WHAT IS A BUDGET?

A budget is a quantitative expression of a plan of action prepared in advance of the period to which it relates.

It usually shows planned income to be generated and/ or expenditure to be incurred during a period and capital to be employed to attain a given objective.

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Applying the rule of debit and credit- Example 8

Example-7   Sold goods worth £4000 to Mr. Ambar on credit

Step 1- Identify the two accounts involved in this transaction

1.   Asset Account (Goods are assets)

2.   Asset Account (Mr. Ambar is an asset account (Trade Debtors/Receivable) because, as a result of the above transaction the business has the right to receive £4000 from Mr. Ambar)

      When goods are sold we credit “Sales Account” not “Goods Account”

Step 2- Understand the nature of the impact of the transaction on the two accounts [goods (Asset) and Debtors- Mr. Ambar (Asset)]

     Sale of goods decrease the asset by £4000     

           

   The amount owed by others to business is termed as Debtors/Receivables. So such amount receivable is arisen/increases as the result of credit sales- that is the value of asset  is increased

Step 3- Decide which account is to be debited and which is to be credited.

            We know that;

When asset account (goods-termed as sales) decreases it is to be Credited and,

When Asser account (Debtors- Mr. Ambar) increases it is to be debited

So, entry is:

Debit Mr. Ambar Account with £4000

Credit Sales Account with £4000

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Applying the rule of debit and credit- Example 7

Example-7   Sold goods worth £4000 for cash

Step 1- Identify the two accounts involved in this transaction

1.   Asset Account (Goods are assets)

2.   Asset Account (cash)

      When goods are sold we credit “Sales Account” not “Goods Account”

Step 2- Understand the nature of the impact of the transaction on the two accounts [goods (Asset) and cash (Asset)]

     Sale of goods decrease the asset by £4000     

           

     Cash balance will increase by £4000 as a result of cash sales

Step 3- Decide which account is to be debited and which is to be credited.

            We know that;

When asset account (goods-termed as sales) decreases it is to be Credited and,

When Asset account (Cash) increases it is to be debited

So, entry is:

Debit Cash Account with £4000

Credit Sales Account with £4000

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Applying the rule of debit and credit- Example-6

Example-6.   Goods worth £500 returned to Jammy Traders as it was faulty.

Step 1- Identify the two accounts involved in this transaction

1.   Asset Account (Goods are assets)

2.  Liabilities Account (here the liability account is Jammy Traders).

      We know that;

      When goods are purchased we debit “Purchases Account”

      So when purchased goods are returned we have to credit “Purchases Returns Account”

      Purchases returns also known as” Return Outwards”

Step 2- Understand the nature of the impact of the transaction on the two accounts [asset (goods) and liability (Jammy Traders)]

     Returning of purchased goods decrease the asset by £500  

           

     Liability of business is decreased by £500 as we returned the purchased goods

Step 3- Decide which account is to be debited and which is to be credited.

            We know that;

When asset account decreases it is to be Credited and,

When liability account (Jammy Traders) decreases it is to be debited

So, entry is:

Debit Jammy Traders Account with £500

Credit Purchases Returns Account with £500

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Applying the rule of debit and credit - Example 5

Example-5.  Purchased goods worth £5000 from Jammy Traders on credit

Step 1- Identify the two accounts involved in this transaction

1.   Asset Account (Goods are assets)

2.  Liabilities Account (here the liability accounts is Jammy Traders. As the purchase is on credit, business is having liability to pay £5000 in future to Traders Account)

      Goods are items which are purchased by a business for using as a raw material in the manufacturing process or to sell at a higher price. It includes raw material work in progress and finished goods.

      When goods are purchased we debit “Purchases Account” not “Goods Account”.

      When goods are sold we credit “Sales Account” not “Goods Account”.

Step 2- Understand the nature of the impact of the transaction on the two accounts (asset and liability)

     Purchase of Goods made the asset increase by £5000                      

     Liability of Business is increased by £5000 as a result of the purchase on credit.

Step 3- Decide which account is to be debited and which is to be credited.

            We know that;

When asset account (Goods-termed as Purchases) increases it is to be Debited and,

When liability account (Jammy Traders) increases it is to be credited

So, entry is:

Debit Purchases Account with £5000

Credit Jammy Traders Account with £5000

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Trading account Vs Manufacturing Account

Trading Account

A trading account is prepared to find out the results (profit or loss) of trading activities. Cost of goods Sold is deducted from the value of sales to find out the trading result, i.e. gross profit. Cost of Goods Sold is calculated as follows,

Opening inventory                      xxx

Add purchase(less returns)             xxx

Add expenses related to purchases      xxx

                                       xxx                                                                                                                           

Less Closing Inventory                 xxx

Cost of Goods Sold                     xxx

So,

Gross Profit = Sales – Cost of Goods Sold

If cost of goods sold is more than value of sales, it will result in Gross Loss.

Manufacturing Account

It is assumed that a trading account is prepared when the trader undertakes only purchasing and selling. I.e. no manufacturing is under taken.

A manufacturing account is prepared to find out cost of production. That is a manufacturing account is relevant when there is manufacturing activities. Cost of production is calculated as follows,

Direct cost of raw material                           xxx

(Opening stock of r.m + purchases of r.m +expenses related to that purchase – closing stock of r.m)

Direct cost of Labour (wages)                         xxx

Direct expenses                                       xxx

Prime Cost                                            xxx

Add manufacturing overhead                            xxx

(Indirect expenses related to production)
Add opening work in progress                          xxx
Less closing work in progress                        (xxx)

Cost of Production                                    xxx

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What is Inventory?

