1. Demonstrate Understanding of accounting principles and policies

APPLY FUNDAMENTALS OF ACCOUNTING – SUMMARY NOTES

1. Understanding Accounting Principles and Policies

1.1 Nature and Purpose of Accounting

Accounting is the process of recording, classifying, summarizing, and interpreting financial transactions.
Purpose:

• To provide financial information

• To aid decision-making

• To determine profit or loss

• To show financial position

• To assist planning and control

1.2 Users of Accounting Information

• Owners – profit, capital, financial status

• Managers – performance and decision making

• Investors – returns and financial stability

• Creditors/Suppliers – creditworthiness

• Government – taxes and regulation

• Employees – job security, wages

• General public – company’s contribution

1.3 Qualities of Accounting Information

• Relevance

• Reliability/Accuracy

• Comparability

• Consistency

• Understandability

• Timeliness

1.4 Accounting Concepts/Principles

• Business Entity

• Going Concern

• Accruals/Matching

• Cost Principle

• Materiality

• Prudence/Conservatism

• Dual Aspect

• Revenue Recognition

1.5 Accounting Standards

Standards provide guidelines for preparing financial statements, e.g.:

• IFRS (International Financial Reporting Standards)

• IAS (International Accounting Standards)

1.6 Accounting Equation

Assets=Capital+Liabilities

2. Apply Double Entry Concept

2.1 Source Documents

Original documents showing transactions, e.g.:

• Receipts

• Invoices

• Credit notes

• Debit notes

• Cheque counterfoils

• Bank statements

2.2 Books of Original Entry

• Sales Journal

• Purchases Journal

• Cash Book

• Sales Return Journal

• Purchases Return Journal

• General Journal

• Petty Cash Book

2.3 Double Entry System

Every transaction has two effects:

• Debit (Dr) – receiving value

• Credit (Cr) – giving value

Example:
Bought goods on credit:

• Dr Purchases

• Cr Accounts Payable

2.4 Trial Balance and Basic Financial Statements

Trial Balance lists all ledger balances to check accuracy.
Basic statements:

• Income Statement (profit or loss)

• Statement of Financial Position (assets, liabilities, capital)

2.5 Computerized Accounting Systems

Examples: QuickBooks, Sage, Tally, ERP software.
Used for automated posting, reporting, reconciliation.

3. Classify Capital, Liabilities and Assets

3.1 Accrued and Prepaid Expenses

• Accrued expenses: incurred but not yet paid

• Prepaid expenses: paid in advance

3.2 Accounting for Revenue

Revenue is recognized when earned, not when received.

3.3 Accounts Receivable & Bad Debts

• Accounts Receivable: customers owing money

• Bad Debts: uncollectible debts

• Allowance for Doubtful Debts: estimate of future uncollectible debts

3.4 Property, Plant & Equipment

Assets used in the business long-term.
Accounting includes:

• Cost

• Depreciation

• Disposal

3.5 Inventory Valuation

Common methods:

• FIFO

• Weighted Average Cost

• Specific Identification

3.6 Accounting for Cash and Bank

Includes:

• Cashbook

• Petty cash

• Bank reconciliation

3.7 Accounts Payable

Money owed to suppliers.
Control account summarizes all suppliers.

4. Correct Accounting Errors and Suspense Accounts

4.1 Errors Detectable by Trial Balance

These cause imbalance:

• Single entry

• Wrong amount on one side

• Arithmetic errors

• Posting errors

4.2 Errors Causing Trial Balance Not to Balance

• Entering only one side

• Unequal debits and credits

4.3 Errors Not Affecting the Trial Balance

• Error of commission

• Error of omission

• Error of original entry

• Error of principle

• Compensating errors

4.4 Procedures of Correcting Errors

Use:

• Journal entries

• Adjustments in ledger

• Re-stating balances

4.5 Errors Corrected by Suspense Account

Suspense accounts temporarily hold differences until errors are corrected.

4.6 Preparation of Suspense Account

Debit or credit the difference, then clear once all errors are fixed.

5. Prepare Sole Trader Statements

5.1 Sources of Capital

• Owner contributions

• Loans

• Retained profits

5.2 Sole Trader Income Statement

Shows profit or loss for the period.

5.3 Statement of Financial Position

Shows:

• Assets

• Liabilities

• Capital

6. Prepare Partnership Statements

6.1 Partnership Agreement Contents

• Capital contribution

• Profit-sharing ratio

• Duties and responsibilities

• Interest on drawings

• Interest on capital

• Salaries to partners

6.2 Current and Capital Accounts

Capital accounts may be fixed or fluctuating.
Current accounts record drawings, interest, and share of profit.

6.3 Partnership Income Statement

Prepared like that of a sole trader.

6.4 Appropriation Account

Distributes profit/loss among partners.

6.5 Statement of Financial Position

Shows capital balances for all partners.

7. Prepare Company Statements

7.1 Types of Share Capital

• Ordinary shares

• Preference shares

7.2 Types of Reserves

• General reserve

• Retained earnings

• Share premium

• Revaluation reserve

7.3 Issue of Shares

• At par

• At premium

• At discount (rare/regulated)

7.4 Rights Issue & Bonus Issue

• Rights issue: offered to existing shareholders at a discount

• Bonus issue: free shares issued from reserves

7.5 Provisions and Reserves

Provisions: liabilities of uncertain amount (e.g., warranty).
Reserves: profits retained for business use.

7.6 Income Tax

Calculated as per tax guidelines.

7.7 Presentation of Company Financial Statements

Includes:

• Statement of Profit or Loss

• Statement of Financial Position

• Statement of Changes in Equity

• Notes to accounts

1.1. Qualities of accounting information is determined

Qualities of Accounting Information

For accounting information to be useful to users, it must possess certain qualitative characteristics. These qualities ensure that financial information is accurate, reliable, and helpful in decision-making.

1. Relevance

Information must be useful for decision-making.
It should influence economic decisions by helping users evaluate past, present, or future events.

2. Reliability (Faithful Representation)

Information must be accurate, complete, and free from error or bias.
It should represent the real financial position of the business.

3. Understandability

Information must be easy to understand by users who have basic accounting knowledge.
Complex information should be clearly explained.

4. Comparability

Users should be able to compare financial statements over time or with other businesses.
This requires using consistent accounting methods.

5. Consistency

The business must use the same accounting methods from period to period unless a change is justified.
This allows meaningful comparison.

6. Timeliness

Information must be provided on time to support decision-making.
Delayed information loses value.

