Entrepreneurship

Sub-topic area: Basic Accounting

Key unit competence: To be able to record initial Accounting entries for a business

Review activity 

In Senior 1, you were introduced to Accounting. 

1. Explain the meaning of Accounting and bookkeeping. 

2. Explain the importance of Accounting. 3 Who are the users of Accounting information? 

4. Name the different business transactions. 5. Name the methods of payment.

Introductory activity

 Mrs Nikuze has just moved to Karumuna in the Eastern Province and plants to start a business. Currently everyone in the region buys their daily bread from Kigali. Mrs Nikuze loves to bake, so she decides to prepare and sell pastries and different bakery products. However, setting up a business also means that she needs to keep track of all of her earnings and expenses. Her brother suggests that she draws up a checklist of financial information that she will need to keep track of in her business. Draw up a checklist of financial information to assist Mrs Nikuze.

7.1 What is Accounting?

 In Entrepreneurship Senior 1 you learnt that financial management is managing the resources of a family or a business in an effective way. Accounting is a system that assists us with good financial management. An accountant keeps, manages and inspects the financial accounts. An Accounting system gives us important information. For example, a business can determine if it is making a profit. A business owner can also use the information to decide if he or she should invest in new machines or a vehicle. An individual person can see if he or she is saving up enough money for retirement. Both businesses and individuals can check that they are following their budgets. Accounting is also important when paying taxes. When we add our financial transactions into an Accounting system, we can determine how much tax we need to pay. To add financial information into an Accounting system, we first need to gather source documents.

7.2.1 Invoices 

When you buy a product or service, you receive an invoice from the seller. An invoice lists the description and the quantity of the item sold or service provided. This document is a record of the sale for both the seller and the buyer. A buyer can pay straight away (known as Cash on Delivery or COD), but sometimes the buyer has a period of time to pay, for example 30 days or 60 days. This information is also on the invoice.

7.2.2 Deposit slips 

We use a deposit slip when we want to deposit money into a bank account and a withdrawal slip when we want to take money out of a bank account. To deposit money, we fill out the form to show how much money we deposit. The teller at the bank keeps the deposit slip along with the cash deposit and provides a receipt. The receipt is proof that the money has been deposited.

7.2.6 Payment order 

A payment order is an instruction to transfer funds from one bank account to another. This can be done manually (on paper) or electronically. A postal order is a type of payment order. Post offices can send (‘wire’) money between two points nationally or internationally. As with cheques, this form of payment has largely been replaced by the electronic transfer (EFT).

Activity 7.1 

1. Visit a local business centre or Bursar and identify various source documents. 

2. Design the following documents for Mrs Nikuze’s bakery: 

• receipts 

• voucher 

• pay slips 

• invoices 

• cheque 

• payment order.

Let us look at the Accounting Equation for your jeans. Jeans (Asset) = savings (Owner’s Equity) + loan from parents (Liability) 10 000 Frw = 8 000 Frw + 2 000 Frw The left-hand side of the Accounting Equation must equal the right-hand side.

Case study 7.1 

A cup of tea

 A cup of tea is a new business that sells quality teas from the Karongi region. Josephine, the owner, has invested in a delivery van and a laptop. She saved 1 100 000 Frw and lent 3 000 000 Frw from the bank.

 1. Identify the possessions of Josephine’s business.

 2. What are Josephine’s Liabilities? 

3. What is Owner’s Equity? 

4. Write the Accounting Equation

 5. Draw up the Accounting Equation for Josephine’s business.

Exercise 7.1 

Mrs Nikuze is shopping for a new oven for her business. She wants to buy an oven for 200 000 Frw. She has 120 000 Frw in savings. Her brother has agreed to lend her the remaining amount. 

1. Explain what is meant by the Accounting Equation. 

2. Use the Accounting Equation to determine how much money Mrs Nikuze must borrow.

Do you recall using the Accounting Equation for buying jeans? Your asset – 10 000 Frw for a pair of jeans increased. This leads to a debit. Your savings 8 000 Frw decreased. Money is also an asset. This leads to a credit. Your liabilities of 2 000 Frw have now increased. This leads to a credit.

The Accounting Equation must always balance! A debit is a transaction that occurs when the business increases assets or decreases liabilities and Owner’s Equity. A credit is a transaction that occurs when the business decreases assets or increases liabilities and Owner’s Equity.

Using accounts

 When we record transactions in the double entry bookkeeping system we use a record called an account. To draw up an account we use a T-shape. The left-hand side is used for debits and the right-hand side to record credits. We use different accounts to record the Assets, Equities and Liabilities of a business. An account is the first step to drawing up financial records for the business.

Asset accounts 

An asset is an item of value. We differentiate between fixed assets and current assets. Fixed assets are items which will stay for a long period of time, normally more than 12 months. A fixed asset is something that the business buys that is used to produce products and services. A delivery vehicle and a manufacturing machine are examples of fixed assets. Current assets are items which will stay for a short period of time, normally less than 12 months. A current asset is an asset such as raw materials, fixed products or cash. It includes items that the business sells or anything that can easily be converted to cash.

