1

Bank Reconciliation
One of the most efficient and most commonly used tools for checking the accuracy of the
bookkeeping system is a check known as the "Bank Reconciliation". This check is usually
carried out once a month, at the end of the month.

What is Bank Reconciliation?

Let us assume for the purpose of this example that your name is Miles and that you are at
the end of June xx. Your accounts show that the current account at Western Union Bank has
a debit balance of $ 1,000 (as was explained, it is possible to relate to a current account as a
personal account. In other words on June 30, xx, the bank owes you $ 1,000). Logically, on
June 30, xx, the Western Union Bank accounts should show that you, Miles, have a credit
with the bank of $ 1,000. If the balance in the Bank's accounts (as may be seen easily from
the bank statement that is received each month by every business) is identical, this proves
that your bookkeeping is incredibly efficient, all communications with the bank, which is
usually a main component in the activities of the business, were recorded correctly.
In reality, the situation is a little different. Almost always, balance at the end of the month
can not be reconciled because, in the main, as a result of data that appear in only one of
the systems (our bookkeeping, the bank's accounts) but not in both of them at once. The
aim of the Bank Reconciliation is to attempt to locate the reasons for the discrepancies
because of which the two balances are not reconciled. It is clear that after "neutralizing" the
reasons for the irregularities that are the cause of the lack of reconciliation, the balances in
both places must be identical.

An example:
For purposes of the example, let us assume that the Western Union Bank accounts are to be
reconciled to June 30,xx.

Details: The balance in Miles' account for the Western Union current account shows a debit
balance of $ 1,000. The bank's accounts, on the other hand, show that on June 30, xx, Miles
had a credit balance of $ 1,500. The reasons for the lack of reconciliation are as follows:

The amounts that appears on only thebank statement:

1. A credit for interest (current account) in an amount of $ 50 for June 30, xx (not
recorded in Miles' accounts).
2. A debit for bank charges for the current account in an amount of $10 as of June 30,
xx (not recorded in Miles' accounts).
3. A credit for a bank error in an amount of $ 300 dated June 27, xx, that belongs to
Miller. Miles' account was credited in error (similar name).

The amounts that appear only in Miles' accounts

1. A check for $ 160 that was paid to a supplier, that had not yet been paid in by the
reconciliation date.

Preparing the Bank Reconciliation Statement

The basic technique for finding the reason that the accounts are not reconciled is to prepare
a "Reconciliation Statement", As a rule, check the following two possibilities for each item:
 2

1. Does the transaction actually belong to us (Miles) - if so, if the transaction has only
been recorded with the bank and not in our accounts - we must record it (the bank
has already recorded it).
On the other hand, it the transaction has only be as recorded in our accounts and not
in the bank's accounts, a parallel record should be made on the bank section in the
reconciliation statement.
2. If the transaction does not belong to us - in this case the bank's records are in error,
and the bank should correct its records.

The Bank Reconciliation statement is in fact divided into 2 T accounts. The right side reflects
our accounts (Miles' accounts) while the left side reflects the Bank's bookkeeping records
that refer to us (in our case, it is reasonable to assume that in the records of the Western
Union Bank, your account is called "Miles Account").
It is important to remember that from our point of view the current account with the Western
Union may be referred to as a real account (the bank "owes" us or "is owed" by us, as may
be the case.

We will go on to a presentation of the Bank Reconciliation Statement:

RECONCILIATION OF THE WESTERN UNION BANK ACCOUNT AS AT JUNE 30, xx

Miles Banks'
Accounts Accounts
Current "Miles"
Account with Account
the Western
Details Union Bank Credit
Credit
Debit Debit
Balance to reconciliation date,
1,000 1,500
30.6.xx
Amounts appearing only on the
Bank Statement
30.6.xx Credit: Interest 50
30.6.xx Debit: Bank charges 10
27.6.xx Credit: Error (belongs to
300
Miller)
Amounts that appear only in our
accounts
30.6.xx Check to supplier, Not yet
160
presented to bank
1050 10 460 1,500
Adjusted Balance as at 30.6.xx 1,040 1,040
Debit

Notice that at in preparing the Reconciliation Statement:

Heading: The name of the bank for which we are preparing the reconciliation statement
 3

and the date of the reconciliation (June 20, xx).

First Row: A record (it is preferable to circle it or mark it in bold) of the balance that
appears in our accounts and at the bank as at June 30, xx pre-reconciliation.

Amounts that appear only on the bank statement

1. Credit: Interest - The bank credited the account with $ 50 interest. From our point
of view nothing has been recorded and therefore we will debit the bank with $ 50 (the
Bank owes us another $ 50 in respect of the interest due to us).
2. Debit: Bank Charges - The bank has debited us with $ 10. From our point of view,
the matter has not yet been recorded. It is clear that the bank is entitled to $10 (bank
charges due to the bank).
3. Mistaken Credit - Deposit for Miller - The amount does not belong to us at all. The
error is that of the bank. Therefore we will indicate in the bank section (the right side
of the reconciliation statement) the fact that bank should debit us (this is how the
bank will cancel the erroneous credit that appears in Miles' accounts). In the right
hand part (Miles accounts) there is no need to record anything as from the start, we
(Miles) have not made any record at all concerning the $ 300.

Amounts that appear only in our accounts.

Check not yet presented- As at the date of reconciliation, the bank does not yet know
that $ 160 is about to be deducted from our account. Had the bank known this, it would
have debited us with this amount (debit, reducing our credit balance). The last row - the
adjusted balance of $ 1,040.
That is the real balance in our account today (and not $ 1,00 or $ 1,500 as appeared in
the pre-reconciliation balances.

The adjusted - balance - $ 1,040 - must be the same in both sections of the reconciliation
statement, If the amount does not agree, it proves that we have not found the cause of
the lack of agreement.