7. Materiality

Only information that is significant enough to influence decisions should be included.
Minor errors that do not affect decisions may be ignored.

8. Verifiability

Different knowledgeable individuals should be able to confirm the information using the same evidence.

9. Neutrality

Accounting information must be free from bias and should not favor any particular group.

1.2. Users of accounting information and their information needs is established

Users of Accounting Information and Their Information Needs

Accounting information is used by different groups of people to assist them in making financial and economic decisions. These users can be classified into internal users and external users.

1. Internal Users

Internal users are people within the organization who use accounting information to manage business activities.

a) Owners / Entrepreneurs

Information needs:

• Profit or loss for the period

• Value of their investment (capital)

• Financial position of the business

• Liquidity and solvency

b) Management

Information needs:

• Performance evaluation

• Budgeting and planning

• Cost control

• Financial forecasts

• Resource allocation

c) Employees

Information needs:

• Job security

• Ability of the business to pay wages/salaries

• Bonus or profit-sharing prospects

• Stability and growth of the company

2. External Users

External users are people outside the organization who use accounting information for decision-making.

a) Investors (Existing and Potential)

Information needs:

• Return on investment (profitability)

• Financial position and stability

• Future growth potential

• Dividend prospects

b) Creditors / Lenders

(Banks and suppliers)
Information needs:

• Business ability to repay loans

• Liquidity position

• Creditworthiness

• Cash flows

c) Government and Regulatory Bodies

Information needs:

• Tax assessment (VAT, income tax, corporate tax)

• Compliance with laws

• Evaluation of economic performance

d) Customers

Information needs:

• Stability and continuity of business

• Ability to continue supplying goods and services

• Long-term contracts reliability

e) General Public

Information needs:

• Company’s contribution to society

• Employment opportunities

• Environmental responsibility

f) Trade Unions

Information needs:

• Ability of business to pay fair wages

• Profitability

• Employee-related benefits

g) Competitors

Information needs:

• Market performance comparison

• Benchmarking against others

• Strategies for competition

1.3. Nature and purpose of accounting is established.

Nature and Purpose of Accounting

1. Nature of Accounting

The nature of accounting refers to what accounting is and how it works. Accounting is:

a) A systematic process

Accounting involves systematic recording, classifying, summarizing and reporting of financial transactions.

b) A financial information system

It provides financial information to different users for decision-making.

c) Quantitative in nature

Accounting records information that can be measured in monetary terms (money).

d) Based on rules and principles

It follows accounting principles, concepts, and standards (e.g., IFRS, IAS).

e) Historical and predictive

It records past transactions (historical) and helps forecast the future (predictive).

f) An art as well as a science

• Science because it uses rules (principles)

• Art because it involves judgment and estimation

2. Purpose of Accounting

The purpose of accounting refers to why accounting is done. Accounting aims to:

a) Determine profit or loss

It helps find out if the business made a profit or incurred a loss over a period.

b) Show financial position

It shows assets, liabilities, and owner’s equity at a specific date (Statement of Financial Position).

c) Facilitate decision-making

Managers, owners, and other users rely on accounting information to make informed decisions.

d) Ensure proper record-keeping

Accounting keeps accurate and organized records of all transactions.

e) Aid in planning and control

• Planning future activities

• Controlling costs

• Budgeting

f) Provide information to stakeholders

Accounting provides information to:

• Owners

• Investors

• Government

• Creditors

• Management

• Employees

g) Ensure compliance

Helps businesses comply with laws, tax regulations, and reporting standards.

h) Safeguard assets

Accounting systems help to track and protect assets from loss or misuse.

Short Summary (Exam-ready)

Accounting is a systematic process of recording, classifying, summarizing, and interpreting financial transactions. Its purpose is to determine profit or loss, show the financial position, help in decision-making, maintain proper records, assist planning and control, ensure compliance, and provide useful information to stakeholders.

2. Apply double entry concept

2. Apply Double Entry Concept

This element covers all the steps required to collect source information, record it in the books of original entry, post to ledger accounts using double-entry, prepare a trial balance, and use computerized systems.

2.1 Accounting Source Documents Are Prepared

Source documents are the original written or electronic records that provide proof a transaction has occurred.
They are the starting point of the accounting process.

Examples of source documents:

• Invoices (sales or purchases)

• Receipts

• Debit notes

• Credit notes

• Delivery notes

• Purchase orders

• Cheque counterfoils

• Bank statements

• Cash register tapes

These documents are used to:

• Verify transactions

• Record accurate details (date, amount, parties involved)

• Support auditing and financial reporting

2.2 Books of Original Entry Are Determined

Books of original entry are the first accounting books where transactions are recorded before posting to ledger accounts.

Types of books of original entry:

1. Sales Journal – for credit sales

2. Purchases Journal – for credit purchases

3. Sales Return Journal – for goods returned by customers

4. Purchases Return Journal – for goods returned to suppliers

5. Cash Book – for all cash and bank transactions

6. Petty Cash Book – for small daily payments

7. General Journal (Journal Proper) – for:

   • Opening entries

   • Closing entries

   • Correction of errors

   • Adjustments

   • Transfers

2.3 Double Entry System Is Applied to Prepare Ledger Accounts

The double entry system states that every transaction has two equal and opposite effects:

• A Debit (Dr) entry

• A Credit (Cr) entry

2.1. Double entry system is applied to prepare ledger accounts.

1. Meaning of the Double Entry System

The double entry system states that for every debit (Dr), there must be a corresponding credit (Cr) of equal value.

This follows the accounting equation:

Assets=Capital+Liabilities

2. Rules of Double Entry

The rules are applied depending on the type of account:

3. Steps for Applying Double Entry in Ledger Accounts

Step 1: Identify the accounts involved

Every transaction affects two accounts or more.

Step 2: Determine the type of each account

Is it an asset, liability, capital, expense, or income account?

Step 3: Apply the double entry rule

Decide which account to debit and which to credit.

