Accounting Documents & Accounting Cycles

It is important that you know the type of documents commonly used to record the occurrence of transactions (Can you think of any examples?). Some of them are:-

  • Official receipts

Normally you will get these when you make payment over the counter to the cashier

  • Cash bills

You seldom get these nowadays. However, if you made purchase of goods from a shop that has no cash register, normally you will get these as proof of payments.

  • Bills

Electricity, water, quit rent & assessment, services. Normally you received these and asked to pay by a specified date.

  • Invoices

Normally you receive these when you purchase physical goods. Same function as bills, invoices ask the recipients to pay by a specified date.

  • Delivery Orders

You get these when you receive the goods that you have ordered previously. However, delivery order is different from invoice, its function is to record the descriptions and quantity of the goods concern, whereas, invoice will state the unit price and also the terms of payments.

The above are the common types of documents you receive when you purchase goods/services (i.e. as a customer/consumer). On the other hand, to the issuing entities, all these documents are issued to their customers when there are sale transactions. Example, for a customer the invoice that he/she received is called specifically as “Purchase Invoices” or “Supplier Invoices”. On the other hand, for a company who sell goods to its customers, the invoices used are referred to as “Sales Invoices”.
  • Purchase Orders

Purchase orders are used to order goods from your suppliers in accordance with your specifications and quantity of the goods.

  • Customer Orders

Customer orders are used for the customers to fill up in ordering the goods.

  • Credit Notes

Credit notes are issued to customers to inform them that their account has been “credited” for the reasons specified in the credit notes (meaning is there is a reduction in the amount that the customer has to pay because of e.g. overcharging of price, defective goods returned, discounts etc.)

  • Debit Notes

Debit notes are issued to customers to inform them that their account has been “debited” for the reasons specified in the debit notes (in contrasts to credit notes, debit notes has the opposite function-the customer is informed that they have to pay more because of e.g. under charging of price, additional charge for miscellaneous services etc.)

  • Payment Vouchers

Payment vouchers are used to record payments made by the business entities in chronological orders, normally in respect of cheque payments.

  • Petty Cash Vouchers

Petty cash vouchers are used to record payments made by the business entities in chronological orders in respect of cash.

  • Goods Received Notes

Goods received notes are used to record receiving of goods purchased. Please take note that the function of Goods Received Notes (GRNs) is different compared to that of the Delivery Orders an entity received from its’ suppliers. Just imagine this – if the entity receives goods from different suppliers, lets say on average of 20 in a day, what would happened if it does not have a systematic way of recording the receiving of goods? HAVOC! However, for many small entities that have minimal purchase transactions, GRNs may not be used as each incident of receiving goods could still be monitored easily. For good control purposes, a receiving logbook is used to record the details of receiving goods (Date, Name of Supplier, Delivery Order Number, Description of goods).

  • Stock Cards & Stock Ledger

Stock cards are used to monitor physical movement of stocks. For better control purposes, stock cards are normally kept and recorded by storekeepers, and only quantity of stocks, stock codes and description of stocks are recorded on the stock cards WITHOUT the unit costs indicated. This is because it is not necessary for storekeepers to know the unit costs of stock (in a way to reduce the risk of pilferage of more expensive stock items). Stock cards are updated based on the evidence of stock-in (goods received notes and delivery orders from suppliers if no goods received notes system practised) and stock-out (delivery orders to customers) In addition to stock cards, some business entities also maintain another type of stock record – stock ledger. Stock ledger is updated with all the details of stocks including the stock code, descriptions, quantity and the total value of each type of stock based on supplier invoices received. At every fixed interval e.g. month end, the quantities of stocks reflected in the stock cards could then be checked and reconciled to the quantities of stocks recorded in the stock ledger and any variances to be investigated and followed-up.