Journal Entries as a result of the Reconciliation

In our accounts (Miles' accounts) we have to make entries in the journal as a result of the
amounts that appear on the right side of the Reconciliation Statement. The entries will
be as follows:
Debit Credit

1. Debit: Western Union current account 50

Credit: Income from Interest 50
Current account interest - 30.6.xx

2. Debit: Expenses for bank charges 10

Credit: Western Union current account 10
Current Account Bank Charges - 30.6.xx

The Nominal Ledger, after the additional entries, will indeed, show a balance of
$1,040 as follows:
WESTERN UNION - CURRENT ACCOUNT
 4

Debit Credit
Pre-reconciliation balance 1,000 Bank Charges 10
Interest 50

1,050

10
1,040

Comment: In the above example, the causes for the lack of agreement were
presented at the beginning of the exercise. In real life, they must be "extracted" by
comparing our bookkeeping accounts with the bank statement we received.
THE IMPORTANCE OF THE BANK RECONCILIATION

If the practice in your business is to reconcile the bank statement each month, your
situation is relatively good. It is reasonable to assume that your bookkeeping is good.
If, on the other hand, the last Bank Reconciliation is done in your business, let us
assume, retrospectively for the last six months, you almost certainly have a problem.
There is a reasonable chance that your Current Account in the bookkeeping system
(as well as the rest of the system) is not up to date.

Bookkeeping records

For your convenience, here are the journal entries that relate to 3 subjects that we
will discuss at various points. The subjects are:
Subject
Salaries
Income Tax Deduction at Source
Value added tax

Salaries

As a general rule, two Journal Entries will suffice. The first - a reference to the net payment
to employees (the figures are "extracted" directly from the payroll). The second - to take into
consideration the existing employer's payments (the figures are "extracted" from relevant
Income Tax and Social Security forms.

The Journal Entry is as follows:

$ $
1 Debit: Nathan 833
 5

.
Debit: Warren 1,290
Debit: Bjorn 1,330
Credit Bank current account 3,278
3,278 3,278
8.9.xx - Net Salary Payments
==== ====
2
Debit: Salary expenses 4,180
.
Debit: Employers' tax expense 152
Debit: Social security expenses 412
Credit: Nathan 855
Credit: Warren 1,290
Credit: Bjorn 1,133
Credit: Income tax deductions 850
Credit: Social Security deductions _________ 616
4,744 4,744
15.9.xx - Salaries Entry 8/xx ===== ====
= ==
3
Debit: Income tax deductions 850
.
Debit: Social Security deductions 616
Credit: Bank current account ________ 1,466
1,466 1,466
15.9.xx - Payment of
===== ====
deductions, Salaries
= ==
The Explanations for Journal Entry No. 2

a. Salary expenses - $ 4,180

The sum has been extracted from the payroll (the gross taxable total).

b. Employers' tax expenses - $ 152

The sum has been taken directly from the relevant tax forms.

c. Social Security expenses

This is the only amount in the Journal Entry that is not extracted from another source. This
amount is arrived at using the following formula:

Total due to Social Security (according

to the 616
relevant Social Security forms
Less: Social Security deductions from 204
 6

employees
(from the payroll data)

The difference is the employer's

contribution 412
for Social Security
====
===

Comment: The three debit accounts above are normal expenses accounts. Their final
destination is, of course, in the Profit and Loss Statement.

d. Employees' Accounts (Nathan, Warren and Bjorn)

These are normal personal accounts that are in credit at this stage, as the employees are
eligible to be credited by the employer with their net salary.

e. Income Tax/Social Security Deductions

There are normal personal accounts in respect of the Salaries for August xx. Both the
institutions (Income Tax and Social Security) are entitled to be credited by the employer with
the amounts that appear in their relevant forms.

Nominal Ledger Records

The T accounts for the three above journal entries will look like this:

Nathan A/c Warren A/c Bjorn A/c

Debit Credit Debit Credit Debit Credit

(1) 855 855 (2) (1) 1,290 1,290 (2) (1) 1,133 1,133 (2)

Current A/c at Bank A/c Salaries Expenses A/c Employers Tax Expenses A/c

Debit Credit Debit Credit Debit Credit

3,278 (2) (2) 4,180 (2) 152

1,466 (3)

Social S. Expenses A/c Deductions Social Deductions

Income Tax
A/c SecurityA/c
Debit Credit Debit Credit Debit Credit
(2) 412 (3) 850 850 (2) (3) 616 616 (2)
 7

The Journal and Nominal Ledger

In order to illustrate the connection between the journal and the nominal ledger, we will use
a simple example - a daily paper.
It is reasonable to assume that before the paper was printed, news was received in the
editing room in a different form. A first, the news is received in the editing room in
chronological order and not according to any classification of the news items.
However, when the final product (the printed newspaper) is received, the news items have
been classified and concentrated according to the common denominator of each section in
the paper. Let us assume that items are received in the news room (by telex from various
reporters - in the following form:

EDITING ROOM
 8

It may be clearly that there are 2 separate systems in the newspaper:

1. The Editing Room -is characterized by a chronological order (and not according to
specific subjects).
2. The sections of the newspaper edited according to the various subjects (sport,
weather, economics, politics and so on).

In the life of a business as described in bookkeeping, there are the same two systems.

1. The Journal-A textual record of events (Debit and Credit) that is characterized by the
fact that all the records it contains are in a sequential chronological order.
2. The Nominal ledger Is made up of separate accounts for each matter (cash, banks,
customers and so forth).