Step 4: Post to the ledger

Enter the information in the appropriate ledger accounts, including:

• Date

• Details (narration)

• Amount

• Folio (if used)

Step 5: Balance off the ledger account

At the end of a period, each ledger account is balanced to find:

• Balance c/d (carried down)

• Balance b/d (brought down)

4. Worked Examples

Example 1: Owner invests Ksh 100,000 into the business

• Dr Cash (asset increases)

• Cr Capital (capital increases)

Ledger Entries:

Cash Account

Capital Account

Example 2: Bought furniture for cash Ksh 20,000

• Dr Furniture

• Cr Cash

Example 3: Sold goods on credit to John for Ksh 15,000

• Dr Accounts Receivable (John)

• Cr Sales

Example 4: Paid electricity bill Ksh 5,000

• Dr Electricity Expense

• Cr Cash

5. Purpose of Applying Double Entry to Ledgers

Applying the double entry system ensures:

• Accuracy of financial records

• Completeness of transactions

• Ability to detect some errors

• Preparation of trial balance

• Preparation of financial statements

The ledger forms the basis for:

• Trial Balance

• Income Statement

• Statement of Financial Position

6. Short Exam-Ready Answer

The double entry system requires every transaction to be recorded with equal debits and credits. Ledger accounts are prepared by identifying the accounts affected, applying the debit and credit rules, posting entries to the relevant ledger accounts, and balancing them. This ensures accurate records that lead to the preparation of the trial balance and financial statements.

2.2. Books of original entry are determined

1. Meaning of Books of Original Entry

These are records where transactions are first written down using data from source documents such as invoices, receipts, and credit notes.

They help to:

• Summarize similar types of transactions

• Reduce the workload in the general ledger

• Provide a clear audit trail

2. Types of Books of Original Entry (Subsidiary Books)

1. Sales Journal (Sales Day Book)

• Records credit sales of goods.

• Uses sales invoices as source documents.

2. Purchases Journal (Purchases Day Book)

• Records credit purchases of goods.

• Uses purchase invoices.

3. Sales Returns Journal (Returns Inwards Book)

• Records goods returned by customers.

• Uses credit notes issued.

4. Purchases Returns Journal (Returns Outwards Book)

• Records goods the business returns to suppliers.

• Uses debit notes issued.

5. Cash Book

Records all cash and bank transactions:

• Cash receipts

• Cash payments

• Cheques received and issued

• Bank transfers
  Acts as both a book of original entry and a ledger.

6. Petty Cash Book

• Records small, regular expenses such as postage, transport, refreshments, stationery.

• Uses petty cash vouchers.

7. General Journal (Journal Proper)

Used for transactions that do not fit in other books, such as:

• Opening entries

• Closing entries

• Correction of errors

• Depreciation entries

• Adjusting entries

• Transfers between accounts

3. Purpose of Books of Original Entry

Books of original entry are used to:

• Record transactions in chronological order

• Group similar transactions for simplicity

• Provide accurate details for posting to ledger

• Reduce errors in the accounting system

• Keep clear documentation for audits

4. Summary Table for Exams

2.3. Accounting source documents are prepared

Accounting Source Documents Are Prepared

Source documents are the original records that provide written or electronic evidence that a business transaction has taken place.
They are the first step in the accounting cycle and are used to record transactions accurately.

1. Meaning of Source Documents

A source document is a proof of a transaction.
It contains key details such as:

• Date of transaction

• Amount involved

• Nature of transaction

• Parties involved

• Signatures / Authorization

These documents must be prepared, collected, and kept for accounting and auditing purposes.

2. Common Types of Accounting Source Documents

Below are the main source documents used in business and what they are used for.

1. Invoice

• Issued when goods or services are sold on credit.

• Seller prepares a sales invoice.

• Buyer receives a purchase invoice.

2. Receipt

• Proof that payment has been received.

• Issued when cash or cheque is received.

3. Credit Note

• Issued when goods are returned by the customer.

• Reduces the amount owed by the customer.

4. Debit Note

• Sent by the buyer when returning goods to the supplier.

• Request to reduce the amount payable.

5. Delivery Note

• Shows goods delivered to the buyer.

• Signed as proof that goods were received.

6. Payment Voucher

• Used to authorize payments, especially in organizations.

7. Cheque and Cheque Counterfoil

• Cheque: document instructing the bank to pay.

• Counterfoil: proof that a cheque was issued.

8. Bank Statement

• Issued by the bank showing deposits, withdrawals, and balances.

9. Cash Register Tape / Till Roll

• Shows cash sales made during the day.

10. Purchase Order

• Sent to supplier requesting goods.

11. Goods Received Note (GRN)

• Confirms goods received from suppliers.

3. How Source Documents Are Prepared

a) Filling in transaction details

Each document must capture:

• Date

• Name of supplier or customer

• Description of goods/services

• Quantity

• Price

• Total amount

b) Authorization

Source documents must be:

• Signed

• Stamped

• Approved by relevant officers

c) Issuing and filing

• Original copy is sent to the customer or supplier.

• Duplicate copy is kept for records.

• Documents are arranged and filed by date for easy retrieval.

d) Using electronic systems

Many source documents are now created using:

• Accounting software

• Point-of-sale (POS) systems

• Enterprise resource planning (ERP) systems

These systems automatically store and organize source documents.

4. Purpose of Source Documents

Source documents are prepared to:

• Provide evidence of transactions

• Support entries in books of original entry

• Help with audit trails

• Prevent fraud

• Enhance accuracy and accountability

3. Classify capital, liabilities and Assets

3. Classify Capital, Liabilities and Assets

This element involves identifying different categories of assets, liabilities, and capital, and applying correct accounting treatment for each according to accounting principles.

3.1 Accrued Expenses and Prepaid Expenses Are Determined

Accrued Expenses (Accrued Liabilities)

These are expenses incurred but not yet paid at the end of the accounting period.
They increase liabilities.

Examples

• Accrued salaries

• Accrued rent

• Accrued electricity

• Accrued interest

Double Entry

• Dr Expense

• Cr Accrued Expense (Liability)

Prepaid Expenses (Prepayments)

These are expenses paid in advance for future periods.
They are classified as current assets.

Examples

• Prepaid rent

• Prepaid insurance

• Prepaid advertising

Double Entry

• Dr Prepaid Expense (Asset)

• Cr Cash/Bank

3.2 Accounting for Revenue

Revenue is recognized when earned, not when cash is received (accrual principle).

Types of Revenue

• Sales revenue

• Service income

• Interest income

• Rental income

Double Entry

When revenue is earned:

• Dr Accounts Receivable / Cash

• Cr Revenue

Revenue increases equity/capital.

3.3 Accounting for Accounts Receivable, Bad Debts and Allowance for Doubtful Debts

Accounts Receivable (Debtors)

Customers who owe the business money for goods/services sold on credit.
Classified as current assets.

Double Entry for Credit Sales

• Dr Accounts Receivable

• Cr Sales

Bad Debts

Amounts confirmed as uncollectible.
Classified as an expense.

Double Entry

• Dr Bad Debts Expense

• Cr Accounts Receivable

Allowance for Doubtful Debts (Provision for Bad Debts)

A percentage estimate of receivables expected to become bad.
Classified as a contra-asset (reduces accounts receivable).

