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Topic 1:

Introduction to Financial Accounting


Learning outcomes

What is a business?
Business transactions
Asset and Liabilities and Capital
Accounting Principles and Characteristics
Accounting Equation
Financial Statements

What is a business?
The purpose of a business is to make a profit for its owner(s)
Profit = income less expenditure
A business is a separate entity from its owner
Every financial transaction has a dual effect
Double entry bookkeeping accounts for the dual aspect of financial transactions

What is a business ?
A business of whatever size or nature exists to make a profit.

Types of business entity


Sole traders refers to ownership, sole traders can have employees

Partnerships two or more people working together to earn profits

Limited liability company owners have liability limited to the amount they pay for their shares

A limited liability company has a separate legal identity from its owners
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Business Transactions
Wherever property changes hands there has been a business transaction.
A cash transaction is where the buyer pays cash to the seller when goods are transferred.
A credit transaction is a sale or purchase which occurs earlier than cash is received or paid.

Assets and liabilities 1


Assets are items of value which a business owns or has the use of.
Assets are categorised as either non-current or current.

Non-current assets are those acquired for us over more than one accounting period, e.g.
land and buildings, machinery, computers and vehicles.

Current assets are those owned by the business with the intention of turning them into
cash, e.g. inventory and receivables.

Liabilities represent amounts that are owed by the business.


Liabilities are categorised as either non-current or current.

Non-current liabilities are those that are not payable within one year, e.g. mortgages, a 5
year bank loan, amounts used in respect of hire purchase agreements.

Current liabilities are those that are payable within one year, e.g. amounts owed to
suppliers, overdrafts repayable on demand.

The Accounting Equation


The purpose of a business is to make a profit (excess of income over expenditure) for its owner.
Under the business entity concept, the assets and liabilities of a business must be kept separate
from the assets and liabilities of its owner.
The accounting equation:

Accounting Equation 1
Assets = Capital + Liabilities

Accounting Equation 2
Assets = (Capital introduced + Retained Profits) + Liabilities

Accounting Equation 3
Assets = Capital introduced + (Earned Profit - Drawings) + Liabilities
Accounting Principles and Characteristics
Basic accounting principles and characteristics are the broad assumptions which underlie the
financial accounts of business entities.
There are five important ones to understand:

Going concern

Accruals

Objectivity

Consistency

Historical cost

Going concern: the business will continue to operate into the foreseeable future at its current
activity level

Accruals: revenue must be matched with the costs incurred in earning it

Objectivity: amounts recorded in the accounting records are based on objective evidence.

Consistency: similar items should be given similar treatment, which is applied from one
accounting period to the next

Historical cost: transactions are stated in the accounts at their historical amount
Amounts are initially recorded in the accounting records at their cost or purchase price.
Example:

Other accounting principles and characteristics:


Business entity principle (a business is separate from its owners or managers)

Only business activities are recorded and not personal activities of the owner.
Every business transaction is recorded form the viewpoint of the business.

Double entry bookkeeping (every transaction gives rise to a debit and a credit entry)

Money measurement (accounts only deal with items to which a monetary value can be attributed):
Economic data are recorded in dollars.

Use dollar amount as a common denominator.


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Financial Statements:
The financial statements of a business are represented by several elements, the most basic being
the Statement of Financial Position and the Statement of Profit or Loss.
Statement of Profit or Loss
The statement of profit or loss (or profit and loss account) shows how the profit or loss for the
period has been made.
Key items on the statement of profit or loss are gross profit and net profit.
Gross profit = Sales Cost of goods sold

Cost of goods sold represents the purchase or production costs of goods sold

Net Profit = Gross profit + Other income Other expenses

Other expenses are overheads incurred in running the business e.g. advertising costs, office
building rental costs, postage costs etc.
Revenue: Resources earned by the business. Increase owners equity as a result of selling
services or products to customers.
Expenses : Resources used up to earn revenue. Using up of assets or consuming services in
the process of generating revenues.

Revenue
Fees revenue
Sales revenue
Interest earned
Rent earned
Commission
received
Discount received

Expenses
Salaries exp
Rental exp
Utilities exp
Advertising
exp
Insurance exp
Carriage
outwards exp
Carriage
inwards

Expenses
Sundry exp
Staff welfare exp
Interest exp
Bad debts exp
Repairs and
maintenance exp
Entertainment exp
Office supplies exp

Expenses
Discount allowed

Statement of Financial Position


The Statement of Financial Position (or balance sheet) shows the assets, liabilities and capital of
the business at the period end.
It represents the accounting equation.
It distinguishes between non-current and current assets, and non-current and current liabilities.
The Accounting Equation:
Assets

Liabilities +

Capital

Assets: Resources owned by the business

Fixed Assets
Land and building (Premises)
Motor vehicle
Office equipment
Furniture and fittings
Plant and machinery

Current Assets
Cash
Stock/ Inventory
Debtors/ Accounts receivable/ credit
customers
Prepaid expense
Accrued revenue
Notes receivable

Liabilities: Resources owing by the business or Resources contributed by non-owners such


as bankers and credit suppliers.