The accounts in the Nominal ledger look, technically, like the letter 'T' as was demonstrated
previously at the start of this Tutorial. Let's try to describe the flow of the records in
bookkeeping
 9

Just as you, when you read a newspaper, go directly to the page in the paper that interests
you (the sports section, the economics and so forth), when you use bookkeeping data you go
directly to the relevant account in the Nominal ledger (the Max Account - will show you
how much Max owes/is entitled to receive from/to pay to the business. The Cash Account -
will show you how much money has been received/paid out.

The Structure of the Nominal ledger

At the beginning of the tutorial, it was pointed out that an account in the Nominal ledger
looks like the letter T. In fact, there are additional auxiliary data in the account Let us
assume that January 1, xx, we received a loan in cash from Max in an amount of $10,000.
The Journal Entry will look as follows: (let us assume that it concerns a voucher for which the
serial number in the journal is xx):

xx Debit: Cash 10,000

Credit: Max 10,000
1.1.xx - Loan from Max, Receipt 013.

The Journal Entry will be transferred to 2 accounts in the Nominal Ledger as follows:

CASH ACCOUNT
Debit Credit
C
Or D Va
ont
de ate lu De
ra Re
r Rec e tail $
Acc f.
No ord Da s
oun
. ed te
t
L
oa
1. R. n 1
28.2
xx Max 1.x 01 fro 0,0
.xx
x 3 m 00
ma
x

MAX ACCOUNT
Debit Credit
C
Or D Va
ont
de ate lu De
ra Re
r Rec e tail $
Acc f.
No ord Da s
oun
. ed te
t
C
1. R. 1
C 28.2 ash
xx 1.x 01 0,0
ash .xx Loa
x 3 00
n
 10

Let us analyze, for example, the "Cash" account. As you see in addition to the sum of $
10,000 debited, there are other auxiliary data as follows:

1. Order Number-In our example, order xx. This is an important detail as the original
document (Receipt 013) is filed under Journal Order Number xx
2. Contra Account This is the account that assisted, in the Journal entry to balance the
record. If we go back to the journal entry, you will see that the contra account for the
Cash is "*** Account". Therefore, in this column, we record "*** Account".
3. Date recorded The date on which the nominal ledger was updated. In the present
instance, despite the fact that the event occurred on 1.1.xx, it was recorded in the
nominal ledger only on 28.2.xx.
4. Value Date The date of the original document (in our case, the receipt was issued on
1.1.xx).
5. Reference This is the number of the original document (Receipt, invoice, etc.)
6. Details A short verbal description, similar in character to the details that appear in
the Journal entry.
Account - Flow and Balance

Let us go back a little, to the example that was explained at the beginning of the tutorial,
The Cash Account (in the Nominal Ledger) looks like this:

Cash Accounts

Debit Credit

600
200
700

We will now learn two new concepts - Flow and Balance

1. Debit Flow This is all the records on the debit side of the account (in the example
before us $ 1,300) (600 + 700).
2. Credit Flow This is all the records on the credit side of the account (in the example
before us $ 200).
3. Debit Balance The difference between the debit transactions and the credit
transactions (when the debit transactions exceed the credit transactions).
4. Credit Balance The difference between the credit transactions and the debit
transactions (when the credit transactions exceed the debit transactions).

In our example, there is a "Debit Balance" in the Cash Account (the total debit transactions
exceed the credit transactions) of $ 1,100 (1300 - 200).

Before we go on to a comprehensive example, we will change the reference to the "Goods

Account" a little. Until now, to keep matters simple, we have referred to the Goods Account
 11

as to a real account (the Warehouse Account), when on purchasing goods, we have debited
the Goods Account (the warehouse 'received") and on selling goods, we have credited the
Goods Account (the warehouse 'gave'). In fact, the reference to goods is different as the
purchase prices ( 'in' to the warehouse) is normally lower that the price on leaving the
warehouse (sale price).
The correct reference to the Goods Account is as to a normal profit and loss account, as for
this purpose, 2 temporary bookkeeping accounts are opened: the first "Goods Purchased"
(an expense - and therefore the account will normally be debited), the second "Goods Sold"
(income - and therefore the account will normally be credited). A simple example appears
below (the example ignores Value added tax):

1.1.xx We bought goods for cash for a sum of $ 1,000.

5.1.xx All the goods were sold for $ 1,200 cash.

The journal entries will be as follows:

Debit Credit
1. Debit: Purchase of goods
Credit: Cash 1,000
1,000
Purchase of Goods, Invoice
.....
2. Debit: Cash
1,200
Credit: Sale of Goods 1,200
Cash sale. Receipt.....

Comprehensive Example

We will go on now to a comprehensive example that we will use until the end of this tutorial
(in the example, we will try to imagine that your name is Miles and that you are the owner of
a new business).

Business data

1.1.xx
We opened a new business in which we invested $ 10,000 dollars in cash.
2.1.xx
We transferred $ 4,000 in cash to open a current bank account at the City Central Bank.
3.1.xx
We bought office furnishings in the sum of $ 1,000 in cash.
4.1.xx
We paid $ 600 in cash for office rental.
5.1.xx
We bough a telephone with a check for $ 300.
30.1.xx
We paid electricity expenses (by check) in an amount of $ 400.
1.2.xx
 12

We bought goods with a check for $ 1,200 (ignore the Value Added Tax).
2.2.xx
We sold part of the goods for $ 1,000; the money received was deposited directly into
the bank account.
3.2.xx
We bought more goods with a check for $ 3,000.
4.2.xx
We sold all the remaining goods for $ 5,000. The money received was deposited directly
into the bank account.
28.2.xx
The bank credited our account with interest in the amount of $ 100.

Pay attention to the journal entries while referring to the general debit/credit table at the beginning of the
tutorial.

