Lecture 2

FUNDAMENTALS OF ACCOUNTING
 AGENDA

1. Accounting Equations and Elements

2. Financial Statements

3. Basic for Transaction Analysis

 1. Accounting Equation &
Elements

Assets = Liabilities + Equity

Liabilities
Assets Equity
 1. Accounting Equation &
Elements
Cash
Accounts Notes
Receivable Receivable
ASSETS
Resources
Vehicles owned by a Land
company

Store Buildings
Supplies
Equipment
 1. Accounting Equation &
Elements
Does the resource provide a right for the potential to receive economic benefits? No

Yes

Is this right also available to other parties at no great cost? Yes

No

Can the business exert control over the resource as a result of a past No
transaction or event?

Yes

Can the resource be faithfully represented in monetary terms? No

Yes

NOT
Accounting asset an accounting asset
 1. Accounting Equation &
Elements
The classification of ASSETS
may vary according to the
nature of the business

Current assets

Non-current assets
 1. Accounting Equation &
Elements
Current Assets

Held for sale or consumption during the business’s

normal operating cycle

Expected to be sold within the next year

Held principally for trading

Cash or near cash

 1. Accounting Equation &
Elements
Current Assets

Inventories

Cash Trade
receivables
 1. Accounting Equation &
Elements
Non-current Assets

Do not meet the definition of current assets

 1. Accounting Equation &
Elements

Accounts Notes
Payable Payable

LIABILITIES
Creditors’ claims
on assets

Taxes Wages
Payable Payable
 1. Accounting Equation &
Elements

The classification of LIABILITIES

Current liabilities

Non-current liabilities
 1. Accounting Equation &
Elements
Current Liabilities

Expected to be settled within the business’s normal operating cycle

Held principally for trading purposes

Due to be settled within a year after the statement of financial

position date

No right to defer settlement beyond a year after the statement of

financial position date
 1. Accounting Equation &
Elements
Non-current Liabilities

Do not meet the definition of current liabilities

 1. Accounting Equation &
Elements

Owner Owner
Investments Withdrawals

EQUITY
Owners’ claims
on assets

Revenues Expenses
 1. Accounting Equation &
Elements

Assets = Liabilities + Equity

_ Owner _
Owner Capital
Withdrawals + Revenues Expenses

Owner's Equity
 2. Financial Statements

Statement of financial position

Balance Sheet

Income statement

Statement of cash flow

 2. Financial Statements

Relationship between major financial statements

 2. Financial Statements
The uses of Balance Sheet

Shows how the business is financed and how funds

are deployed

Can provide a basis for assessing the value of the business

Relationships between assets and claims can be assessed

Performance can be better assessed

 2. Financial Statements
ABC Balance Sheet as at Dec 31 2021
£000 £000
ASSETS LIABILITIES AND EQUITY
Current assets Liabilities
Inventories 23 Current Liabilities
Trade Receivables 18 Trade Payables 37
Cash at bank 12 Non-current Liabilities
53 Long-term borrowings 50
Non-current assets Equity
Property 45 Owners Investment 60
Plant and equipment 30
Motor vans 19
94
Total Assets 147 Total Liabilities and Equity 147
 2. Financial Statements
Income Statement
One of the major financial statements used by accountants and
business owners

Showing the profits and losses of a company over a period of time,

typically a month, quarter, or year following the company’s operations

Showing a company’s ability to generate sales, manage expenses,

and create profits

A predecessor to the other two core statements

 2. Financial Statements

Income Statement uses for measuring profit

Profit
Total revenue for the period
(or loss)
for the
= −
period Total expenses incurred in generating that revenue
 Income Statement

 Main Items:

– Revenues and Gains

 Revenues from operating activities

 Revenues or income from non-operating activities

 Gains (e.g., gain on the sale of long-term assets, gain on lawsuits)

– Expenses and Losses

 Expenses involved in operating activities

 Expenses from non-operating activities

 Losses (e.g., loss on the sale of long-term assets, loss on lawsuits)

– If the net amount of revenues and gains minus expenses and losses is positive, the bottom line of the profit
and loss statement is labeled as net income. If the net amount (or bottom line) is negative, there is a net loss
 2. Financial Statements

Relationship between the income statement and the balance sheet

+
Assets = Equity Profit (Loss) + Liabilities
(−)