Double Entry

To create allowance:

• Dr Doubtful Debts Expense

• Cr Allowance for Doubtful Debts

3.4 Property, Plant and Equipment (PPE) Accounts Are Managed

PPE are long-term assets used in the business for more than one year.

Examples

• Buildings

• Machinery

• Motor vehicles

• Furniture and fittings

Key Accounting Treatments

1. Initial Cost

Includes purchase price + installation + delivery.

2. Depreciation

Allocation of asset cost over its useful life.

Double Entry for Depreciation

• Dr Depreciation Expense

• Cr Accumulated Depreciation

3. Disposal of Asset

When asset is sold or scrapped:

• Remove cost

• Remove accumulated depreciation

• Record gain or loss

3.5 Inventory Is Recognized, Measured and Valued Based on Cost Method

Inventory includes goods held for resale.

Recognition

Inventory is recorded when the business takes ownership of goods.

Measurement

Inventory is measured at cost, which includes:

• Purchase price

• Transport (carriage inwards)

• Import duty

• Handling costs

Valuation Methods

(Using cost principle)

1. FIFO (First In, First Out)

Oldest items are sold first.

2. Weighted Average Cost

Average cost per unit is applied.

3. Specific Identification

Each item tracked individually.

Note: Inventory must be valued at the lower of cost or net realizable value (NRV).

3.6 Accounting for Cash and Cash Equivalents, Bank Reconciliation

Cash and Cash Equivalents Include:

• Cash at hand

• Cash at bank

• Short-term deposits

• Treasury bills

• Petty cash

These are classified as current assets.

Cash Book

Records all cash and bank transactions.
Acts as:

• A book of original entry

• A ledger account

Petty Cash Book

Used for small payments such as:

• Postage

• Stationery

• Local transport

Operates under the imprest system.

Bank Reconciliation Statement

Prepared to match the cash book (bank column) with the bank statement.

Differences arise from:

• Unpresented cheques

• Deposits in transit

• Bank charges

• Direct deposits or debits

• Errors in cash book or bank statement

Purpose:

• Detect errors

• Prevent fraud

• Ensure accurate cash records

Short Exam-Ready Summary

Assets include resources such as cash, receivables, inventory, and PPE.
Liabilities include obligations such as accrued expenses and accounts payable.
Capital is the owner’s investment plus retained profits.

This element requires:

• Determining accrued and prepaid expenses

• Recognizing revenue when earned

• Accounting for receivables, bad debts, and allowances

• Managing PPE through cost, depreciation, and disposal

• Recognizing and valuing inventory using cost methods

• Accounting for cash, cash equivalents, and preparing bank reconciliation statements

3.1. Accounting for revenue

Accounting for Revenue

Revenue is the income earned by a business from its normal operations, such as selling goods or providing services. Proper accounting ensures that revenue is recognized in the correct accounting period and accurately reported in financial statements.

1. Definition of Revenue

Revenue is the gross inflow of economic benefits arising from the ordinary activities of a business.

Examples:

• Sales of goods

• Service fees

• Interest income

• Rent income

• Commission income

2. Recognition of Revenue

Revenue should be recognized when it is:

1. Earned (the goods or services have been delivered)

2. Measurable (the amount can be reliably determined)

3. Collectible (there is a reasonable expectation of receiving payment)

This follows the accrual principle:

• Revenue is recorded when earned, not necessarily when cash is received.

3. Accounting for Revenue (Double Entry Rules)

a) Cash Sales

When revenue is received in cash immediately:

b) Credit Sales

When revenue is earned on credit (payment to be received later):

c) Other Revenue

Other types of revenue, like interest or rent, are recognized as earned:

4. Revenue and the Income Statement

Revenue is a key component of the Income Statement.

• Total revenue earned is recorded at the top of the Income Statement

• Expenses are deducted from revenue to determine profit or loss

Profit/Loss=Revenue−Expenses

5. Key Points in Revenue Accounting

1. Accrual Principle: Revenue is recognized when earned.

2. Matching Principle: Revenue must be matched with related expenses.

3. Documentation: Sales invoices, receipts, and contracts support revenue entries.

4. Internal Controls: Revenue should be verified to prevent errors or fraud.

3.2. Accrued expenses and prepaid expenses are determined as per the accounting principles

Accrued Expenses and Prepaid Expenses

These are adjustments made at the end of an accounting period to comply with the accrual principle of accounting, which states that expenses must be recorded in the period they are incurred, not necessarily when they are paid.

1. Accrued Expenses (Accrued Liabilities)

Definition:
Expenses that have been incurred during an accounting period but have not yet been paid by the end of the period.

Classification:

• Current liabilities on the Statement of Financial Position (Balance Sheet).

Examples:

• Salaries and wages payable

• Rent payable

• Utilities payable

• Interest on loans

Accounting Treatment (Double Entry):

Purpose:

• Recognizes expenses in the correct accounting period

• Ensures accurate profit or loss calculation

2. Prepaid Expenses (Prepayments)

Definition:
Expenses paid in advance for goods or services to be received in a future accounting period.

Classification:

• Current assets on the Statement of Financial Position.

Examples:

• Prepaid rent

• Prepaid insurance

• Prepaid subscriptions

Accounting Treatment (Double Entry):

Adjusting Entry at the End of Period:
When the prepaid expense is used up, it becomes an expense:

Purpose:

• Ensures expenses are recorded in the period they relate to

• Prevents overstating expenses or understating assets

3. Key Accounting Principle

Both accrued and prepaid expenses are determined according to the accrual principle, which ensures:

• Expenses are matched with the revenue they help generate (Matching Principle)

• Financial statements reflect the true financial position of the business

Short Exam-Ready Summary

• Accrued expenses: Expenses incurred but not yet paid → liability → Dr Expense, Cr Accrued Expense.

• Prepaid expenses: Expenses paid in advance → asset → Dr Prepaid Expense, Cr Cash/Bank.

• Both are adjustments made to comply with the accrual principle for accurate financial reporting.

4. Correct accounting errors and suspense account

4. Correct Accounting Errors and Suspense Account

Accounting errors occur when transactions are recorded incorrectly. Identifying and correcting errors ensures accurate financial statements. The trial balance is the main tool used to detect errors.

4.1 Errors That Can Be Detected by the Trial Balance

The trial balance ensures that total debits = total credits. Errors detectable include:

1. Transposition errors

   • Digits are reversed (e.g., 540 recorded as 450).