For most business entities, the two most important activities are sales and purchases. And another important accounting cycle, which in a way is related to these two activities, is the cash receipt and payment cycle.A simplified activities chart for a trading company’s sales cycle is as follow:-

Sales Cycle  

saleschart 

 

In each activity, try to list down the type of documents used based on what you know thus far. Compare to the following:-

  • Receive customers’ inquiry

– This can be in many ways, walk-in, telephone, fax, email etc. For internal information record purposes, a separate file to keep track of customers’ inquiry is desirable because any form contact from potential customers should be treated seriously. However, this is not part of the accounting documents because no transactions occurred at this point in time.

  • Check availability of stocks

– Obviously, the store keeper will be contacted to make sure sufficient quantity of stocks are available (stock cards) or else exact date of new arrival of stocks should then be checked and communicated to the customers.

  • Inquire mode of payment

– No documents are used.

  • Check creditworthiness of customer if on credit

– Some form of database of customer maintained by the business entity would be referred to for existing customers. Those with outstanding balances unpaid should be checked as to any outstanding debts exceeding the credit period allowed and also as to the credit limit of the customers. For new customers, details required should be obtained and submitted to the approval of responsible personnel e.g. Sales Manager before accepting orders.

  • Check and agree on pricing

– Approved price list. This is also not part of the accounting documents. Cash purchases normally are cheaper compared to those on credit.

  • Complete customer orders

– Obviously the customer orders. Based on the customer orders, further arrangement such as packing of stocks, transportation arrangement & etc. will be arranged for the delivery of stocks to the customers.

  • Store prepares stocks for delivery

– Initially based on customer orders to prepare stocks. Update stock cards based on actual quantity of stock-out based on delivery orders to customers.

  • Generate delivery orders

– Obviously the delivery orders to customers.

  • Generate sales invoices

– Obviously the sales invoices to customers.

  • Delivery to customers

– The physical stocks together with the delivery orders and the sales invoices to the customers.

Note: Some of the documents generated are made more than one copy. For example, the customer orders could be printed in three copies – the original to the customer, a copy to store and another kept by the sales department. This is dependent on the requirement of each business entity. A document flowchart could also be drawn up to show how the accounting documents are generated and used throughout the whole sales cycle (Not shown here). It is very often that sales invoices are handed over to the customer together with the delivery orders and the goods because payment is expected to be received faster compared to if the sales invoices are generated and given to the customers at a date subsequent to delivery of goods. 

 

Purchases Cycle

A simplified activities chart for a trading company’s purchases cycle (assume purchase on credit term) is as follow:-

PurchasesChart

 

In each activity, try to list down the type of documents used based on what you know thus far. Compare to the following:-

  • Raise purchase requisition

– Dependent on the nature of the businesses, when stocks level reach re-ordering level, for “back-to-back” orders where no stocks are kept, when receiving customers’order.

  • Contact suppliers and obtain quotations

– Dependent on the policy of the business entities concerned, some require minimum three quotations to be obtained from different supplier for comparison.

  • Select supplier in accordance with policy set

– Dependent on the policy of the business entities, selection of supplier may not necessary based the lowest price quoted, past dealings that give indication of quality of goods, speed of delivery & etc. should also be considered in selecting supplier.

  • Generate purchase orders

– Once the supplier is selected, purchase orders are generated.

  • Placing orders with supplier

– Approved purchase order is given to the selected supplier.

  • Receiving goods together with delivery orders and invoices

– Checking the correct specification, condition and quantity of good received by matching to the purchase order raised previously.

  • Generate goods received notes

– Obviously the goods received notes and also update the stock cards.

  • Delivery notes, invoices and goods received notes to Accounts Department for checking and payment

– Delivery notes, supplier invoices and good received notes would be handled over to the Accounts Department for checking and prepare payment. Stock ledger will be updated

Note: Purchase orders are generated in multiple copies – example, the original copy to the supplier, one copy kept by the Purchasing Department, one copy to the Store and one copy to the Accounts Department. Sometimes, the delivery orders and invoices received from the supplier are handed over from the store receiving goods to the Purchasing Department instead of directly to the Accounts Department. The Purchasing Department would perform the checking role on the purchases. Once approved by the Purchasing Department, the Accounts Department would proceed straight to updating stock ledger and payment.