JOURNAL ENTRIES
Debit and
Journal
Date Debit Credit Account Type Credit Rule
No.
No.
Cash
Owners Equity 10,000 Real 2
1. 1.1.xx
Owners Investment 10,000 Personal* 1
in Cash
Current account at Real/Persona
4,000 1-2
2. 2.1.xx City Central l**
4,000 2
Cash Cash Deposit Real
Fixed assets
Cash 1,000 Real 2
3. 3.1.xx
Purchase of 1,000 Real 2
furniture for
Expenses for office
rental
600 Temporary 3
4. 4.1.xx Cash
600 Real 2
Payment of rent in
cash
Fixed assets
City Central current Real
300 2
5. 5.1.xx account Real/Persona
300 1-2
Purchase of l
telephone
Electricity expenses
City Central current Temporary
30.1.x 400 3
6. account 400 Real/Persona
x 1-2
Payment of l
electricity
7. 1.2.xx Purchase of goods 1,200 Temporary 3
City Central current 1,200 Real/Persona 1-2
account l
 13

Purchase of goods
City Central current
Real/Persona
account 1,000 3
8. 3.2.xx l
Sales of goods 1,000 1-2
Temporary
Sale of goods
Purchase of goods
Temporary
City Central current 3,000 3
9. 3.2.xx Real/Persona
account 3,000 1-2
l
Purchase of goods
City Central current
Real/Persona
account 5,000 1-2
10. 4.2.xx l
Sale of goods 5,000 3
Temporary
Sale of goods
City Central current
account
Income from interest Real/Persona
28.2.x 100 1-2
11. Income from l
x 100 3
interest, City and Temporary
Central Current
Account
26,600 26,600

Owners Equity Account

A normal personal account that is in credit as the owner of the business (Miles) "is credited
as eligible" to receive from the business (refer to the business as a separate body) his basic
investment in the sum of $ 10,000. To differentiate between the external creditors of the
business (suppliers, lenders and so forth), and the owner of the business, the prefix "Owners
Equity" appears at the beginning of the name of the account. Remember that from the point
of view of the business, the business owners eligibility to be credited with $ 10,000 is not as
important as the financial eligibility of a normal supplier to receive $ 10,000. In the current
cash management of the business, the eligibility of the owner of the business can be almost
completely ignored as this obligation is not immediately repayable.

** Current Account

The account can be referred to as both a real account (like Cash) or as a personal account.

1. Real account

Imagine for a moment that the money in the bank is in a metal cash box that belongs to
you. On depositing money, the box "received" money (received - debit) while when drawing
a check the box "gave" money (gave - credit)

2. Personal Account

In making a deposit in the current account it is as though the bank manager (personal) owes
you money. When you draw money out of the account, the bank manager owes you less
 14

than he did a moment before you made the withdrawal. (A reduction of a debit is expressed
in bookkeeping as a credit transaction).

Structure of the Nominal Ledger

Comment: For the sake of brevity, only the following details appear on each account page.
1. The journal entry number.
2. Name of the contra-account.
3. Description of the transaction.

Cash Accounts

Debit Credit
1. Owners Equity - 2. City Central current account -
10,000 4,000
Investment Deposit
3. Fixed assets - Furnishing 1,000
4. Rental expenses - Rental 600
____________
_________ 5,600
10,000

OWNERS EQUITY ACCOUNT

Debit Credit
1. Cash - Owners Investments 10,000

CITY CENTRAL CURRENT ACCOUNT

Debit Credit
2. Cash - Deposit 4,000 5. Fixed Assets - Telephone 300
8. Sale of goods - Sales 1,000 6. Electricity expenses - Expenses 400
10. Sale of goods - Sales 5,000 7. Purchase of goods - Purchases 2,200
11. Income from interest - Current 9. Purchase of goods - Purchases 3,000
100
interest _________
_________ 4,900
10,100

FIXED ASSETS ACCOUNT

Debit Credit
3. Cash - Furniture Purchase 1,000
5. City and Central current account -
300
Telephone
_________
1,300
 15

OFFICE RENTAL EXPENSES ACCOUNT

Debit Credit
4. Cash - Rent 600

ELECTRICITY EXPENSES ACCOUNT

Debit Credit
6. City Central current account Payment of 40
expenses 0

PURCHASE OF GOODS ACCOUNT

Debit Credit
7. City Central account-Goods
1,200
purchase
9. City Central account -Goods
3,000
purchase
_________
4,200

SALE OF GOODS ACCOUNT

Debit Credit
8. City Central current account -
1,000
Sales
10. City Central current account -
5,000
Sales
_________
6,000

INCOME FROM INTEREST ACCOUNT

Debit Credit
11. City Central current account Income 10
from interest 0

Tax Deduction at Source

In general, 2 different bookkeeping accounts are needed:

 16

1. The "Deductions at source from suppliers" Account - the account organizes the tax
that was deducted from your suppliers or service providers as well as the tax paid to
the tax authorities on the due date each month.
2. The tax deducted at source from customers. = the account organizes the tax
deducted from you by your customers.

Records in the "Tax Deduction at Source from Suppliers"

Account

Data : 1.4.xx - You paid $100 plus VAT of $15 for printing. You deducted
tax at source at a rate of 20%.
(115 x 20% = $ 23)
7.5.xx - You transferred a sum of $ 23 to the tax authorities.

Bookkeeping records
Debit Credit
1.4.xx 1. Office expenses 100
Value added tax on inputs 15
Bank current account 92
tax deduction at source 23

115 115

7.5.xx 2 Tax deducted at source from suppliers 23

Bank current account 23

23 23
=== ===

Visually, the accounts would look as follows:

Office expenses VAT on inputs Bank current a/c Deductionsurce from

at sosuppliers
Debit Credit Debit Credit Debit Credit Debit Credit
1 1 (1)92 (1) 23 2 (1
00( 5(1 3 )
1) )

Take care as the "Deductions at source from suppliers" account is, in all ways, a personal
 17

credit and debit account. The card indicates the amount that the Income Tax is entitled to
receive from you for tax you have deducted from suppliers. The balance of the account may
be in credit (before you have transferred the deductions on the due date) or it may be at
zero (after you have made the payment to the income tax) but it can never show a debit
balance.

