We continue the posting of all the transactions of a complete accounting cycle, which we began in the previous lesson.
All these transactions are presented in a mini accounting software which you can download to study (you can change the figures, but not the transactions).
We already posted 10 transactions (in yellow). There remain 9 transactions to post.
Transaction 11: we (the shop) send(s) a cheque to Deirdre (the supplier of goods) 1500€.
This is a partial payment, since we owe Deirdre 4000€. It can readily be seen by taking a look at Deirdre's account in our ledger of accounts.
So we debit Deirdre's account:
and we credit the bank account:
Often partial payments are made to strengthen the trust which a creditor has in us. This is in order to... buy some more on credit.
Transaction 12: we buy more goods on credit from Deirdre, 3000€
We can compute the ongoing "balance" of Deirdre's account. We add up the figures in each column (debit and credit). The debit column adds up to 1500€, and the credit column adds up to 7000€. So we say that the balance is 7000€ - 1500€ = 5500€ in credit. In other words, we still owe 5500€ to Deirdre.
Transaction 13: we make a cash sale for 3000€. That is we sell 30 items, at 100€ apiece, to a customer who pays cash.
Notice that there is no new debt owed to us here. Therefore there is no need to make a note of who pays us, since we receive cash (you don't write the name of the payer on a banknote!). However, in management accounting, we will want to know to whom this sale was made. But in general accounting it is not necessary.
We debit the Cash account 3000€
and we credit the Sales account
Transaction 14: another cash sale, 1000€
Notice that the "balance" of the Cash account is now 6000€ in debit (= 16000 - 10000).
Exercise: why a Cash account can never have a balance in credit?
Transaction 15: the shop acquires machinery on credit from James, 5000€
We debit a "Machinery account"
Question: do we have the money at the bank to pay James by cheque?
Answer: let's look at our "Bank account"
We see that the balance of our Bank account is (8000 + 2000) - (1000 + 1500 + 3000 + 1500) = 3000€ in debit.
This means, we only have 3000€ at the bank.
Anyway, first we pay James with an IOU:
Transaction 16: the shop gets a long term bank loan, 2000€. And the sum is directly transfered in the "Bank account" of the firm.
So we debit our "Bank account"
and we credit a new account called "Long term loan"
This is a new liability of Joe's shop.
The loan will have to be repaid according to a schedule specified in the loan contract.
Furthermore, the loan contract states what is the interest rate, and therefore the interest charges to be paid on a yearly basis, on the debt outstanding. Suppose for the sake of simplicity that the yearly interest payments begin only in the next accounting cycle, so we don't have to take care of such a transaction in the present cycle.
Transaction 17: the shop settles James account by cheque, that is sends James a cheque for 5000€
Since we received 2000€ in our bank account, coming from the bank loan, we exactly have 5000€ in our bank account. So we can pay James by cheque.
We credit our bank account:
After the cheque to James, our Bank account balance is (temporarily) zero.
Remember that during the first cycle, usually, the banker will not let us go in debt in our bank account.
And later on, when we happen to be in credit in our bank account (our view), which is the same as in debit in our account at the bank (banker's view), we will have to pay agios to the banker.
To complete the transaction, we debit James account:
This "settles" James account: that is the new balance is zero.
Transaction 18: we take cash to the bank, 5000€, because we have plenty of cash, and we need to replenish our bank account.
Now we have 5000€ at the bank.
And we still have 1000€ of cash in the till.
Transaction 19: the shop pays salaries, 2500€, by cheque.
We debit a Salaries account:
Remember that this figure of 2500€ in debit in the salaries account actually records the value of work which came into the firm.
And we credit the bank account:
The same figure of 2500€ is entered here on the credit side. It measures the money paid for the work recorded in the salaries account.
Next steps. We are finished with the posting of all the transactions of the accounting cycle. In the next lesson we shall
Inventories: let's have a glance at the evolution of the inventory of goods during the cycle
During the cycle, we purchased altogether 175 items (at 40€ apiece), and we sold 70 items (at 100€ apiece).
The 70 items sold correspond to the Sales figure of 7000€ which can be checked in the Sales account:
By coincidence, we purchased also for 7000€ (= 175 items x 40€ per item). But of course the cost of goods sold is only 70 items x 40€ = 2800€.
We are left, at the end of the cycle, with 105 items in inventory, valued at 105 x 40 = 4200€ (buying price).
These calculations will be part of the year-end adjustments which we shall study in a lesson after the coming lesson on the Trial balance.
Question: Why a cash account can never have a balance in credit?
Answer: Because you cannot have less than zero euros (in banknotes and coins) in your pocket, or in the till.
Whereas it is possible to "go negative" at the bank. Indeed, bank records are the equivalent of algebraic figures which can be positive or negative, while the figure on a banknote or a coin is always a positive number.