Cash Receipt and Payment Cycle
 
I will not show this cycle in terms of activities chart as the procedures involved are much simpler compared to the sales and purchase cycles. However, the typical procedures in receiving cash and payments would be discussed.

Receiving cash

Dependent on the nature of business, the mode of receiving payment from customers includes cash, cheque, direct deposit to the bank account via wire-transfer & credit card. Can you think of others? The most important control checkpoint in receiving payments from customers is to be able to account for each and every single payment received and ensure that it is deposited into the bank account of the business entity. For this purpose, pre-numbered official receipt is used. For cash collected from customers, it should be counted at the end of the day and be deposited into the bank account of the business entity the soonest possible. A listing of official receipt indicating the total receipts of the day should then be prepared, matched to the bank deposit slips and properly approved. Similarly for other form of receipts, cheques, credit cards, wire transfer & etc. as soon as they are deposited into the bank account of the business entity, checking of the money deposited to the official receipts MUST BE DONE. The most frequent problem that I have encountered in respect of receipts from customers is in the situation whereby customers deposited payment directly into the bank account of the business entity. If no systematic procedures established with regard to this, the result is unidentified receipts appearing in the bank statements and it could result in unnecessary time and effort spent to trace the identity of the payee. Proper deposit form should be distributed to each customer who wish to make payment in this manner and make sure that a copy is completed properly with all the required payment details and forward a copy to the business entity.

Payments

Payments could be made for purchases in the form of cash for small sum and cheques for larger amounts. For cash payments, petty cash vouchers are used and each payment must be supported by the relevant supporting documents such as bills and official receipts. For cheque payments or wire-transfers, payment vouchers are used. All the relevant payment supporting documents such as invoices, bills & etc. must be enclosed together and properly checked and approved.

In addition to the above, can you name the common types of documents that are used by business entities? (different business entities in different industries may have their own special type of documents pertaining to their industries)

The Income Statement

 

Remember in my previous post on the Balance Sheet? The Balance Sheet shows the “position” of an entity at a certain point in time. However, the Income Statement shows a different picture than the Balance Sheet – Income Statement or Profit and Loss Accounts is used to match the income/revenue generated by an entity with all the expenses/costs/losses the entity incurred over a specific period of time, normally this is done yearly to arrive at the final outcome, i.e. the Profit for the year/period. Examples of transactions that have an effect on the Income Statement are as follows:- 

3. Purchase from trade creditor

Assume ABC Co. Ltd purchase goods worth $2,500 from its supplier, Top Goods Co. Ltd on credit term of 30 days. The double entry to record this transaction is as follows: –

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Purchases

 

 

$2,500

 

Cr Trade Creditor

 

$2,500

 

 

 

Assume the Balance Sheet of ABC Co. Ltd. BEFORE this transaction is as per Example 2 of my post, “the Balance Sheet”, the impact of this purchase transaction of $2,500 on the Balance Sheet and the Income Statement is as follows:-

 

ABC Co. Limited

 

Balance Sheet as at 31 December 2006

 

 BEFORE

Impact of this purchase transaction of $2,500

 AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Assets

 

 

 

 

Computer desk

500

 

 

500

Cash at bank

10,000

 

 

10,000

 

10,500

 

 

10,500

Liabilities

 

 

 

 

Trade creditor-Top Goods Co. Ltd

 

 

2,500

 (2,500)

Creditor-Mr X

(500)

 

 

(500)

 

 

 

 

(3,000)

TOTAL (Assets – Liabilities)

10,000

 

 

7,500

Owners’ Equity

 

 

 

 

Paid-up share capital

10,000

 

 

10,000

Accumulated loss

 

2,500

 

(2,500)

