also possesses a reference of sales invoice against

which such return were made. Rest of the contents of credit note are commonly understood, such as:

Name & Address of the business (Seller)

Name & Address of the customer

Date

Particulars

Quantity

Rate

Amount

Sketch of Credit Note

Name of Vendor Co.

Address of Vendor Co.

Credit Note No:

Date:

Customer's Name

Customer's Address

Ref. Invoice No

Account No:

Item No.

Description

Quantity

Rate

Trade

Net Amount

Discount

Total

Figure 3.6

Purchase return journal: (Returns outward journal)

Need for a Purchase Return Journal?

Purchase return journal has the same story as we just have discussed in previous unit. The only thing to

remember is that it is also known as return outward journal/daybook. Obviously these transactions (for

purchase returns) could also be recorded in the purchase journal as negative entry but same as for sales

return journal it is required to have a separate journal for purchase returns because of its reverse nature to

the purchases. The total of purchase return journal will cause a reduction in the purchases expenses and also

a reduction in the amount of creditors.

Supporting document:

Although purchase returns are evidenced by a copy of credit note received from the seller, which is treated as

a reversal document against purchase invoice. But here we shall also discuss the need of a "Debit Note". A

"debit note" is in fact a request, put to the seller by the purchaser business, for issuance of a credit note. A copy

of debit note is sent to the seller along with the rejected goods, in which all of the particulars of goods

rejected and returned along with the reference of relevant invoice number are entered. Remember, a

business cannot record purchases returns considering a debit note as a supporting document because the

Fundamentals of Auditing ACC 311

effects of purchase invoice are not considered cancelled unless acceptance of rejected goods is received

from the seller in shape of a copy of credit note.

Entering Transactions in Purchases Return Journal:

you will find nothing new in this section except the treatment of total of purchase return journal which is

debited to the creditors account and credited to the purchases return account.

Sketch of a Purchase Return Journal

Date

Creditor Name

Credit

Post.

Amount

Note No.

Ref.

Figure 3.7

Cash Book:

Cash book is a book of original entries in which all of the cash transactions are recorded very firstly. If we

refer to the figure 3.1, we can notice that the (books of original entry) journal is subdivided for two types of

transactions i.e. credit transactions and cash transactions. As discussed in previous units, all credit

transactions are recorded in different journals. The cash transaction of a concern needs a separate book

named as cash book.

A cash book is divided into two sections, one for cash receipts and the other for cash payments. Each of

the section is formatted for date, particulars, post reference and amount. See below for its proper sketch;

Cash book

Date

Particulars

Post

Amount Date

Particulars

Post

Amount

Ref.

Figure 3.8

Left hand side of a cash book is known as receipt side and right hand side is known as payment side. In a

way, we can say that within a cash book, we prepare two cash journals, one, cash receipt journal and second,

cash payment journal.

Supporting Documents:

For Cash Receipts

All cash receipts are evidenced by a copy of cash memo/receipts retained by the business. These cash

memos/receipt are already serially pre-numbered and for each receipt of cash, the cash office issues an

original copy of the cash memo/receipt to the person making payment and retains a carbon copy or

counterfoil of it within the office which are used to record receipts of cash in the cash book.

For Cash Payments

All cash payments are evidenced by an original copy of cash memo/receipts issued by the recipient

business. These are attached with a cash voucher as evidence that cash was paid to recipient who issued this

cash memo/receipt.

Fundamentals of Auditing ACC 311

Fundamentals of Auditing ACC 311

Fundamentals of Auditing ACC 311

Fundamentals of Auditing ACC 311

Fundamentals of Auditing ACC 311

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