 Inventory is a term for the raw materials, goods in process, and finished goods that a business plans to sell.

   

 Inventory is an Asset.

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Applying The Rule of Debit and Credit- Example 4

Example-4.  Purchased goods worth £5000 for cash

Step 1- Identify the two accounts involved in this transaction

1.   Asset Account (Goods are assets)

2.   Asset Account (Cash Account)

  Goods are items which are purchased by a business for using as a raw material in the manufacturing process or to sell at a higher price and not for permanent use in the business It includes raw material work in progress and finished goods.

  When goods are purchased we debit “Purchases Account” not “Goods Account”.

  When goods are sold we credit “Sales Account” not “Goods Account”.

Step 2- Understand the nature of the impact of the transaction on the two accounts (Assets- Goods and cash)

     Purchase of Goods made the asset increase by £5000

Cash is decreased by £5000 by the payment for goods

Step 3- Decide which account is to be debited and which is to be credited.

            We know that;

When asset account (Goods-termed as Purchases)increases it is to be Debited and,

When asset account (cash) decreases it is to be credited

So, entry is:

Debit Purchases Account with £5000

Credit Cash Account with £5000

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Applying The Rule of Debit and Credit - Example 3

Example 3.  Bought furniture worth £6000 on credit (ie,payment will be made later)from GK Furniture

Step 1- Identify the two accounts involved in this transaction

1.      Asset Account (furniture is an asset)

2.     liability Account (here the liability account is GK furniture. As the purchase is on credit, business is having liability to pay in future to GK Furniture)

Step 2- Understand the nature of the impact of the transaction on the two accounts (furniture(asset) and GK Furniture (Liability))

     Purchase of furniture made the asset increase by £6000

Liability towards GK Furniture has arisen(increased) by £6000

Step 3- Decide which account is to be debited and which is to be credited.

            We know that;

When asset account (furniture) increases it is to be Debited and,

When liability account (GK Furniture) increases it is to be credited

So, entry is:

Debit Furniture Account with £6000

Credit GK Furniture Account with £6000

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Applying the Rule of Debit and Credit- Example 2

Example 2.  Bought furniture worth £5000 for cash

Step 1- Identify the two accounts involved in this transaction

1.      Asset Account (furniture is an asset)

2.      Asset Account (cash is an asset)

Step 2- Understand the nature of the impact of the transaction on the two accounts (assets- furniture and cash)

     Purchase of furniture made the asset increase by £5000

Cash is decreased by £5000

Step 3- Decide which account is to be debited and which is to be credited.

            We know that;

When asset account (furniture) increases it is to be Debited and,

When asset account (here it is cash) decreases it is to be credited

So, entry is:

Debit Furniture Account with £5000

Credit Cash Account with £5000

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Applying Rule of Debit and Credit- Example 1

Example 1. Mr. Kevin started a business with £50000.

Step 1- Identify the two accounts involved in this transaction

1.      Capital Account

2.      Asset Account (cash is an asset)

Step 2- Understand the nature of the impact of the transaction on the two accounts (capital and cash)

            For the business the amount of capital is increased by £50000 as result of the transaction

            Cash is also increased by £50000

Step 3- Decide which account is to be debited and which is to be credited.

            We know that when capital account increases it is to be Credited and,

            When asset account (here it is cash) increases it is to be Debited

Debit Cash Account with £50000

Credit Capital Account with £50000

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Classification of accounts and Rules of Debit and Credit

Normally there are five categories of accounts (First category). They are;

1.      Asset Accounts (Buildings, plant, furniture, cash, inventory, debtors etc.)

2.      Expense Accounts (salary, rent, electricity, depreciation etc.

3.      Liability Accounts (debentures, loans, creditors, outstanding expenses etc.

4.      Income Accounts (interest, dividend, commission, fees etc. received)

5.      Capital Accounts. (Equity share capital, preference share capital etc.)

There is another categorization of accounts. (second category)

1.      Personal Accounts

2.      Real Accounts

3.      Nominal Accounts

Rules of debit and credit (when to debit an account and when to credit an account)

Rule of debit and credit based on first categorization;

Account	Effect	Debit/Credit
Assets	increase	debit
	decrease	credit
Expenses	increase	debit
	decrease	credit
liabilities	increase	credit
	decrease	debit
Incomes/revenue	increase	credit
	decrease	debit
capital	increase	credit
	decrease	debit

Rule of debit and credit based on second categorization;

Name of Account as per first categorization	Name of Account as per second categorization	Rule
Capital Account Liabilities Accounts	Personal Account	Debit the Receiver Credit the Giver
Assets	Real Account	Debit What Comes In Credit What Goes Out
Income/Revenue Expenses	Nominal Account	Debit All Expenses and Losses Credit All Incomes and Gain

Let us go through some examples

Example 1. Mr. Kevin started a business with £50000.

Step 1- Identify the two accounts involved in this transaction

1.      Capital Account

2.      Asset Account (cash is an asset)

Step 2- Understand the nature of the impact of the transaction on the two accounts (capital and cash)

            For the business the amount of capital is increased by £50000 as result of the transaction

            Cash is also increased by £50000

Step 3- Decide which account is to be debited and which is to be credited.

            We know that when capital account increases it is to be Credited and,

            When asset account (here it is cash) increases it is to be Debited

So, 

Debit Cash Account with £50000

Credit Capital Account with £50000

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