Concept of Incomplete Records and Single entry

Introduction

In small businesses, a major problem arises in that due to shortages of time and experience, it is not possible to maintain full accounting records under the double entry system. Furthermore, small businesses generally can't afford to hire outside staff to maintain these records.

However, every business needs to know about its trading results after specific intervals of time.

For this reason, we can say that any sets of procedures that are aimed at ascertaining the profit or loss of a business, and that do not involve maintaining records under the double entry system, are generally referred to as single entry systems.

It is also worth noting that a single entry does not mean the single entry of a transaction. Instead, it only indicates the incomplete nature of the records kept under this system. In fact, single entry systems are a mixture of double entry, single entry, and no entry.

Under the single entry system, some transactions are completely recorded. For example, cash allocated from debtors is recorded in the debtor's account as well as the cash account. Also, some transactions are partially recorded, such as cash purchases. Likewise, certain transactions are not recorded at all (e.g., bad debts and depreciation).

In a nutshell, the single entry is a system in which accounting records are not recorded exactly like the double entry system.

Given that the records are not kept under the double entry system, they are considered incomplete records. In turn, this means that a trial balance cannot be prepared. This can result in fraud and misappropriation.

Limitations of the single entry system

1. Since the trial balance cannot be prepared, the arithmetical accuracy of the work completed cannot be checked.
2. The system may create opportunities for fraud and misappropriation.
3. Under this system, nominal accounts are not maintained. Due to this, it is not possible to prepare final accounts. In turn, various important ratios such as the operating cost ratio and gross profit ratio cannot be computed.
4. Due to incomplete records, proper appraisal of the financial position of a business is impossible.
5. Due to legal restrictions, no limited companies can keep records under this system.

Computation of profit or loss under single entry system

There are two approaches used to determine the profit or loss under the single entry system:

i. Balance sheet approach (or net worth method)

If the books of a business are maintained under the single entry system, then profit or loss cannot be calculated using the trading account and profit and loss account.

The reason for this is that the records kept under the single entry system are incomplete. To calculate the profit or loss under the single entry system, the following fundamental equation for the balance sheet can be used:

Capital (Net Worth) = Assets — Liabilities

This method is also known as the statement of affairs method. This is because, using this method, two balance sheets (statements of affairs) are prepared.

The first statement of affairs prepared at the start of the year will show "Opening Capital," whereas the second statement prepared at the end of the year will give "Closing Capital."

By comparing "Opening Capital" and "Closing Capital," we can calculate the profit or loss. If closing capital is greater than opening capital, this indicates an increase in capital (i.e., "Profit").

On the other hand, if "Closing Capital" is less than "Opening Capital," it indicates a decrease in the capital, corresponding to a loss for the period.

The above formula can be written down in the form of the following statement:

Capital at close	xxx
Add drawing (if any)	xxx
Total capital at close		xxx
Less
Capital at start	xxx
Add: Additional capital (if any)	xxx
Total capital at start		xxx
Net profit or loss		xxx

Example

A trader keeps his books using the single entry system. He started his business on 1 January 2019 with a total capital amount of Tshs. 100,000. On 1 July 2019, he borrowed Tshs. 40,000 at 10% p.a. Additionally, on 31 December 2019, his assets and liabilities (besides the above) were:

Cash: Tshs. 6,000

Stock in trade: Tshs. 94,000

Debtors: Tshs. 71,000

Furniture: Tshs. 50,000 (charge 10% depreciation on furniture)

Creditors: Tshs. 42,000

The trader drew Tshs. 2,500 for personal use. During the year, he further invested in Tshs. 25,000 through the sale of his private property.

Required: Ascertain the trader's profit or loss for the year.

Solution

Statement of affairs as on 31st December 2019

Asset	Amount	Liabilities	Amount
Cash	6,000	Creditors	42,000
Debtors	71,000	Loan	40,000
Stock	94,000	Accrued interest	2,000
Furniture	45,000	Capital	132,000
	216,000		216,000

Statement of profit and loss for the year ended 31st December 2019

Closing capital		132,000
Add: Drawing during the year		2,500
		134,000
Less: Opening capital	100,000
Fresh capital	25,000	125,000
Net profit for the year		9,500

ii. Transaction approach (or conversion method)

This approach is applicable where the double entry system is maintained. In this approach, every transaction is analyzed and the net result of the business is calculated. Under this approach, a sequence of steps is adopted, as described in this section.

First of all, transactions are recorded in the journal. After recording transactions, these are classified into the ledger. In turn, to check the arithmetical accuracy of the work done, a trial balance is prepared from the ledger.

Adjusting entries are then passed to record the internal transactions, including depreciation. The next step is to prepare the second trial balance, which is called the adjusted trial balance, to incorporate adjusting entries.

From the trial balance, nominal accounts are subsequently transferred to the trading account and profit and loss account. Finally, the trading account and profit and loss account indicate the gross profit and net profit of the business.