TOTAL

10,000

 

 

7,500

 

   
   

 

ABC Co. Limited

 

Income Statement for the year ended 31 December 2006

 

 BEFORE

Impact of this purchase transaction of $2,500

 AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Sales

 

 

Cost of Sales:-

 

 

 

Purchases

2,500

 

(2,500)

 

 

 

 

 

Other income

 

 

Other expenses

 

 

Loss for the year

 

 

(2,500)

 

 

 

 

 

 

Please take note of the following points:-

  • As there were no transactions affecting the Income Statement before this purchase transaction, all the items in the Income Statement have nil value.
  • As there was no other income statement transactions during the year ended 31 December 2006 (the meaning is-the relevant period that we are talking about here is from 1 January 2006 to 31 December 2006) except this $2,500 purchase of goods, the loss for the year is therefore $2,500.
  • The loss for the year of $2,500 would be reflected as Accumulated Loss in the Balance Sheet
  • The impact of this $2,500 purchase transaction MUST be recorded in pair i.e. one Debit (to the Accumulated Loss in this example) and one Credit (to the Trade Creditor-Top Goods Co. Ltd. in this example) to the Balance Sheet. This is the RULE of Double Entry system in accounting! It applies to ALL transactions, except for those transactions affecting items within the Income Statement e.g. reclassifying one type of expense/income to another type of expense/income or setting off an expense item with an income item (e.g. cash discounts against sales).
  • When you compare the Balance Sheet “Before” and “After” this $2,500 transaction, you would notice that Trade Creditor-Top Goods Co. Ltd and Accumulated Loss which both show the same amount of $2,500 are the “Impact” or “Changes”. In other words, the “Impact” or “Changes” in the Accumulated Loss (Retained earnings/profits if the entity is making profits) account in the Balance Sheet is the NET RESULT comparing the Balance Sheet between two different points in time and the complete details of this NET RESULT are shown in the Income Statement!

4. Recognition of Closing Inventories or Stock

Logically speaking, by making a purchase of $2,500 but unable to sell the goods would result in what we call inventories or closing stock in hand. In other worlds, the Balance Sheet and Income Statement shown in Example 3 above are incomplete without recording the recognition of closing inventories!

After ABC Co. Ltd. made a purchase of $2,500 from Top Goods Co. Ltd but unable to sell these batch of goods to its customer, ABC Co. Ltd would need to recognise closing inventories of $2,500 before finished preparing its Balance Sheet and Income Statement by the following double entry:-

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Inventories

$2,500

 

 

 

Cr Cost of sales-Closing Inventories

 

 

 

 $2,500

 

The Balance Sheet and Income Statement of ABC Co. Ltd showing the impact of both the purchase of goods from Top Goods Co Ltd. and recognition of closing inventories are as follows:-

  

ABC Co. Limited

 

Balance Sheet as at 31 December 2006

 

   BEFORE

Impact of $2,500 purchase transaction and recognition of closing inventories

   AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Assets

 

 

 

 

Computer desk

500

 

 

500

Inventories

 

2,500

 

2,500

Cash at bank

10,000

 

 

10,000

 

10,500

 

 

13,000

Liabilities

 

 

 

 

Trade creditor-Top Goods Co. Ltd

 

 

2,500

 (2,500)

Creditor-Mr X

(500)

 

 

(500)

 

 

 

 

(3,000)

TOTAL (Assets – Liabilities)

10,000

 

 

10,000

Owners’ Equity

 

 

 

 

Paid-up share capital

10,000

 

 

10,000

Retained profit/(Accumulated loss)

 

2,500

2,500

TOTAL

10,000

 

 

10,000

 

 

ABC Co. Limited

 

Income Statement for the year ended 31 December 2006

 

   BEFORE

Impact of $2,500 purchase transaction and recognition of closing inventories

   AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Sales

 

 

Cost of Sales:-

 

 

 

Opening inventories

 

 

Purchases

2,500

 

(2,500)

Closing inventories

 

 

2,500

2,500

 

 

 

 

Other income

 

 

Other expenses

 

 

Profit/(Loss) for the year

 

 

 

 

 

 

 

 

Can you see the differences by comparing the Balance Sheet and Income Statement of ABC Co. Ltd in Example 3 and Example 4. Omission of recognising the closing inventories after adjusting the purchases at year end is still a common mistake that I noticed in my auditing assignments to date!