Liability accounts 

Liabilities are amounts owing to lenders, investors or other creditors. A liability is debt that the business owes. When we buy expensive things, such as a car or a home, we usually borrow money that we must pay back over a long period of time. This is called a long-term liability. A business pays back a long-term liability over a long period of time, usually more than a year. A short-term liability is a debt that the business must pay back in the near future. If the business buys raw materials on credit, the supplier usually wants payment within one month. A telephone bill must also be paid within a short period of time, so this is also a short-term liability

Equity accounts 

Every business is owned by somebody. The money that the owner invests in his or her business is called Equity. The Equity accounts track how the owner invests in a business. These accounts include: 

• The Capital account: To start a business, the owner typically invests his or her savings. This money is used to buy equipment, to advertise the business and pay other costs for the new business.

 • Retained Earnings: This account tracks the profit or losses of the business from its starting date. At the end of each year, the profit or loss is added to this account.

Exercise 7.2 

1. Write down a definition for the following terms: account, Asset, Liability, Owner’s Equity. 

2. Write down the Accounting Equation and explain why this equation always balances. 

3. Explain how the double entry bookkeeping system works.

When the information has been captured in the prime books, it is then transferred to the Ledgers. The Ledger accounts are used to prepare the financial statements for the business.

7.5 Debit and credit entries 

It is sometimes difficult to identify the debit and the credit entries in each transaction. Use the guidelines below to decide which entry is the debit and which is the credit. 

Debit side increases:

 • Drawings (owner withdraws money from the business) 

• Expenses 

• Assets 

Credit side increases: 

• Capital (owner invests money in the business)

 • Liabilities (debts) 

• Income

Exercise 7.3 

Mrs Nikuze invests 100 000 Frw in her business. She buys equipment for her bakery for 150 000 Frw. She asks her brother to lend her the remaining amount. 

1. Identify the transaction that affects the Assets, Liabilities and Equity accounts of Mrs Nikuze.

 2. Complete the Accounting Equation for Mrs Nikuze’s transactions.

7.5.1 The General Journal 

The General Journal is a master journal used to keep a chronological record of all financial transactions of a company. It is also called a master journal. A typical General Journal has columns that lists the date of the transaction, a description of the account, a posting reference (PR) and the debit (Dr) and credit (Cr) amounts. Below are the General Journal entries that Mrs Nikuze entered when she bought equipment for her bakery business. (See Exercise 7.3)

The date and description of each transaction are included in the General Journal. Each transaction is also listed as a debit or credit entry. As you can see, the debits and the credits must add up to the same amount. At the end of each year (or reporting period), the transactions are taken from the General Journal and posted to ledgers. A ledger records the information from the journals.

7.5.2 The Sales Journal 

The General Journal is divided up into smaller journals. The Sales Journal records the credit sales of a business (when the goods are sold and payment is collected at a later date).

7.5.3 Purchases Journal 

The Purchases Journal is a record of all the items that a business buys on credit (where the goods are paid at a later date).

7.5.4 Sales Returns Journal

 A Sales Returns Journal records when a customer returns a product. This happens when goods are damaged or when a customer receives an incorrect order.

7.5.6 Cashbooks 

The Cash Journal or cashbooks are journals where cash transactions are recorded. There are two types of cash journals, a Cash Receipts Journal (CRJ) and a Cash Payments Journal (CPJ).

Cash Receipts Journal (CRJ) 

Whenever a business receives cash, the information is entered into the Cash Receipt Journal (CRJ). A business receives cash for different reasons. The simplest transaction is a cash sale. This happens when a customer pays cash for a good or service.

7.6 Summary of the prime books

7.7 The General Ledger 

The General Ledger is a record of all the accounts that the company uses. When all the transactions have been added into their respective journals, the information is posted to the General Ledger. A General Ledger is a record that the business uses to keep track of financial transactions. The General Ledger contains all the accounts for the Assets, Liabilities, Owner’s Equity, Income and Expenses. The General Ledger is used to draw up the Trial Balance. A Trial Balance is a list of all the General Ledger accounts. This list shows the name of each ledger and the amount. The Trial Balance shows either a debit or a credit amount. The debit amounts are then added and the credit amounts are added. The total credit amount must be equal to the total debit amount. If the amounts are not equal, the accountant must identify and correct mistakes in the ledgers. When the Trial Balance is correct, the accountant draws up the financial statements. These statements show how well the business did during the year. The financial statements includes an Income Statement that shows how much profit a business made and a balance sheet that shows the Assets and Liabilities of a business. The cycle now starts anew. The source documents are again recorded for a new year. Note The Journal entries on the previous pages are examples of some of the information that is posted to the General Ledger

7.8 Recording transactions using the double entry Accounting principle

Let us investigate how to record transactions using the double entry Accounting principle.

Recording transactions at Colourful Trading 

The following transactions took place during one week in July 2017 at Colourful Trading, a retailer that sells paints in Kigali.