Records in the "Deductions at source from customers"

account

Data: On 5.4.xx, you issued a tax invoice in the amount of $ 1,000 plus $ 150 value added
tax.
The payer deducted 20% ( $ 1,150 x 20% = $ 230). The cash balance was deposited
directly into the Western Union Bank.

The Bookkeeping records

Debit Credit
5.4.x Western Union current
920
x account
Customer's deduction at
230
source
Receipts 1,000
VAT on transaction 150

1,150 1,150

Visually, the accounts will look as follows:

Western Customer'sction at Income VAT on transactions

Current A/c dedusource
Union
Debit Credit Debit Credit Debit Credit
Debit Credit
10 15
920 0 0

Take care as the "Deductions at source by customers" account is in all ways a personal debit
and credit account. The account indicates the amount that the Income Tax owes you as a
result of the fact that tax was deducted from you at source.
The balance of the "deductions at source by customers" accounts may show zero if no tax
was deducted from you, or it may show a debit but the account may never be in credit.
 18

VALUE ADDED TAX (V.A.T.)

For the purposes of value added tax records, three bookkeeping accounts must be kept.

1. The VAT on inputs account.

2. The VAT on transactions account.
3. Debit and Credit VAT account.

1. The VAT on Inputs Account - This account will usually show a debit (the VAT
authorities "owe" you money for the VAT you have paid and that are entitled to
receive from them).
2. The VAT on Transactions Account - This account will usually show a credit (the
VAT Authorities are "entitled" to receive the VAT from you that you have collected
from them. The money is not yours and it is only temporarily in your possession until
the due date for the payment of VAT.
3. The VAT Debit and Credit account. This is the account to which the 2 first
accounts are posted. The account balance may show a credit, when the periodic
report to the VAT is for a payment to be made, or it may show a debit when the
periodic report shows that that money is to be returned.
4. A simple example:

30.1.xx - The total purchases that you made amount to $ 1,000 plus $ 150 VAT on
inputs.
30.1.xx - The total sales you made amount to $ 4,000 plus $ 600 VAT on transactions.

15.2.xx - You paid the balance to that VAT authorities that was owing to them.
5. The bookkeeping records will look as follows:

Debi Cred
t it
1,00
1. Purchases 0
VAT on transactions 150
Current account at bank 1,500
(30.1.xx) Purchases recorded for January

4,60
2. Current account at bank 0
Sales 4,000
VAT on transactions 600
(30.1.xx) Sales recorded for January

3. VAT on transactions 600

VAT on inputs 150
VAT debit and credit account 450
 19

(30.1.xx) Transfer of surplus to debit & credit

account

4. VAT debit and credit account 450

Current account at bank 450
(15.2.xx)Payment of VAT reported for January

Trial Balance

After transferring the records to the Journal (Journal Entries) and from there to the account in
the Nominal Ledger, the balance for each account is found (by hand or by using a
computerized system).
We will organize all the transactions and balance in every account in the nominal ledger into
a table. This arrangement is called the Trial Balance.

Debit
Account Credit Debit Credit
Transactio
Name Transaction Balance Balance
n
Cash 10,000 5,600 4,400 -
Owners
- 10,000 - 10,000
Equity
City Central
current 10,100 4,900 5,200 -
account
Fixed assets 1,300 - 1,300 -
Rental
600 - 600 -
expenses
Electricity
expenses
400 - 400 -

Purchase of
goods
4,200 - 4,200 -

Sales of
- 6,000 - 6,000
Goods
Income from
- 100 - 100
interest
26,600 26,600
TOTAL
======= =======
16,100 16,100
TOTAL ====== ======
= =

The expression 'Trial Balance' comes, as is shown in the table, from the fact the debit and
credit columns must balance (hence the word balance). Moreover the above table
constitutes a trial (check) that the records in the journal have been properly transferred to
 20

the nominal ledger.

It is important to point out that the fact that the Trial Balance (flow or balances) balances is
not necessarily proof that the entries in the journal were recorded correctly. However, this
subject is not under discussion just now. We will be content with pointing out the following
main facts:

Trial Balance (Flow)

In addition to the fact that the "Debit Transaction" column is identical to the "credit
transaction" column, both columns must be equal to the sum in the journal (in the example
before you, the journal total was $ 26,600 as well.

The Trial Balance (Balances)

This is in fact the more important of the two Trial Balances. In the Trial Balance (balances),
the "Total Debit Balances" column must be identical to the "Total Credit Balances" column.
Nevertheless, the column total (in our example, $ 16,100) will always be less than the
journal total or the "Trial Balance (Flow)" column. As has been mentioned, the more
important Trial Balance is the Trial Balance "(Balances)" as the balances are transferred
directly from it to the two main statements that are prepared at the end of the year.

The two statements are:

A. The Profit and Loss Statement.
B. The Balance Sheet.

The two statements are known as the Annual Statements.