 

More Examples

5. Sale of goods to customer

Assume ABC Co. Ltd sells goods worth $3,000 to a customer subsequent to 31 December 2006, let’s say on 3 of March 2007, Mr Y. The double entry to record this transaction is:-

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Trade debtor-Mr Y

$3,000

 

 

 

Cr Sales

 

 

 

$3,000

 

Let’s consider transaction in Example 6 below before ABC Co. Ltd closes its books for the year ended 31 December 2007 (meaning is to end its financial period and prepare a complete set of final accounts which includes the Balance Sheet and the Income Statement for the financial year ended 31 December 2007) and show the Balance Sheet and Income Statement after this sale of goods transaction.

6. Collections from debtors

 ABC Co. Ltd received a cheque of $3,000 from Mr Y on 21 May 2007 and subsequently deposited the cheque into ABC Co. Ltd’s bank account. The double entry to record this transaction is as follow: –

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Cash at bank

$3,000

 

 

 

Cr Trade debtor-Mr Y

 

$3,000

 

 

Before ABC Co. Ltd. closes its books and prepares the Balance Sheet and Income Statement for the year ended 31 December 2007, the following double entry is required to be made to recognise the opening inventories for the year ended 31 December 2007:

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Cost of sales-Opening Inventories

 

 

 $2,500

 

Cr Inventories

 

$2,500

 

 

 

The Balance Sheet and Income Statement of ABC Co. Ltd. after taking into account these 3 transactions (Sale of goods, Collection from debtor and Recognition of Opening Inventories) are as follows:-

ABC Co. Limited

 

Balance Sheet as at 31 December 2007

 

   BEFORE

Impact of the 3 double entries in Example 5 & 6

   AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Assets

 

 

 

 

Computer desk

500

 

 

500

Inventories

2,500

 

2,500

Trade debtor-Mr Y

3,000

3,000

Cash at bank

10,000

3,000

 

13,000

 

13,000

 

 

13,500

Liabilities

 

 

 

 

Trade creditor-Top Goods Co. Ltd

 (2,500)

 

  

 (2,500)

Creditor-Mr X

(500)

 

 

(500)

 

(3,000)

 

 

(3,000)

TOTAL (Assets – Liabilities)

10,000

 

 

10,500

Owners’ Equity

 

 

 

 

Paid-up share capital

10,000

 

 

10,000

Retained profit/(Accumulated loss)

 

 

 500

TOTAL

10,000

 

 

10,500

 

 

ABC Co. Limited

 

Income Statement for the year ended 31 December 2007

 

   BEFORE

Impact of $3,000 sale transaction and recognition of opening inventories

   AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Sales

 

3,000

3,000

Cost of Sales:-

 

 

 

Opening inventories

2,500

 

(2,500)

Purchases

 

 

Closing inventories

 

 

 

 

 

 

 

(2,500)

Other income

 

 

Other expenses

 

 

Profit/(Loss) for the year

 

 

500

 

 

 

 

 

 

The Balance Sheet

 

As discussed in my earlier posts, the balance sheet shows the financial position of an entity. In addition to the example introduced earlier whereby the owner contributed $10,000 cash at bank as capital (please refer to my post titled Debits and Credits), there are many more examples of transactions that have an impact on the balance sheet, i.e. they would change the items and figures reflected in the balance sheet. Some of the examples are as follows:-

