The ICB syllabus is excellently designed to equip budding bookkeepers with the knowledge and skills that will allow them to build a fulfilling career, looking after businesses in many sectors.
You probably know the Level 3 syllabus by the types of business for which you are going to prepare final accounts:
- Sole traders
- Partnerships
- Not-for-profit
- Limited Companies
These business structures have different reporting requirements, meaning that there are differences in what appears in the “Profit & Loss” account or the Balance Sheet.
However, this article is going to look at what they have in common as you move to Level 3 from Level 2, where you’ve successfully recorded and correctly classified transactions, using a trial balance as a check.
The first thing to realise is that arriving at that trial balance involves summing up all the invoices, bills, receipts and payments that have gone through the business in the period.
Knowledge of some of the Fundamental Accounting Concepts should tell us why there is more to do before drawing up accounts which give a “true and fair view” of everything that the business has done.
Consider this short scenario.
It is 4th December and Billie Bookkeeper has received an invitation to attend a conference which will take place in April next year. Tickets are on an “Early Bird” special offer of £345, so Billie registers and pays the full amount.
At the year end, of 31st December, Billie’s trial balance correctly shows an expense for “Training and Development” of £345.
However, the ACCRUALS concept tells us that expenses should be recognised when they are incurred, not when they are paid.
Although paid in the past year, £345 should be treated as an expense in the coming year – i.e. when the conference takes place. Therefore, there will be a year end adjustment that takes £345 out of Training and Development expense and carries it over to next year, where it will appear correctly.
Accruals and Prepayments
That is an example of a ‘prepayment’, when an expense is paid in advance and we have a year end falling between the date of payment and the date of use,
Learning about prepayments is coupled with learning about accruals, which is effectively the opposite. It’s when we’ve arrived at the year end and realised that we’ve incurred some expenses but we’ve not yet received the bill. Typically, utilities bills (electricity, gas and telephone) are paid in arrears. At the end of December, we’ll know that we’ve used those utilities but, without a bill, will have to record an estimate of the expense by way of a journal entry.
One of the first things you will do at Level 3 is to make adjustments to expense accounts to ensure that the total amount recorded for the year is as accurate as can be.
The accruals concept is also known as the MATCHING concept as the accounts aim to match a business’s income to the expenses that gave rise to it.
Depreciation
This is another application of the matching concept.
Level 2 will have taught you that there is a difference between ‘revenue’ and ‘capital’ expenditure. Capital expenditure is made to acquire or upgrade (fixed) assets which are expected to deliver benefits over an extended period.
In other words, it is expenditure that supports the delivery of income over more than one year. Instead of matching that expenditure to the income of one year, it will be matched across all years in which the assets are expected to benefit the business.
The ‘cost’ (or expense) associated with a fixed asset is not necessarily the amount paid to acquire it. If I buy a vehicle now for £36,000, I might expect to be able to sell it in three years’ time for £12,000. Therefore the ‘cost’ which I will account for as an expense is going to be £24,000 and, in simple terms, I’ll make that £8,000 for each of the three years.
Other approaches are possible and there are other considerations you will have to make before fully accounting for fixed assets and depreciation.
Bad and Doubtful Debts
Another fundamental concept which comes into play, requiring us to make adjustments to the trial balance is the PRUDENCE concept.
In effect, it is prudence that got accountants the reputation for being safe and boring. That and Monty Python but I digress…
In simple terms, I shouldn’t say that I have an asset valued at £15,000 if the slightest inspection were to reveal I’d be lucky if it were worth £2,500. So, the bookkeeper is going to have to look at the value of assets in the balance sheet and make journal adjustments to ensure they reflect a ‘true and fair’ position.
One area that you will come across is an analysis of the business’s position on debtors. A detailed inspection of an aged debtor listing should raise questions leading to two possible adjustments:
- Writing off a bad debt
This happens when we realise that we have no hope of recovering money owed to us. Maybe the customer has gone into liquidation. Maybe we didn’t carry out sufficient checks when making the sale and we gave credit on the back of a false address to a man with a suspicious nose/glasses/moustache combo.
However it’s happened, our Prudence tells us that we should not include the value of that debt as an asset so we’ll make a journal entry to reduce the total value of debtors.
Incidentally, the other side of this write off is to create an expense, rather than to reverse the sale. We want to have it clearly on record that we made that sale but whether through bad luck or judgement, we’re not getting the money.
- Creating a doubtful debt provision
This is similar bad debts in that we’ll recognise that there’s a chance that we won’t receive income from all of the outstanding debtor balances.
We can look at a specific customer and put a ‘virtual’ question mark against their account if we think there’s still a chance they’ll come good. But prudence says that if there’s sufficient doubt we shouldn’t include the debt at full value. We won’t write it off, though; we want it to remain on the debtors’ list so that we remember to chase that customer regularly.
We could also apply a general measure of prudence to our debtors balance by making a small provision without necessarily naming the debtors about whom we are doubtful.
Incidentally, the value of stock should be scrutinised in the same way but this will not figure as extensively in your studies as there are fewer consequences.
Finally, the Prudence concept could be said to apply when accounting for fixed assets. The process of depreciation above, as well as creating an expense, results in your asset being stated at a lower value than you paid for it. After one year, that vehicle that cost £36,000 will show in the balance sheet with a value of £28,000.
Conclusion
ICB’s Level 3 Certificate involves a lot more than these three areas but, once all these adjustments have been made, you’re close to arriving at what old accountants like me would call an “Extended Trial Balance”. That was in the days before spreadsheets and bookkeeping software, when we would work on paper and needed an A3 sheet with 15 columns on it to do the work!
In practice, and in this century, the principle remains that the trial balance you’ve arrived at having recorded all the bills, invoices and payments will require adjustments to expenses and assets before arriving at values you can put into the final accounts. All Level 3 exams will touch on these so I hope that an awareness of the concepts helps to give you a leg up in your studies.