A journal entry

Up until now we have seen that each single business transaction is recorded in a journal
entry which is comprised of 2 components, a debit and a credit.
A complete journal entry is comprised of the following components:
1. The account that is debited.
2. The account that is credited.
3. A row of particulars - including date, the type of transaction and the number of the
document that is used as a reference for the transaction (receipt, invoice, check and so
forth).
Care should be taken to see that the credit line is always recorded a little to the right of the
debit line.
The function of the Journal entry is very simple, the immediate recording, as close as
possible to the date on which the transaction is carried out, of all economic activities that
occur in a business in chronological order (with the recording being made in the new
language we have learned, bookkeeping language, that records each single transaction
twice, once as a debit and once as a credit).
 21

We will take another step forward. Let us assume that in the above example there were not
5 records but 500. The question is whether we are able to obtain an immediate answer from
the journal to the question, "What is the cash balance?" - It is clear that the answer is
negative. For this purpose, we must go over 500 journal entries (1000 rows), and from these
rows, sort out all the events in which a reference is made to the words 'Cash Account'.
For this purpose, another system exists in bookkeeping that is known as the "Nominal
ledger".

THE DEBIT AND CREDIT RULES

Type of
To Debit the Account To Credit the Account
Account
When the person whose When the person in
in whose name the whose name the
1. Personal
account is kept is in account is kept is in
debt to us credit with us
When the account When the account
2. Real received money/the gives us money/the
equivalent equivalent
Any account that ends Any account that ends
Profit
3. with the words 'Expense with the words
and Loss
Accounts'. 'Revenue Account'

Comprehensive Example:

1. 1.1.xx We bought goods from Waterman for an overall sum of $ 1,000 (Invoice No. 123).
2. 2.1.xx We sold part of the goods for $ 600 cash (Receipt No. 1950)
3. 3.1.xx We paid $ 200 cash for electricity expenses (Expense Voucher 001).
4. 4.1.xx We bought a store from Max for $ 20,000 (Invoice No. 953).
5. 5,1,xx We rented the store out for $ 700 cash (Invoice No.001)

We will practice making the bookkeeping records that are the subject of the above table
(Comment: In the first part of the solution, the records will be presented in the form of a T
account, and they will be presented textually in the second part. This will be explained more
fully later on.

T ACCOUNTS
 22

Goods Account Waterman Account

Debit Credit Debit Credit

(1) 1,000 600 (2) 1,000 (1)

Cash Account Electricity Expenses Account

Debit Credit Debit Credit

(2) 600
200 (3) (3) 200
(5) 700

Store Account Max Account

Debit Credit Debit Credit

(4) 20,000 20,000 (4)

Store Rental Account

Debit Credit

700 (5)

Textual Records (Journal Entries)

Credi
Debit
t
(1) Debit Goods Account
Credit: Waterman Account 1,000
1.1.xx Purchase on credit 1,000
Invoice 123
(2) Debit: Cash Account
600
Credit: Goods Account
600
2.1.xx Cash Sale, Receipt 1950
(3) Debit: Electricity Expenses
Credit: Cash 200
3.1.xx Cash payment, 200
Expenses Voucher 001
(4) Debit: Store Account
20,00
Credit: Max Account
0 20,00
4.1.xx Purchase of Store,
0
Account 953
 23

(5) Debit: Cash

700
Credit: Income from Rental
700
5.1.xx Cash Rental Account 001
22,50 22,50
0 0

Let's go over the entries together:

Event 1:

The Goods Account (a real account) is debited - because an account was received (Rule 1 in
the table).

The Waterman Account, (a personal account) is credited - as it is due to receive money (Rule
2 in the table).

Event 2:

The Cash Account (a real account) is debited - because the cash was received (Rule 2 in the
table)
The Goods Account (a real account) is credited - because the warehouse issued goods (Rule
2 in the table).

Event 3:

The Electricity Expenses - (A profit and loss account) is debited - as every expense account
is debited (Rule 3 in the table).

Event 4:

The Store Account (a real account) is debited - the transaction received a monetary value
(Rule 2 in the table).
The Max Account (a personal account) is credited - according to Rules 1 or 2.

Event 5:

The Income from the Rental Account (a profit and loss account) is a credit - as all receipts
are a credit (Rule 3 in the table).
The Cash Account is debited - according to Rule 2 in the table.

Comment: It is easy to remember that every expense account is debited (the expense is a
 24

negative matter from an economic point of view and it is a debt of the business).Similarly, all
receipts are a credit (a credit is something positive from an economic point of view and it is
to the credit of the business). An additional stage that should be emphasized is that the first
part (the T - Accounts) in fact serve us as a draft for the purpose of illustrating the records.
In actual fact, the bookkeeping records are only inwords, the professional term for each
record being a "Journal Entry: (or a "journal voucher").

The Balance Sheet Structure

The Balance Sheet logic is completely consistent with the two basic rules (the rules of
debit/credit) that were demonstrated at the beginning of the tutorial.

1. Debit Side- Describes either assets that belong to the business (property, a real
account, according to Rule No. 2 an asset is always a debit) or debts owed by
customers to us. Customers according to Rule No. 1 - are a personal account that
must be a debit (the accounting entity must have a "debt" to the business).
2. Credit Side- Describes the obligations of the business to either of two factors as
follows:
1. External agencies (suppliers, lenders and so forth).
2. The owner of the business (Capital Account or accumulated profits).
In either case, according to Rule 1 either the external agencies or the owner of
the business are eligible to be "credited" with money from the business and
therefore they are in credit.

Why does the Balance Sheet balance?

In principle, there are two explanations for why the Balance Sheet must balance.

1. A Logical Explanation.

The Balance Sheet is in fact made up of two parts while:

The total assets of the business (the debit side) = The total
obligations to external agencies (the credit side) + the total
obligations to the owner of the business.

2. An accounting explanation

The Balance Sheet is made up directly from the Trial Balance (Balances) which is itself a
Balance Sheet.
It is clear, therefore, that if we went from a Trial Balance to a Balance Sheet, then the final
result (a Balance Sheet), that also takes account of the balance in the Profit and Loss
Statement, will be balanced.

