Which one of the following statements is not correct ?

Correct — A, (a) Capital account has a debit balance. The booklet sets 'not' in bold italic — the item asks which statement is NOT correct — and this is the one that states the opposite of the position.

The capital account records what the business owes its owner. Under the business entity concept the business is treated as separate from the proprietor, so money the proprietor puts in is a liability of the business to him; it is credited to his capital account when introduced, credited again with the profit of the year and with interest on capital, and debited with drawings and with any loss. In the ordinary case those credits exceed those debits, so the capital account carries a CREDIT balance and appears on the liabilities side of the balance sheet.

Under the traditional classification the capital account is a personal account — the proprietor's own — and the golden rule for personal accounts is debit the receiver, credit the giver. The proprietor gives capital to the business, so he is credited. Under the modern approach the same result follows from the accounting equation: assets equal liabilities plus capital, and an increase in capital is recorded as a credit.

A debit balance on a capital account is possible but exceptional. It arises where accumulated losses and drawings have exceeded the capital introduced and the profits earned, and in a partnership it shows a partner owing money to the firm — a capital deficiency, which on dissolution raises the rule in Garner v. Murray for how the deficiency of an insolvent partner is borne. That is the exception, and a statement offered as a general proposition of accounting is judged by the rule.

The other three statements are each correct, and the distractor notes identify the rule behind each. Note also that this stem is word for word the stem of the item printed above it on the same page apart from the emphasised 'not', and that option (d) carries its own unemphasised negation — 'are not recorded' — so two negations have to be tracked at once.

Why the others are wrong

• (b)Discount column of cash book records cash discount. — This statement IS correct. The discount columns of a three-column cash book record CASH DISCOUNT — the discount allowed to a customer for prompt payment, entered in the discount column on the debit (receipts) side, and the discount received from a supplier for prompt payment, entered in the discount column on the credit (payments) side. Cash discount arises at the time of payment and is therefore recorded in the books. It must be kept apart from TRADE DISCOUNT, which is a reduction in the list price allowed on the quantity or class of purchase; trade discount is deducted before the invoice is drawn and never appears in the books at all, neither in the cash book nor anywhere else. The discount columns of the cash book are also memorandum columns, totalled and posted in total to the discount allowed and discount received accounts rather than balanced.
• (c)Under traditional approach, rent outstanding is a personal account. — This statement IS correct. Under the traditional approach accounts are personal, real or nominal, and personal accounts include not only natural persons and artificial persons such as companies but REPRESENTATIVE personal accounts — accounts that stand for a person or a group of persons even though no name appears. Outstanding rent, outstanding wages, prepaid insurance, accrued commission and capital and drawings accounts are all representative personal accounts, because each represents an amount due to or from a person. Outstanding rent represents the landlord to whom rent is owed, so it is a personal account and is balanced and carried forward to the balance sheet as a liability, unlike the rent account itself, which is nominal and is closed to the profit and loss account.
• (d)Cash sales are not recorded in the sales day book. — This statement IS correct, and note that it carries a negation of its own inside an item whose stem is already negative. The sales day book records CREDIT SALES OF GOODS ONLY. Cash sales are recorded in the cash book, because the cash book is itself a book of original entry for every receipt and payment of money, and recording them in the sales day book as well would duplicate the entry. The day book also excludes the sale of an asset, whether for cash or on credit, because it is confined to goods in which the business deals; the sale of an old machine goes through the journal proper. The same logic applies on the purchases side: the purchases day book records credit purchases of goods only, and cash purchases go to the cash book.

This item ranges across four separate corners of book-keeping, and each has a rule that can be stated in a line. CAPITAL: under the business entity concept, capital is what the business owes the proprietor, so it is credited on introduction and with profit and interest on capital, debited with drawings and losses, and normally shows a credit balance on the liabilities side. DISCOUNT: trade discount is a deduction from list price, allowed before the invoice is made out and never entered in the books; cash discount is allowed or received for prompt settlement and is entered in the discount columns of the cash book, which are memorandum columns posted in total. CLASSIFICATION OF ACCOUNTS under the traditional approach: personal accounts, which include natural, artificial and representative personal accounts such as outstanding and prepaid items; real accounts for assets, tangible and intangible; and nominal accounts for expenses, losses, incomes and gains. SUBSIDIARY BOOKS: each records one class of transaction and only that class — the sales day book credit sales of goods, the purchases day book credit purchases of goods, the returns books the corresponding returns, the bills books bills receivable and payable, and the cash book every receipt and payment, with anything that fits none of them going to the journal proper. Knowing which book a transaction belongs in is the same skill as knowing which account it belongs to, and the papers test both.

Key facts

• The capital account normally carries a CREDIT balance and appears on the liabilities side of the balance sheet.
• Capital is credited on introduction and with profit and interest on capital, and debited with drawings and losses.
• A debit balance on a capital account signifies a capital deficiency, arising when losses and drawings exceed capital and profits.
• Cash discount is recorded in the discount columns of the cash book; trade discount is deducted from the list price before invoicing and never enters the books.
• The discount columns of the cash book are memorandum columns, totalled and posted to the discount allowed and discount received accounts.
• Under the traditional approach outstanding and prepaid items are REPRESENTATIVE personal accounts — outstanding rent, outstanding wages, prepaid insurance, accrued commission.
• The sales day book records credit sales of goods only; cash sales go to the cash book and sales of assets to the journal proper.
• The purchases day book likewise records credit purchases of goods only.
• The business entity concept is why capital is a liability of the business to its owner.

Common traps

• Missing the emphasised 'not' — the item above on the same page asks the same question positively.
• Losing the second negation, inside option (d), while tracking the first in the stem.
• Confusing trade discount with cash discount. Only cash discount is recorded.
• Treating outstanding rent as a nominal account. The rent account is nominal; outstanding rent is a representative personal account.
• Assuming the sales day book records all sales. It records credit sales of goods only.

• practice — not a real PYQ

  Which one of the following never appears in the books of account ?

  • (a)Cash discount allowed
  • (b)Cash discount received
  • (c)Trade discount
  • (d)Provision for discount on debtors

  Answer(c) Trade discount

• practice — not a real PYQ

  Under the traditional classification of accounts, 'prepaid insurance' is :

  • (a)A nominal account
  • (b)A real account
  • (c)A representative personal account
  • (d)A contingent account

  Answer(c) A representative personal account