1. Purchase of asset using cash at bank (by way of issuing cheque)

Using the example of ABC Limited in which the owner have contributed $10,000 cash at bank as capital, assume the owner decided to use part of the money to purchase an asset e.g. a computer desk costing $500, the double entry would be as follow:-

Dr. Computer desk                                $500

Cr. Cash at bank                                             $500

After the transaction has been effected, the balance sheet of ABC Co. Limited would show:-

ABC Co. Limited

Balance Sheet as at 31 December 2006

 

$

Assets

 

Computer desk

500

Cash at bank

9,500

Liabilities

TOTAL

10,000

Owners’ Equity

 

Paid-up share capital

10,000

TOTAL

10,000

 

As you can see here, $500 cash at bank used to purchase the computer desk is now recorded as a new asset item called “Computer desk” and as a result, the money left in the bank has reduced from $10,000 to $9,500. Take note that this transaction has NO EFFECT on the Owners’ Equity nor its Liabilities. In other words this is a transaction that affects the assets of ABC Co. Limited.

2. Purchase of asset under credit

Refer to the example of ABC Co. Ltd again, assume this time instead of purchasing the $500 computer desk using the money in the bank, the Owner of ABC Co. Ltd purchased it under credit, i.e. ABC Co. Ltd owes the creditor (Mr X, the computer desk vendor) $500 until it is paid. The double entry would be as follow:-

Dr. Computer desk                                $500

Cr. Creditor-Mr X                                   $500

After the transaction is effected, the balance sheet would show:-

ABC Co. Limited

Balance Sheet as at 31 December 2006

 

$

Assets

 

Computer desk

500

Cash at bank

10,000

 

10,500

Liabilities

 

Creditor-Mr X

(500)

TOTAL (Assets – Liabilities)

10,000

Owners’ Equity

 

Paid-up share capital

10,000

TOTAL

10,000

 

Same as Example 1, a new asset, “Computer desk” is created. In addition, a new liability item, “Creditor-Mr X” is also created. Again this is a transaction that has NO EFFECT on Owners’ Equity. However, it is a transaction that has an effect on Asset (Computer desk) and Liability (Creditor-Mr X).

Please take note that not all transactions affect only the Balance Sheet, there are transactions that have their effect on the Income Statement or Profit and Loss Account as well which I will discuss in later topics.

Debits and Credits

 

These two words are typical to the world of accounting and they relate to the Accounting Equation: –

Assets = Liabilities + Owners’ Equity

Under what we called double entry system in accounting, each transaction must be recorded TWO times. For example, when you as an owner of an entity you contribute capital to the business by opening a bank account lets say $10,000, the following entry is made: –

Dr. Cash at bank                $10,000 (Asset)

Cr. Paid-up share capital      $10,000 (Owners’ Equity)

Note: Dr. represents “debit” and Cr. represents “credit”

Points to note: –

1. All assets item when recorded initially, you must follow the convention of “debiting” the account relating to that particular asset.

2. All liabilities item and Owners’ Equity item on the other hand you must “credit” the relevant accounts relating to that item when you first recognise them.

Refer to the above example, if right after you have contributed the capital to the business and there are no further transactions till the end of the financial year (this is the last day of the period that you wish to set as the financial period for your business entity, 12 months is the full financial period in a year) say 31 December 2006, the Balance Sheet of your business as at 31 December 2006 looks like this: –

ABC Co. Limited

Balance Sheet as at 31 December 2006

 

$

Assets

 

Cash at bank

10,000

TOTAL

10,000

 

 

Liabilities

 

 

Owners’ Equity

 

Paid-up share capital

10,000

TOTAL

10,000

 

The above balance sheet shows the financial position of ABC Co. Limited as at 31 December 2006 i.e. on this date, the entity has $10,000 worth of asset, cash at bank to be specific, which is financed or represented by the $10,000 of paid-up share capital contributed by its owner. Can you see that with the figures included, the Accounting Equation has now become meaningful? Of course in this example, the entity has no liabilities.