Sales
Assets = Equity + revenue − Expenses
+ Liabilities
 2. Financial Statements
£
Sales revenue 232,000
Cost of sales (154,000)
Gross profit 78,000
Salaries and wages (24,500)
Rent and rates (14,200)
XYZ Heat and light (7,500)
Income statement for the Telephone and postage (1,200)
year ended Dec 31 2021 Insurance (1,000)
Motor vehicle running expenses (3,400)
Depreciation – fixtures and fittings (1,000)
Depreciation – motor van (600)
Operating profit 24,600
Interest received from investments 2,000
Interest on borrowings (1,100)
Profit for the year 25,500
 2. Financial Statements
Cash flows Statement

Cash and cash

Operating activities Investing activities
equivalent
balances

Financing activities
 2. Financial Statements
The relationship between the statement of financial position,
the income statement and the statement of cash flows
 2. Financial Statements
KLS plc
Statement of cash flows
for the year ended Dec 31 2021
£000
Cash generated from operations 2,558
Interest paid (522)
Corporation tax paid (47)
Net cash generated from operating activities 1,989
Net cash generated from investing activities 279
Net cash used in financing activities (1,387)
Net increase in cash and cash equivalents 881
 3. Transaction Analysis

The accounting equation MUST remain in

balance after each transaction.

Assets = Liabilities + Equity

 3. Transaction Analysis

The accounting equation MUST remain in

balance after each transaction.

Assets = Liabilities + Equity

 3. Transaction Analysis

1. Identify what accounts involve in the transaction

2. Categorise what type of these accounts

3. Define increase and decrease of these accounts

 3. Transaction Analysis

(1) Smith invests £30,000 cash to start a consulting business.

The accounts involved are:

Cash (asset)

Owner Capital (equity)

 3. Transaction Analysis

(1) Smith invests £30,000 cash to start a consulting business

Assets = Liabilities + Equity

Accounts
Cash Supplies Equipment Payable Notes Payable Smith Capital
(1) £ 30,000 £ 30,000

£ 30,000 £ - £ - £ - £ - £ 30,000

£ 30,000 = £ 30,000
 3. Transaction Analysis

(2) Purchased supplies paying £2,500 cash

The accounts involved are:

Cash (asset)

Supplies (asset)
 3. Transaction Analysis

(2) Purchased supplies paying £2,500 cash

Assets = Liabilities + Equity

Accounts
Cash Supplies Equipment Payable Notes Payable Smith Capital
(1) £ 30,000 £ 30,000
(2) (2,500) £ 2,500

£ 27,500 £ 2,500 £ - £ - £ - £ 30,000

£ 30,000 = £ 30,000
 3. Transaction Analysis

(3) Purchased equipment for £26,000 cash

The accounts involved are:

Cash (asset)

Equipment (asset)
 3. Transaction Analysis

(3) Purchased equipment for £26,000 cash

Assets = Liabilities + Equity

Accounts
Cash Supplies Equipment Payable Notes Payable Smith Capital
(1) £ 30,000 £ 30,000
(2) (2,500) £ 2,500
(3) (26,000) £ 26,000

£ 1,500 £ 2,500 £ 26,000 £ - £ - £ 30,000

£30,000 = £30,000
 3. Transaction Analysis

(4) Purchased Supplies of £7,100 on credit

The accounts involved are:

Supplies (asset)
Accounts Payable (liability)
 3. Transaction Analysis

(4) Purchased Supplies of £7,100 on credit

Assets = Liabilities + Equity

Accounts
Cash Supplies Equipment Payable Notes Payable Smith Capital
(1) £ 30,000 £ 30,000
(2) (2,500) £ 2,500
(3) (26,000) £ 26,000
(4) 7,100 £ 7,100

£ 1,500 £ 9,600 £ 26,000 £ 7,100 £ - £ 30,000

£ 37,100 = £ 37,100
 3. Transaction Analysis

(5) Provided consulting services receiving £4,200 cash

The accounts involved are:

Cash (asset)

Revenues (equity)
 3. Transaction Analysis

(5) Provided consulting services receiving $4,200 cash

Assets = Liabilities + Equity

Accounts
Cash Supplies Equipment Payable Notes Payable Smith Capital Revenue
(1) £ 30,000 £ 30,000
(2) (2,500) £ 2,500
(3) (26,000) £ 26,000
(4) 7,100 £ 7,100
(5) 4,200 £ 4,200
£ 5,700 £ 9,600 £ 26,000 £ 7,100 £ - £ 30,000 £ 4,200

£ 41,300 = £ 41,300
 3. Transaction Analysis

Examples