Summary
 25

In a graphic format, the accounting system looks like this

Survey of The Accounting System (Locating Irregularities)

At this stage, now that the subject of the Profit and Loss Statement and the is quite clear,
during the year, you can easily survey the Nominal Ledger and locate balances which would
appear to be unreasonable.
The logical test will be carried out according to the model in the following chart:

Below is an example of unreasonable balances that need to be clarified with the

bookkeepers:
Personal Debi Credi
Account t t
Loan received +
Loan granted +
Goods
+
purchases
Goods sold +
....Expenses +
....Receipts +
 26

Vehicles +
Real Estate +
Customers +
Suppliers +

Annual Statements

At the end of each year, the bookkeeping system produces two statements (directly from the
Trial Balance). Let us assume that we are concerned with the year ending on December 12,
xx. The two statements will be:

Statement 1 - The Profit and Loss Statement for the year ending December 31, xx.
Statement 2 - The Balance Sheet as on December 31, xx.

The Profit and Loss Statement

In principle, it is important in the normal T account, when the debit side organizes all the
accounts that end with the words "….Expense Account" while the credit side organizes all
the accounts that end with the words "…. Receipts Account" and it is indeed logical that the
Financial Statement is the total of all the receipts less the total expenses (Take care, as the
Profit and Loss Accounts refers to a period of a year and not to the last day of the year. In
other words. The Profit and Loss Statements is for the year ending on December 31, xx and
does not show what the profit/loss was on the last day only, but for the entire year ending on
December 31, xx)

Balance Sheet

In principle go back to the normal T account where the debit side shows what assets
belonged to the business while the credit side shows the obligations that the business has to
other agencies.
Take care, as distinct from the Profit and Loss Statement that refers to the "Year ending
December 31,xx" the Balance Sheet shows a photograph of the situation on the last day
only.

Transfer from the Trial Balance

We will go back to the Trial Balance (Balances) on the previous pages. Every balance will be
transferred to the Profit and Loss Statement (if an expenses/receipts account is concerned)
or to the Balance Sheet, while an iron rule that must be strictly observed is - "a balance
cannot change its character" (in other words, a debit balance in the Trial Balance must be
transferred to the debit side, whether on the Profit and Loss Statement or on the Balance
Sheet, similarly a credit balance in the Trial Balance must appear only on the credit side,
whether on the Profit and Loss Statement or on the Balance Sheet.

Profit & Loss Statement for the Year... Balance Sheet as at 31.12.xx

Debit Credit Debit Credit

Rent Go 6,000 Cash 4,400
600
Expenses od Owners 10,000
s
 27

Elec.Expense sal Bank current equity

400 5,200
s e a/c
Goods I Fixed Assets 1,300
4,200
Purchsd nt
er _________
100
est
re 10,900
_________ cd ---------- -----------> ____________
5,200
10,000
Profit for
900
year
_____
_____ 10,900
__
6,100
Cr
edi
t
Ba
lan 900
ce
(Pr
ofi
t)

The Development of Bookkeeping.

In each area of life, techniques are developed and inventions made to answer the problems
that arise therein. Thus, for example, the invention of the "airplane" provided an answer to
the problem of reducing travel time between distant cities. The discovery of "canned foods"
on the other hand gave an answer to the need to keep food fresh for long periods. This is
similar to what happened with bookkeeping, in that it answered the severe problems that
arose in managing modern commerce. It is important to remember that we are in fact
talking in a new language that you have yet to learn, as you had to learn any foreign
language when young.
Before we go into the structure of the language, we will try to see which problems are
answered by bookkeeping.

1. The problem of human memory - In a commercial business, even in the smallest

business, hundreds and thousands of transactions are carried out over a year. It is
obvious that without proper records, it would be difficult for you to reconstruct past
transactions relying on your memory alone.
2. Determining the annual profit - Determining the precise annual profit is of the
utmost importance, both to you as the owner of the business and to the Tax
Authorities (Income Tax, V.A.T. and Social Security). Bookkeeping is in fact the raw
material used as a basis for determining the profit.
3. Current Control - By means of up-to-date bookkeeping, it is possible to obtain
current data in real time. Thus for example, you are able to use bookkeeping to
obtain answers to questions of the sort: 'What is the cash balance?' 'What is the
balance at the bank?' 'What credit is available to any particular supplier?', and more.
4. Business analysis - It is reasonable to assume that you will ask yourself how to
increase the profits of the business. Is it possible to reduce any particular class of
expense and so on It is obvious that the main tool to assist you in an analysis of this
type, is the bookkeeping system.
 28

We will go on to the technical part which is, in fact, the structure of the language known as
"bookkeeping". As with any other language, this stage resembles learning the alphabet and
basic rules of grammar and it is, naturally enough, fairly boring. Try not to skip this stage as
it is actually the basis for bookkeeping language.

BOOKKEEPING CONVENTIONS

Bookkeeping language is based on 2 basic conventions:

1. The Convention of the Common Monetary Denominator

Try to add the following two data:

Let us assume that you are deal in textiles. On the 15th of the month, you bought 13
kilogram of fabric and 17 meters of material.
It is clear that adding the 2 numbers (13 and 17) amounts to 30 but it lacks all
significance as the base is different (a kilogram - a unit of weight as compared to a
meter - a unit of length).
However, if we add the following data to the example, we will reach a logical result.
Let us assume that the material is $ 1,000 a kilo or $ 50 a meter, you can state in
monetary terms that you bought goods with a value of $13,850/(13 x $ 1000 = $
13,000 plus 17 x $ 50 = $ 850, Total $ 13,850)
It is clear, therefore, that the common basis for every bookkeeping record is the
monetary value.

2. The "Dual Aspect" Convention.

This convention is in fact at the very heart of a bookkeeping system.