2. Addition/subtraction errors

   • Totals in ledger accounts or trial balance are miscalculated.

3. Partial omission

   • A debit or credit is completely omitted.

Note: Only errors that affect the equality of debits and credits are immediately detectable.

4.2 Errors Where the Effect Causes the Trial Balance Not to Balance

These are errors that make the trial balance unequal:

• Single-sided entry: Only debit or credit recorded

• Addition errors: Total of debit ≠ total of credit

• Transposition errors: Digit reversal affecting one side

Detection:

• The trial balance shows a difference, prompting investigation.

4.3 Errors Where the Effect Causes the Trial Balance to Still Balance

These errors do not affect the equality of debits and credits. They are harder to detect:

1. Error of omission

   • Transaction completely omitted from books.

2. Error of commission

   • Wrong account used (e.g., rent expense posted to utilities expense).

3. Error of principle

   • Wrong type of account used (e.g., treating capital expenditure as revenue).

4. Compensating errors

   • Two equal but opposite errors cancel each other.

Detection: Requires detailed review of accounts.

4.4 Procedures for Correcting Errors

The organization must follow standard operating procedures (SOPs):

1. Identify the error type

2. Determine the correct entry

3. Pass correcting journal entry:

4. Update ledger and trial balance

Documentation:

• Use error correction notes

• Ensure approval from accountant/manager

4.5 Errors That Can Be Corrected by Suspense Account

A suspense account is a temporary account used when the trial balance does not balance.

Errors corrected using suspense account include:

• One-sided entries (missing debit or credit)

• Transposition errors causing imbalance

• Unidentified discrepancies in trial balance

Process:

• Post the difference to a suspense account

• Investigate the cause

• Correct affected accounts

• Close suspense account when error is resolved

4.6 Suspense Account Preparation

Steps to Prepare Suspense Account

1. Determine trial balance difference

2. Open Suspense Account in ledger

3. Post the difference:

   • Dr Suspense if trial balance shows debit deficiency

   • Cr Suspense if trial balance shows credit deficiency

4. Correct the errors in the respective accounts

5. Transfer balance to correct accounts and close suspense account

Example:
Trial balance shows debit > credit by Ksh 2,000:

• Dr Suspense 2,000

• After identifying error: correct the specific account and Cr Suspense 2,000

Short Exam-Ready Summary

1. Errors detected by trial balance: transposition, addition, single-sided entries.

2. Errors causing imbalance: omissions, wrong amounts, one-sided entries.

3. Errors that do not affect balance: errors of omission, commission, principle, or compensating errors.

4. Correction procedures: identify, pass correcting journal entries, update ledger and trial balance.

5. Suspense account: used temporarily to balance trial balance until errors are resolved.

6. Preparation: post difference, correct errors, transfer balance, and close suspense account.

4.1. Errors where the effect of the error causes the trial balance not to balance are identified.

Errors That Cause the Trial Balance Not to Balance

When preparing a trial balance, the total debits must equal total credits.
Some errors break this equality, making the trial balance show a difference. These errors are easily detectable.

1. Types of Errors That Cause Imbalance

1.1 Single-Sided Entry (Omission of One Side)

• Definition: Only one side of a transaction is recorded (either debit or credit).

• Effect: Trial balance totals do not match.

• Example: Paid Ksh 5,000 rent but only credited cash; debit not recorded.

1.2 Transposition Error

• Definition: Digits of a number are reversed when posting.

• Effect: Trial balance difference appears.

• Example: Ksh 540 posted as Ksh 450 (difference = Ksh 90).

1.3 Addition or Subtraction Error

• Definition: Mistakes in totaling ledger accounts or trial balance columns.

• Effect: Difference appears in trial balance.

• Example: Total of purchases ledger column is 25,000 instead of 26,000.

1.4 Partial Omission

• Definition: Only one part of a double-entry transaction is recorded.

• Effect: Trial balance does not balance.

• Example: Paid supplier Ksh 3,000 but recorded only debit to supplies account; credit to cash omitted.

1.5 Carrying Forward or Balance Transfer Error

• Definition: Incorrectly transferring ledger balances to trial balance.

• Effect: Trial balance totals mismatch.

• Example: Ledger balance Ksh 10,000 entered as 1,000.

2. Key Characteristics

• Trial balance will show a difference.

• Errors are detectable immediately.

• Correction requires identifying the specific account and nature of the error.

3. Short Exam-Ready Summary

Errors causing the trial balance not to balance include:

1. Single-sided entries (debit or credit missing)

2. Transposition errors (digits reversed)

3. Addition or subtraction errors in ledger totals

4. Partial omission of a transaction

5. Errors in carrying forward balances to trial balance

4.2. Errors that can be detected by the trial balance are determined.

Errors Detectable by the Trial Balance

A trial balance is a statement showing all ledger account balances: debits on one side and credits on the other. Its main purpose is to check that total debits equal total credits.

Some errors can be detected immediately because they cause the trial balance not to balance.

1. Types of Errors Detected by Trial Balance

1.1 Single-Sided Entry (Omission of One Side)

• Occurs when a debit or credit entry is completely omitted in the ledger.

• Example: Rent expense of Ksh 5,000 is debited but not credited to cash.

• Effect: Trial balance will not balance.

1.2 Transposition Error

• Occurs when two digits in a number are reversed.

• Example: Ksh 540 recorded as 450.

• Effect: Trial balance will not balance, usually by a difference divisible by 9.

1.3 Addition or Subtraction Error

• Occurs when totals of a ledger account are miscalculated.

• Example: Adding a column incorrectly in the purchases ledger.

• Effect: Trial balance will show a difference.

1.4 Partial Omission

• Only one part of a transaction is recorded in the ledger (either debit or credit).

• Example: Cash paid for supplies recorded only as credit.

• Effect: Trial balance fails to balance.

1.5 Carrying Forward Error

• Error made when transferring balances from ledger to trial balance.

• Example: Balance of Ksh 10,000 recorded as Ksh 1,000.

• Effect: Trial balance difference appears, detectable.

2. Key Point

• Only errors that affect the equality of debits and credits can be detected by the trial balance.

• Errors that do not affect the balance (e.g., wrong account used, complete omission of a transaction on both debit and credit sides) cannot be detected.

3. Short Exam-Ready Summary

Errors detectable by trial balance include:

1. Single-sided entries (debit or credit missing)

2. Transposition of numbers

3. Addition or subtraction errors in accounts

4. Partial omission of transaction

5. Errors in carrying forward balances

These errors cause the trial balance not to balance and prompt investigation.