Current Liabilities
Creditors/ Accounts payable/ credit
suppliers
Bank overdraft
Short term loan
Unearned revenue
Accrued expense/Expense due/
Expense owing/ expense outstanding
Notes payable

Non-current liabilities
Bank loan
Mortgage loan
Debenture bonds/Bonds payable
Notes payable

Capital/ Owners equity: Resources contributed by the owner into the business.

Drawings: Resources taken out by owner from business for personal use

Recording business transactions using Accounting Equation


A business transaction is an economic event or condition that directly changes an entitys
financial condition or its results of operations.
Transactions
January 2012
1 Nancy deposited $50,000 in a bank account in the name of Nancy Trading.
8 Nancy Trading bought furniture worth $12,500 paying by cheque.
10 Supplies of $6,300 was bought on credit.
16 Nancy Trading received $2,880 for rental from tenants through GIRO.
20 The following expenses were paid by cheques: wages $1,500, utilities $350
and repairs $550.
24 Nancy Trading paid creditors $3,400 with a cheque.
31 Nancy determined that the unused supplies was $1,900.
31 Nancy withdrew $ 2,100 from Nancy Trading for her personal use.
Assets

= Liabilities

Owners Equity

Financial Statements
Statement of Comprehensive Income/ Income Statement: Shows the financial performance of a
business. Based on matching concept.
Statement of Owners Equity
Statement of Financial Position/ Balance Sheet: Shows the financial position of a business.
Based on the accounting equation.
Cash Flow Statement (Topic 9)
The Accounting Equation Expanded:
Assets
Assets
Assets

=
=
=

Liabilities +
Liabilities +
Liabilities +

Capital + Revenues - Expenses


Capital + Net Profit
Capital - Net Loss

Sample:

Excel Company
Trading, Profit and Loss Account for the year ended 30 April 2012
$
$
Sales
100,000
Less: Return Inwards
(9,000)
Net Sales
Less: Cost of Goods Sold
Opening Stock
Purchases
Less: Return outwards
Carriage inwards
Customs duties
Less: Closing Stock
Cost of Goods Sold
Gross Profit
Add: Commission received
Discount received
Interest received
Rent received

91,000

12,000
56,000
(11,000)
2,500
1,800
(20,000)
(41,300)
49,700
2,600
1,600
3,400
10,800
68,100

Less: Expenses
Insurance
Bad debts expense
Increase in PFDD
Depreciation
Carriage outwards
Salaries and wages
Interest expense
Rent expense
Utilities expense
Discount allowed
Net Profit

7,500
3,700
5,700
4,500
2,450
12,800
1,500
6,500
6,900
1,060

Excel Company
Statement of Owners Equity for the year ended 30 April 2012
Opening Capital
110,000
Add; New Capital
0
Add: Net Profit
15,390
Less: Drawings
(6,030)
Closing Capital

(52,610)
15,390

119,360

Excel Company
Balance Sheet as at 30 April 2012
$
Current Assets
Stock
Trade receivable/Accounts receivable
Less: Allowance for doubtful debts
Prepaid expense
Accrued revenue
Cash

20,000
45,000
(11,500)

Fixed Assets
Premises
Less: Accumulated depreciation
Motor vehicle
Less: Accumulated depreciation
Plant and machinery
Less: Accumulated depreciation
Office Equipment
Less: Accumulated depreciation
Furniture and fittings
Less: Accumulated depreciation

100,000
(45,000)
55,000
(12,500)
60,000
(16,900)
29,000
(9,800)
23,000
(8,500)

Current Liabilities
Trade payables/Accounts payable
Accrued expense
Unearned revenue
Short term loan

33,500
6,890
5,670
13,600

79,660

55,000
42,500
43,100
19,200
14,500

37,000
8,700
10,500
8,400

Non Current Liabilities


Loan from OCBC /Mortgage loan

174,300
253,960

64,600

70,000

Owners Equity
Opening Capital
Add: Net Profit
Less: Drawings
Closing Capital

110,000
15,390
(6,030)
119,360
253,960

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Topic 1 Practice Qn 2
A Park
Balance Sheet as at 30 April 2012
Current assets
Cash in hand
Cash at Bank
Accounts receivable
Inventory

2,900
1,600
4,100
8,600

Fixed assets
Fixtures
Car
Total assets

9,600
12,300

Current liabilities
Accounts payable

17,200

21,900
39,100

7,400

Long term Liabilities


Owner's equity
Capital

31,700

Total liabilities & OE

39,100

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Practice Questions
Question 2
A. Park has the following items in her statement of financial position on 30 April
2012: Capital $31,700; Accounts payable $7,400; Fixtures $9,600; Car
$12,300; Inventory $8,600; Accounts receivable $4,100; Cash at bank
$1,600; Cash in hand $2,900.
Draw up A Parks statement of financial position as at 30 April 2012.
Question 3
During the first week of May 2012, Mary entered into the following transactions:
a.
b.
c.
d.

She bought a piece of furniture for $1,100 on credit.


One of the debtors paid her $450 by cheque.
She paid $60 for stationery expenses.
She put an extra $500 into the business in cash.

Show how the accounting equation is affected with the above transactions
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Review Chapter Round up , Quick Quiz and Answers to Quick Quiz

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