Date 

2/7 The owner invests 50 000 Frw in her business. The amount is deposited in the bank.

 3/7 Cash sales of paint for 20 000 Frw. The amount is deposited in the bank. 

3/7 Cash payment of wages for 8 000 Frw. 

3/7 Buy inventory from Musanze Traders for 20 000 Frw on credit. 

5/7 Buy office supplies from ABC stores for 2 000 Frw on credit. 

5/7 Credit sales to J Ishimwe for 2 000 Frw. Invoice number 103 issued.

Activity 7.2

 Mutoni grows and sells dried pyrethrum. The following transactions took place during one week in August 2017. 

Date

1/8 The owner invests 20 000 Frw in her business. The amount is deposited in the bank. 

3/8 Credit sales to Pyrethrum Coop for 50 000 Frw. Invoice 555 issued. 

4/8 Cash payment of wages for 6 000 Frw. 

4/8 Buy fertiliser from Musanze Farm stores for 10 000 Frw on credit. 

5/8 Buy seeds from Rwanda Seed Supply for 5 000 Frw on credit. 

5/8 Cash sales for 10 000 Frw. The amount is deposited in the bank.

Use the example from page 99 to draw up your own Journals and Ledgers in your workbook. Use these to record Mutoni’s transactions. 

a) Enter the above transactions in their General Journal. 

b) Post the transactions in their respective ledger accounts.

Unit summary 

What is Accounting 

• Accounting is a system that assists a business with good financial management and this information assists various stakeholders to make an informed business decision. 

• The Accounting process starts when source documents are processed in the Accounting system.

Source documents 

• A source document is the original document used in a financial transaction and is proof that the transaction took place.

 • Source documents could be: cheque, invoice, receipt, voucher 

• A receipt is proof that a payment was received.

 • A voucher is a document to proof that payment was made for a specific service. The holder of the voucher gives the voucher to receive the goods or services. 

• An invoice is a document issued detailing the goods or services, date of the transaction and the quantity of goods purchased. An invoice can be paid cash or after a predetermined time period e.g. after 30 days, 60 days or 90 days. 

• A cheque is issued to pay for goods or services and this amount is guaranteed by the bank. It is a safe way to pay large sums of money

• A payment order is a written instruction made from one bank to another bank to transfer funds. 

• A bookkeeper is the person who captures all the source documents into the Accounting system and prepares certain financial statements. 

• Internal and external users use Accounting information for various different reasons.

The Accounting Equation 

• All business owners should know the difference between Assets, Equity and Liabilities. These are stated as the Accounting Equation.

The double entry bookkeeping system 

• The double entry bookkeeping system is the Accounting method used in a business to manage finances. Assets = Owner’s Equity + Liabilities 

• In this system there are two components to every transaction. One entry is called a credit and one is called a debit.

Different books of prime entry

 • Prime books, also known as Accounting records, is the first place where source documents are recorded.

Steps in the Accounting Cycle are:

 • Source documents: a receipt, a voucher, a pay slip, an invoice, a cheque, a payment order

 • Capture in various applicable Journals 

• Post to the Ledger or T-accounts 

• Draw up Trial Balance 

• Compile Financial Statements

Self-assessment 

1. Give three examples of source documents.

 2. Explain the following: 

a) Accounting Equation 

b) Double entry method of bookkeeping 

3. List the entries that you will do in the following prime books: 

a) Sales Returns Journal 

b) General Journal 

4. Explain the difference between long-term and short-term liabilities.

Topic area: Summative assessment (Units 6 and 7)

 Section A 

Read the text. Then answer the questions that follow.

Music to my ears

 Music, dance and poetry play an important role in Rwandan society. Suzanna has started a new business called ‘Music to my ears’. In this business, she will produce and sell double-skin drums made from hardwood, cattle skin and lacing. She has rented a space at a retail market in Kigali where she can make and sell her drums.

1. Explain what is meant by a budget. (2) 

2. Describe how Suzanna can develop a personal budget. (4) 

3. Suzanna estimates that she can earn 40 000 Frw per month from selling her drums. Below is a list of her monthly costs.

a) Calculate Suzanna’s total monthly costs. (2) 

b) Draw up a budget that shows Suzanna’s income and expenses for the next year. (10)

 c) How much money can Suzanna save every month? (2) 

                                                                                              [20]

Section B 

Peter maintains the gardens at hotels and other businesses. Here are some transactions in Peter’s Garden Service business.

1. Explain what is meant by double entry bookkeeping. (4)

 2. What is a source document? (2) 

3. List two types of source documents. (2) 

4. Draw up a record of the transactions for Peter’s Garden Service. (12)

Section C 

1. Suzanna sells a drum to a customer. Draw up a suitable source document that shows this transaction(4) 

2. Suzanna finds it difficult to start a new business. Suggest ways that Suzanna can increase her income for her business ‘Music to my ears’. (6) 

                                                                Total marks: 50