5. Prepare sole trader statement

Errors That Cause the Trial Balance Not to Balance

When preparing a trial balance, the total debits must equal total credits.
Some errors break this equality, making the trial balance show a difference. These errors are easily detectable.

1. Types of Errors That Cause Imbalance

1.1 Single-Sided Entry (Omission of One Side)

• Definition: Only one side of a transaction is recorded (either debit or credit).

• Effect: Trial balance totals do not match.

• Example: Paid Ksh 5,000 rent but only credited cash; debit not recorded.

1.2 Transposition Error

• Definition: Digits of a number are reversed when posting.

• Effect: Trial balance difference appears.

• Example: Ksh 540 posted as Ksh 450 (difference = Ksh 90).

1.3 Addition or Subtraction Error

• Definition: Mistakes in totaling ledger accounts or trial balance columns.

• Effect: Difference appears in trial balance.

• Example: Total of purchases ledger column is 25,000 instead of 26,000.

1.4 Partial Omission

• Definition: Only one part of a double-entry transaction is recorded.

• Effect: Trial balance does not balance.

• Example: Paid supplier Ksh 3,000 but recorded only debit to supplies account; credit to cash omitted.

1.5 Carrying Forward or Balance Transfer Error

• Definition: Incorrectly transferring ledger balances to trial balance.

• Effect: Trial balance totals mismatch.

• Example: Ledger balance Ksh 10,000 entered as 1,000.

2. Key Characteristics

• Trial balance will show a difference.

• Errors are detectable immediately.

• Correction requires identifying the specific account and nature of the error.

3. Short Exam-Ready Summary

Errors causing the trial balance not to balance include:

1. Single-sided entries (debit or credit missing)

2. Transposition errors (digits reversed)

3. Addition or subtraction errors in ledger totals

4. Partial omission of a transaction

5. Errors in carrying forward balances to trial balance

5.1. Sole trader Income statement is drafted as per accounting period

Sole Trader Income Statement

The Income Statement (also called Profit and Loss Account) shows the financial performance of a sole trader over a specific accounting period. It calculates profit or loss by comparing revenues earned and expenses incurred.

1. Purpose of the Income Statement

• Determine profit or loss for the period

• Help the owner make business decisions

• Provide information to banks or investors

• Comply with accounting principles (accrual principle, matching principle)

2. Accounting Period

• The income statement is prepared for a specific period, usually:

  • Monthly

  • Quarterly

  • Annually

• Only revenue earned and expenses incurred during the period are included.

3. Structure of a Sole Trader Income Statement

4. Key Points in Drafting

1. Revenue Recognition: Only revenue earned during the period is included.

2. Expense Matching: Expenses are matched to the period in which revenue was earned (matching principle).

3. Accrual Adjustments: Include:

   • Prepaid expenses (asset)

   • Accrued expenses (liability)

4. Cost of Goods Sold (COGS):

   $\text{COGS} = \text{Opening Inventory + Purchases – Closing Inventory}$COGS=Opening Inventory + Purchases – Closing Inventory

5. Example

Given:

• Sales: Ksh 150,000

• Opening Inventory: Ksh 20,000

• Purchases: Ksh 80,000

• Closing Inventory: Ksh 15,000

• Expenses: Rent Ksh 10,000; Salaries Ksh 25,000

Income Statement:

6. Short Exam-Ready Summary

• The Income Statement shows profit or loss for a specific accounting period.

• Structure: Revenue – COGS = Gross Profit – Expenses = Net Profit/Loss

• Include adjustments for prepaid and accrued expenses.

• Helps evaluate business performance and make decisions.

5.2. Sources of capital for sole trader are established

Sources of Capital for a Sole Trader

Capital is the money or resources that a sole trader invests in their business to start operations and support growth. For a sole trader, the owner and the business are legally considered the same entity, so all capital comes from the owner or external financing.

1. Main Sources of Capital

1.1 Owner’s Personal Savings

• The most common source of capital for a sole trader.

• Money saved personally by the owner and invested into the business.

• Accounting Treatment:

  • Dr Cash/Bank

  • Cr Capital Account

1.2 Retained Profits

• Profits from previous periods that are reinvested into the business.

• This is internal financing.

• Accounting Treatment:

  • Dr Cash/Bank

  • Cr Capital/Retained Earnings

1.3 Loans and Borrowings

• Funds obtained from external sources such as banks or friends.

• Usually short-term or long-term debt.

• Accounting Treatment:

  • Dr Cash/Bank

  • Cr Loan/Bank Loan Payable

1.4 Sale of Personal Assets

• The owner may sell personal property (e.g., car, equipment) and use the proceeds as capital.

• Accounting Treatment:

  • Dr Cash/Bank

  • Cr Capital Account

1.5 Contributions from Family or Friends

• Financial support from family or friends in exchange for a share of profits or as a loan.

• Accounting Treatment: Similar to loans or capital injection.

2. Key Points

• Sole trader capital is primarily from the owner.

• Capital can be in the form of cash, assets, or other resources.

• The amount of capital determines the size and operations of the business.

• All capital contributions are recorded in the Capital Account in the ledger.

3. Short Exam-Ready Summary

Sources of capital for a sole trader include:

1. Owner’s personal savings

2. Retained profits from the business

3. Loans or borrowings from banks or friends

4. Sale of personal assets

5. Contributions from family or friends

Accounting treatment: Increase cash or assets debit, increase capital or loan credit.

6. Prepare partnership statements

6. Prepare Partnership Statements

A partnership involves two or more individuals carrying on a business with shared profits and liabilities. Accounting for partnerships requires proper preparation of agreements, accounts, and financial statements.

6.1 Contents of a Partnership Agreement

A partnership agreement is a legal document that defines the rights and responsibilities of partners. It usually includes:

1. Capital Contributions – Amount each partner invests.

2. Profit and Loss Sharing Ratio – How profits and losses are divided.

3. Interest on Capital – Interest payable on partner’s capital, if any.

4. Interest on Drawings – Charges on money withdrawn by partners.

5. Salary or Remuneration – Fixed salaries for partners if agreed.

6. Admission or Retirement of Partners – Procedures for changes in partnership.

7. Dissolution Terms – How assets and liabilities will be handled on dissolution.

Note: The partnership agreement must comply with SOPs and legal requirements.

6.2 Preparation of Current and Capital Accounts

Each partner usually has:

• Capital Account: Shows the original investment and permanent changes (e.g., additional capital, share of profit).

• Current Account: Shows temporary changes like drawings, salary, interest, and share of profit/loss.