Let us take an example of an economic transaction done in the Middle Ages. Jo brings
a kg. of fish to the market and in exchange he buys a pair of shoes from Jake.
Each of the parties to the transaction "received" a certain economic value and "gave"
an identical value.

3.

At this stage, you are of course wondering why we have taken an example from the
Middle Ages for commercial life in the 21st century. I am sorry to disappoint you but
the situation is very similar today.
Let's alter the previous example to suit our times. Let's assume that Jo buys a pair of
shows from Jake for $ 80. We can see here as well that although we are concerned
with a single commercial transaction (from Jo's point of view - buying shoes for cash,
from Jake's point of view - selling shoes for cash). We are still left with the "dual
aspect" convention as follows:
4.

In other words, the language of bookkeeping tends to record a single

transaction in dual manner. Once, what the tradesman "received", and
the second time, what that same trader "gave".
 29

Jake - "received" a kilo

Jo - "received": a pair of
of fish
shoes
and "gave" a pair of
and "gave" a kilo of fish
shoes
5.

At this stage, you are of course wondering why we have taken an example from the
Middle Ages for commercial life in the 21st century. I am sorry to disappoint you but
the situation is very similar today.
Let's alter the previous example to suit our times. Let's assume that Jo buys a pair of
shows from Jake for $ 80. We can see here as well that although we are concerned
with a single commercial transaction (from Jo's point of view - buying shoes for cash,
from Jake's point of view - selling shoes for cash). We are still left with the "dual
aspect" convention as follows:
6.

In other words, the language of bookkeeping tends to record a single

transaction in dual manner. Once, what the tradesman "received", and
the second time, what that same trader "gave".

Jake - "received"
Jo - "received" goods
money
(shoes)
and "gave" goods
and "gave" money
(shoes)
7.

In other words, the language of bookkeeping tends to record a single

transaction in dual manner. Once, what the tradesman "received", and
the second time, what that same trader "gave".

In bookkeeping, each single"

commercial
transaction is recorded twice.
The Double Entry
On the
Convention
"Received" side and then
again on the
"Gave" side
1. DIVIDING THE TRANSACTION INTO SUBSIDIARY
COMPONENTS

Bookkeeping Does not refer to a business as a single unit but as a body that contains
a number of subsidiary units with a particular person being responsible for each
 30

subsidiary unit.
In order to organize the business activities, we will take a separate sheet of paper
that will organize all the activities that are connected to the person in charge.

So for example, the Cash Page - will describe everything connected with the cashier,
the Goods Page - will describe everything that is connected with the warehouseman,
while the Bank Page - will coordinate all that is connected with the person that deals
with the banks.

Event 1 - We bought goods for $100 cash.

Event 2 - We transferred $60 in cash to our bank account.
Event 3 - We bought goods from a supplier for $30 that we took out of cash.

The bookkeeping records are as follows:

Event 1:

Warehouse
Goods Page Cash Page Cashier
man
Received Received Gave
Gave

100 (1) 100 (1)

The explanation is very simple:

The Goods Page - that describes the events from the point of view of the
warehouseman - received an economic value of $ 100. The Cash Page - that
describes the event from the point of view of the cashier - gave $ 100.

Comment - The decision that the left side of the page reflects "Received" while the
right side shows "Gave" has no logical explanation and it is a convention adopted for
the sake of uniformity only (rather like the rule that all vehicles travel in the right
lane on the roads in most countries, a safety regulation that affects everyone in
principle (uniformity).
Further Comment: The professional expression for each bookkeeping page is not
the "Goods Page" and/or the "Cash Page" but ACCOUNT (as distinct from an account
submitted to a supplier for goods or services he :gave" or a tax invoice), somewhat
similar to the expression "Report".

From this stage on, we will use the expressions "Goods Account" and Cash Account"
and so on.

Event 2:

Let's sketch "Accounts" (pages). It is obvious that the relevant accounts are: the
"Bank Account that describes what happened in the transaction from the point of
 31

view of the person in charge of the account with the bank and the "Bank Account".
The record will look as follows:

Warehouse
Goods Page Cash Page Cashier
man
Received Received Gave
Gave

60 (2) 60 (2)

Event 3:

The record will look like this:

Warehouse
Goods Page Cash Page Cashier
man
Received Received Gave
Gave

30 (3) 30 (3)

In actual practice, the account looks somewhat different. The three sides are
removed from the original account and the resulting format resembles the letter 'T'.
In fact, the custom is to call accounts by the name 'T Accounts'.

Bookkeeping Course: TYPES OF ACCOUNTS

 32

1. PERSONAL ACCOUNT - Any account that bears the name of a particular

person (including, of course, names of companies, suppliers, customers and
so forth). For instance, the Walters Account, the Mortimer Account, the Calvin
Motors Ltd. Account, and more.

2. REAL ACCOUNT - Any account for which that recorded on the account can be
really verified. For instance, the Cash Account (if the Cash Account shows that
we received $ 80, then we can check physically to see if we have $ 80 in
cash). Another example is the Goods Account. If the Account shows that we
received goods worth $ 100, then goods to that value should be physically
present in the warehouse.

3. PROFIT AND LOSS ACCOUNT- Any account that describes an expense or

receipts (the name of the account will always be followed by the words ' ...
Expense Account' or '... Receipts Account'}.

Until now we have learned that the left hand side of the account is called 'Received'
and the right hand side is called 'Gave'. The correct expressions that are used in the
profession are:

The left hand side (the 'Received' side)- the Debit Side.
The right hand side (the 'Gave' side)- the Credit Side.

Moreover, there are clear rules as to when to debit the account (that is to say, to
enter the record on the left hand side) and when to credit the account (that is to say,
to enter the record in the right hand side). We shall use the following tables and the
example that follows it to help us understand more fully: