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Trial balance - Control mechanism

The trial balance verifies the arithmetic accuracy by comparing the sum of the debit and credit entries to see if they agree or disagree.

The trial balance records the ledger account balances remaining in the accounting books at the end of a period of time to assist the preperation of the financial statements/

If the TB agrees it is arithmetically correct but the following errors will not be revealed because the sum of the debits will equal the credits:

  • Original entry, commisson, omission, principle and reversal

If the TB disagrees, the book keeper will open a suspense account to record this difference implying the TB is arithmetically incorrect.

  • This account will remain open until the errors have been found
  • This implies that one part of the double entry has been omitted or entered incorrectly.
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Bank reconciliation statement - control mechanism

The bank reconciliation statement process verifies the trader's bank balance in the cash book with the Bank statement which can be seen as an independent record.

Advantages:

  • Verify the opening and closing bank balances in the cash book
  • Check that un-presented items from last month have cleared this month
  • Identify un-presented items that have not cleared this month
  • Identify omission in the cash book such as bank charges
  • Prevents or discourages fraud by the book keeper
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Control accounts

Control accounts can be used to verify:

  • The balance owed by debtors in the sales ledger
  • The balance owed to creditors in the purchase ledger

Control accounts verify the sales or purchase ledger balance by agreeing these totals with a appropriate control totals.

However, even if the balances are arithmetically agreed, the following errors may still exist:

Omission, commission and orginal entry

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Financial records

  • They enable the trader to determine if he is making a profit or loss which is important given he is liable for his debts and can be made bankrupt if he is unable to pay them
  • They enable the trader to calculate his or her capital by listing the assets and liabilites of the business
  • They enable the trader to provide evidence to revenue and customes of the profit or loss to asses the amount of income tax that must be paid
  • They enable the trader to prevent fraud by using control accounts and the bank reconciliation process

Who is interested in the final accounts?

  • Owner
  • Employees
  • Creditors
  • Revenue and customers
  • Customers
  • bank
  • potential investors
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Errors

  • Commission - The correct amount has been posted to the correct side of an incorrect debtor or creditor - the trial balance will still agree as the amounts are the same on both credit and debit
  • Reversal - The debit and credit entries are reversed -  the trial balances still agrees as the same amount was entered on both the debit and credit sides
  • Omission - An entry from a source document has not been entered into the day book and so the double entry has been omitted from the ledgers - the trial balance still agrees as both the debit and credit entry have been missed
  • Original entry - an incorrect amount is posted from a source document to the day books and while the debit and credit entry in the ledgers agree, they are for the wrong amount
  • Principle - A correct amount is posted on the correct side of the ledgers but in the wrong type of account - the trial balance will still agree because the debit and credit entries are the same
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Daybooks/subsidiary books

  • Cashbook - To record bank and cash transactions using cheque stubs or paying in receipts, bank statements, direct debits, standing orders, credit transfers
  • Purchase day book - the record credit purchases using purchase invoices
  • Sales day book - to record credit sales from sales invoices
  • Purchase returns (returns out) day book - To record returns to suppliers from credit notes recieved
  • Sales returns (returns in) day book - To record returns from customers from credit notes issued
  • Journal - to record non routine transactions - purchases of fixed assets, correction of erros, depreciation and transfers

Purpose : To reduce the number of entries into the ledger accounts, to speed up the processing of accounting information, to record source documents

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Source documents

  • Sales invoice - Records the value of a sale to a customer - sent to customer - sales day book
  • Purchase invoice - Records the value of a purchase from a supplier - sent by supplier - purchase day book
  • Credit note issued - A trader issues a credit note to customers to record returns in
  • Credit note recieved - A trader will recieve a credit note from suppliers to record returns out
  • Cheque counterfoil -  Records the value of a cheque paymet ro a supplier - cashbook
  • Paying in slip - Records receipts of money from customers in the form of cash of cheque, now in the traders bank
  • Cash reciepts - Indicates the reciept of cash sales and is recorded on debit side of the cashbook
  • Till roll - Record the total of cash sales and should be entered on the credit side of sales accounting and debit of cash book
  • Bank statement - Document containing traders bank reciepts and payments and can be used to identify omissions from the cash book such as DD.
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Banks

  • Standing order - Regular and fixed payment from the payees bank to the payees bank
  • Direct debit - Regular and variable payment controlled by the payee
  • Credit transfer - Automatic transfer from one bank to another bank ie wages
  • Bank Charges - Deduction from bank account by the bank to cover the running costs of the traders account dr bank statement cr cash book
  •  BACS - banks automatic clearing system i.e a way to pay wages automatically
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Stakeholders interest in a business

  • Customers - will the bussines be able to supply ordered goods?
  • Suppliers - Will the business be able to pay for the ordered materials? Will the payment be on time?
  • Employees - Will the wages be paid on time? Will the business continue to offer employment?
  • Bank - Profit or loss? Can the afford to repay their loans?
  • Goverment - How much tax needs to be paid? Is the trader declaring all cash sales?
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Reasons for keeping financial records

  • Day books allow the trader to record source documents in date order and to provide detailed information for completing the ledgers.
  • The trial balance allows the trader to verify arithmetically the accuracy of the double entry to ensure errors have not occurred.
  •   The trader can prepare an income statement to judge how profitable the business is and to reassure creditors such as banks that he can repay loans
  • The balance sheet will indicate the net worth of the business and is useful if the trader is considering selling the business or wanting to borrow from a bank.
  •  Control mechanisms such as bank reconciliation statements help detect and discourage fraud by employees because the trader can compare his records with a bank statement.
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