Double Entry Examples:

1. Investing Capital:

   • Dr Cash/Bank

   • Cr Partner’s Capital Account

2. Partner’s Drawings:

   • Dr Partner’s Current Account

   • Cr Cash/Bank

3. Share of Profit:

   • Dr Profit & Loss Appropriation Account

   • Cr Partner’s Current Account

6.3 Partnership Income Statement

The Income Statement (Profit & Loss Account) for a partnership is similar to a sole trader but includes gross profit, expenses, and net profit to be shared among partners.

Steps:

1. Calculate revenue and expenses.

2. Deduct expenses from revenue to get net profit.

3. Net profit is transferred to Profit & Loss Appropriation Account for distribution.

6.4 Appropriation of Profit and Loss Account

This account distributes profits (or losses) among partners according to the agreement.

Steps:

1. Add interest on capital (if any).

2. Deduct partner salaries (if any).

3. Deduct interest on drawings (if any).

4. Allocate remaining profit/loss according to profit-sharing ratio.

Example:

6.5 Partnership Statement of Financial Position (Balance Sheet)

The Statement of Financial Position shows assets, liabilities, and partners’ equity.

Steps:

1. List current and non-current assets.

2. List liabilities (loans, payables).

3. List partners’ capital accounts and current accounts under equity.

Format Example:

Short Exam-Ready Summary

1. Partnership Agreement: Defines capital, profit-sharing, interest, salaries, and dissolution terms.

2. Capital & Current Accounts: Record capital investments, drawings, and share of profits/losses.

3. Income Statement: Calculates net profit/loss.

4. Profit & Loss Appropriation: Distributes profit or loss among partners.

5. Statement of Financial Position: Shows assets, liabilities, and partners’ equity.

6.1. Current and capital accounts are prepared as per the SOPs as per accounting standards

Current and Capital Accounts for Partners

In a partnership, each partner has two main accounts in the ledger:

1. Capital Account – Records permanent investments made by the partner and their share of accumulated profits.

2. Current Account – Records temporary transactions such as drawings, interest on capital, partner salaries, and share of profit/loss.

These accounts are prepared as per SOPs and accounting standards to ensure accurate tracking of each partner’s equity and transactions.

1. Capital Account

Purpose:

• To show the partner’s initial and additional investment in the business.

• To reflect the partner’s permanent share of profit.

Typical Entries in Capital Account:

Key Point:

• Permanent balance that remains in the business unless the partner withdraws capital.

2. Current Account

Purpose:

• To track temporary transactions affecting the partner’s equity:

  • Drawings

  • Salary or remuneration

  • Interest on capital or drawings

  • Share of profit/loss

Typical Entries in Current Account:

Key Point:

• Current account starts with zero each period and adjusts with transactions throughout the accounting period.

3. Preparation Steps According to SOPs

1. Open ledger accounts for each partner:

   • Capital Account

   • Current Account

2. Record capital contributions in the capital account.

3. Record drawings, salaries, and interest in current accounts.

4. Allocate share of profits or losses from the Profit & Loss Appropriation Account to current accounts.

5. Prepare closing balances:

   • Capital account shows permanent capital

   • Current account shows net effect of temporary transactions

4. Example

Assume:

• Partner A invests Ksh 100,000 and Partner B invests Ksh 50,000.

• Drawings: A = 10,000; B = 5,000

• Profit sharing: A 60%, B 40%

• Partner salaries: A = 5,000, B = 3,000

Capital Accounts:

Current Accounts:

5. Short Exam-Ready Summary

• Capital Account: Permanent investment + share of accumulated profits.

• Current Account: Tracks temporary transactions like drawings, salary, interest, and share of profits/losses.

• SOP Compliance: Accounts must reflect accurate partner equity, follow double-entry principles, and comply with accounting standards.

• Closing Balances: Capital = permanent investment; Current = net temporary transactions.

6.2. Contents of a partnership agreement are determined as per the SOPs.

Partnership Agreement Contents

A partnership agreement is a legal document that outlines the rights, responsibilities, and obligations of partners in a business. It ensures clarity, prevents disputes, and guides accounting for the partnership.

1. Key Contents of a Partnership Agreement

1.1 Name and Nature of the Partnership

• Legal name of the partnership

• Type of business activity

• Duration of the partnership (fixed term or indefinite)

1.2 Capital Contributions

• Amount of money or assets each partner contributes

• Terms of additional capital contributions

• Treatment of interest on capital, if any

1.3 Profit and Loss Sharing

• Ratio in which profits and losses will be distributed among partners

• May be equal or unequal depending on the agreement

1.4 Partner Salaries or Remuneration

• Whether partners receive salaries for management services

• Terms for calculating salaries

1.5 Interest on Drawings

• Interest charged on money withdrawn by partners from the business

• Helps prevent misuse of business funds

1.6 Admission, Retirement, or Death of Partners

• Rules for admitting new partners

• Procedure for retirement or death of a partner

• How capital and profit shares are adjusted

1.7 Dissolution and Winding Up

• Circumstances under which the partnership may be dissolved

• Method for distributing assets and settling liabilities upon dissolution

1.8 Dispute Resolution

• How disputes among partners will be resolved

• May include mediation or arbitration clauses

1.9 Other Special Clauses

• Restrictions on competition

• Confidentiality agreements

• Voting rights and decision-making processes

2. Key Points According to SOPs

• The agreement must be signed and dated by all partners.

• It must comply with local laws and accounting standards.

• All financial and operational arrangements must be documented clearly.

• Provides the basis for preparing capital accounts, current accounts, and profit/loss appropriation.

3. Short Exam-Ready Summary

A partnership agreement should clearly include:

1. Partnership name, business type, and duration

2. Capital contributions and interest on capital

3. Profit and loss sharing ratio

4. Partner salaries and interest on drawings

5. Rules for admission, retirement, or death of partners

6. Dissolution procedures

7. Dispute resolution mechanism

8. Special clauses (confidentiality, voting, restrictions)

7. Prepare company statements

7. Prepare Company Statements

Companies are separate legal entities, and their accounting involves share capital, reserves, provisions, and taxation. Preparing company statements requires following the Companies Act, organizational policies, and accounting standards.

7.1 Types of Share Capital (as per Companies Act)

Share capital represents funds raised by the company from shareholders in exchange for ownership (shares). Types include:

1. Ordinary/Equity Shares

   • Most common; shareholders get dividends and voting rights.

2. Preference Shares

   • Fixed dividend; priority over ordinary shares during profit distribution and liquidation; usually no voting rights.

