AAT Level 2 Chapter 1 - Introduction to Financial Accounting

  • Created by: jpegg
  • Created on: 23-10-16 12:11

Business Entity - Sole Traders

  • A business owned by one person, it is an unincorporated business which means that in the eyes of the law, there is no distinction made between the owner and the business.
  • The owner has unlimited liability, which means they are personally responsible for all debts of the business.
  • There is very little regulation on the financial records of a sole trader.
1 of 9

Business Entity - Partnership

  • A business owned by two or more persons. Like sole traders it is also an unicorporated business.
  • Those engaged in a partnership generally have unlimited liability. However, in some forms of partnerships a partner may decide to have limited liability, this would allow the partner to invest only funds in the business and cannot be directly involved in the management side of the business. Limited liability means the partner is liable to the debts of the business only to the extent of the funds they have personally invested in the business.
2 of 9

Business Entity - Limited Companies

  • Owned by individuals known as shareholders.
  • They are incorporated, meaning that each company has its own legal identity.
  • Those who own shares in a limited company have only limited liability; if the company encounters financial difficulties its shareholders are protected, and the maximum they can lose is limited to the extent of their personal investment in shares of the company.
3 of 9


Definition - A systematic process by which financial information is identified, recorded, measured, summarised and interpreted.

The two main functions of accounting:

  • Financial accounting - this compromises of financial record keeping and and the use of informationm from within the financial records to prepare financial statements such as the statement of profit or loss. All business organisations regardless of their size and type are legally required to keep financial records.
  • Management accounting - the purpose of management accounting is to provide financial information at a time, and in a format that makes it suitable for the purpose of planning and controlling the business,
4 of 9


Definiton - A systematic routine where the financial transactions of a business are processed and recorded.

  • The books represent a record of all transactions that have ever taken place.
  • Smaller soler trader and partnership type organisations use a bookkeeping systerm known as the single entry system. This systerm consists of a simple cash book or journal, often kept using a spreadsheet, where a business's receipts and payments are recorded and analysed.
  • Medium or large business organisations use a system known as the double entry bookkeeping system. A manual double entry bookkeeping system is sub-divided and consists of several books through which transactions are processed.

Information provided by a business's bookkeeping system should include:

  • The nature and value of the asssets of the business.
  • The claim of the owner(s) on the assets of the business (the capital claim of a sole trader or partners, or the equity claim of the shareholders of a company).
  • The liabilities of the business.
  • The income earned by the business from trading or non-trading activities.
  • The costs and expenses incurred in the running and adminastration of a business.
5 of 9

Distinction between accounting and bookkeeping

  • Bookkeeping is mainly concerned with the recording of financial transactions, accounting is associated with the use of financial information from within the bookkeeping system for the purpose of preparing financial statements.

Financial statements include:

  • Statement of profit or loss - this statement is prepared for a a particular accounting period. It is an account of income earned by the business in the accouting period and the costs and expenses incurred by the business in the same accounting period.
  • Statement of financial position - shows the financial position of a business as at a particular point in time. It provides information of what a business owns (assets) and what it owes (capital, equity and liability claims).
6 of 9

Source Documents (1)

  • Cash receipt - cash sales transactions should be supported by a cash receipt issued to the customer. Cash sales transactions are usually recorded in the business's bookkeeping system from an end of day print-out that shows an analysis of the total of the cash sales through the till that day.
  • Invoice - the document issued by a supplier to the customer to support a credit based transaction. The seller uses the invoice they issue to record the sales transaction, which includes the amount they are owed, in their bookkeeping system. The buyer uses the invoice they receive to record the purchase transactions, inlcuding the amount they owe, in their bookkeeping system,
  • Credit note - reduces the value of an invoice. The supplier issuing the credit note will use it to record 'sales returns' in their bookkeeping system. The customer receiving the credit note will use it to record 'purchase returns' in their bookkeeping system.
  • Remittance advice - issued by the customer to the supplier to support payments, it should give a detailed breakdown of the payment being made. Receipts from credit customers, and payments to credit suppliers are recorded in the accounting system of the buyer and the seller using the remittance advice as the source document.
7 of 9

Source Documents (2)

  • Cheque book counterfoil - when payment is made by cheque details from the cheque should be copied onto the cheque book counterfoil.The cheque is then issued to ther payee with the counterfoil being left in the cheque book giving details of the payments made.
  • Bank statement - the statement of account is often used as a source document from which some of a business's receipt and payment transactions are processed.
  • Schedule of standing orders and direct debits - The schedule is a list of standing orders and direct debit payments giving details of each payment to be made/collected in terms of payment date; who the payment is made to; what the payment is for. Often automated payments such as payments made by standing order or direct debit are processed from the bank statement. The schedule is then used to check that any standing order and direct debit payments appearing on the bank statement are valid.
  • Petty cash voucher - where payment is made from petty cash a cash recepit should be collected and retained as evidence of the payment. Details are then copied from the receipt to a petty cash voucher; the voucher is then used as the source document for recording the petty cash expenditure in the bookkeeping system.
8 of 9

Source documents (3)

  • Supplier statement of account - the statement summarises, in date order, the transactions that have taken place between the supplier and the customer during the month and requests payment.
  • Paying-in-slip - a pre-printed form on which cash and cheques to be paid into a bank current account are listed and summarised.
9 of 9


No comments have yet been made

Similar Accounting resources:

See all Accounting resources »See all Chapter 1 - Introduction to Financial Accounting resources »