3. Issued, Authorized, and Paid-Up Capital

   • Authorized: Maximum capital company can issue.

   • Issued: Shares actually issued to shareholders.

   • Paid-Up: Amount shareholders have paid.

Accounting Entry for Share Issue:

• Dr Cash/Bank

• Cr Share Capital (Ordinary/Preference)

7.2 Types of Reserves (as per Organizational Objectives)

Reserves are retained earnings set aside for specific purposes:

1. Revenue Reserves – Created from profits for business operations (e.g., general reserve).

2. Capital Reserves – Arises from non-operating activities (e.g., sale of fixed assets above book value).

3. Statutory Reserves – Required by law for specific purposes.

Accounting Entry for Appropriation to Reserve:

• Dr Profit & Loss Account

• Cr Reserves Account

7.3 Issue of Shares (as per Organizational Requirements)

• Shares can be issued to raise capital for expansion.

• Steps:

  1. Board resolution authorizing share issue

  2. Determine number of shares, nominal value, and premium

  3. Record application money, allotment, and call money

Accounting Entries:

1. Application money received:

   • Dr Cash/Bank

   • Cr Share Application Account

2. On allotment:

   • Dr Share Application

   • Cr Share Capital

3. On call money received:

   • Dr Cash/Bank

   • Cr Share Capital

7.4 Rights Issues and Bonus Shares (Company Policies)

• Rights Issue: Existing shareholders offered additional shares at a discount.

  • Example: 1 new share for every 5 held.

• Bonus Shares: Issued from reserves to reward shareholders.

Accounting Entries:

• Rights issue: same as ordinary share issue.

• Bonus issue:

  • Dr Reserves

  • Cr Share Capital

7.5 Provisions and Reserves

Provisions:

• Amount set aside for known liabilities of uncertain amounts (e.g., bad debts, depreciation).

• Accounting Entry:

  • Dr Expense

  • Cr Provision Account

Reserves:

• Retained earnings set aside for future use or expansion.

Difference: Provisions = for liabilities; Reserves = for general purposes.

7.6 Income Tax Calculation (as per SOPs)

• Companies calculate tax on taxable profit.

• Accounting treatment:

  • Dr Income Tax Expense (P&L)

  • Cr Income Tax Payable (Liability)

Adjust for deferred tax if applicable, following SOPs and accounting standards.

7.7 Accounting Treatment and Presentation

1. Statement of Profit or Loss (Income Statement)

   • Revenue – Expenses = Net Profit

2. Statement of Financial Position (Balance Sheet)

   • Assets = Liabilities + Equity (Share Capital + Reserves)

3. Presentation Guidelines:

   • Separate equity, reserves, and liabilities clearly.

   • Follow International Financial Reporting Standards (IFRS) or local accounting standards.

   • Disclose share capital, reserves, provisions, and taxation in notes to accounts.

Short Exam-Ready Summary

7.1. Types of reserves are determined as per the organizational objectives

Types of Reserves

Reserves are portions of a company’s profits set aside for specific purposes, either as a safety buffer or to fund future activities. The type of reserve a company maintains depends on its organizational objectives, legal requirements, and strategic plans.

1. Main Types of Reserves

1.1 Revenue Reserves

• Purpose: Fund operational needs, expansion, or contingencies.

• Source: Profits from normal business operations.

• Examples:

  • General reserve

  • Dividend equalization reserve

• Use: Can be distributed as dividends if the company chooses.

1.2 Capital Reserves

• Purpose: Arises from non-operating activities; usually not available for dividend distribution.

• Source:

  • Sale of fixed assets above book value

  • Revaluation of assets

  • Premium on share issue

• Use: Strengthen financial position or for specific capital projects.

1.3 Statutory or Legal Reserves

• Purpose: Required by law or regulatory authorities.

• Examples:

  • Banking regulations may require a statutory reserve

  • Insurance companies may have specific reserves

• Use: Protect creditors and ensure financial stability

1.4 Specific or Special Reserves

• Purpose: Set aside for clearly defined objectives.

• Examples:

  • Research & development reserve

  • Dividend equalization reserve

  • Contingency reserve

2. Accounting Treatment of Reserves

• Creation of reserve:

  • Dr Profit & Loss Account

  • Cr Reserve Account

• Utilization of reserve:

  • Dr Reserve Account

  • Cr Cash/Bank or Specific Expense Account

Note: Revenue reserves can be distributed as dividends, while capital reserves are usually retained in the business.

3. Key Points According to Organizational Objectives

1. Operational Efficiency: Revenue reserves support smooth running of business.

2. Expansion & Investment: Capital reserves fund growth projects.

3. Legal Compliance: Statutory reserves ensure the company meets regulatory requirements.

4. Risk Management: Special reserves mitigate unforeseen risks.

4. Short Exam-Ready Summary

7.2. .Types of share capital are identified as company’s Act

Types of Share Capital

Share capital represents the funds a company raises by issuing shares to shareholders. The Companies Act specifies the types of shares that a company can issue.

1. Ordinary (Equity) Shares

• Definition: Standard shares representing ownership in the company.

• Rights:

  • Voting rights at general meetings

  • Right to dividends (after preference shareholders)

  • Right to share in residual assets upon liquidation

• Risk & Return: High risk, potentially high returns through dividends and capital gains.

2. Preference Shares

• Definition: Shares with fixed dividend paid before ordinary shares.

• Rights:

  • Fixed dividend (priority over ordinary shares)

  • Usually no voting rights, except in certain situations

  • Priority in repayment during liquidation

• Types:

  1. Cumulative preference shares – unpaid dividends accumulate.

  2. Non-cumulative preference shares – unpaid dividends are not carried forward.

  3. Redeemable preference shares – company can buy back at a future date.

  4. Convertible preference shares – can be converted to ordinary shares.

3. Issued, Authorized, and Paid-Up Share Capital

• Authorized Capital: Maximum amount of share capital a company can issue.

• Issued Capital: Portion of authorized capital actually issued to shareholders.

• Paid-Up Capital: Portion of issued capital actually paid by shareholders.

Example:

• Authorized: Ksh 1,000,000

• Issued: Ksh 600,000

• Paid-up: Ksh 500,000

4. Accounting Treatment

• Dr Cash/Bank – when money is received

• Cr Share Capital (Ordinary/Preference) – increases equity

Short Exam-Ready Summary

1. Ordinary Shares: Voting rights, dividends, residual claim.

2. Preference Shares: Fixed dividend, priority in liquidation, usually no voting.

3. Authorized, Issued, Paid-Up Capital: Legal and accounting distinctions.