topic1 introduction to fa (dms)
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SIMGE-DMS Financial accountingTRANSCRIPT
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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.
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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
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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 owner’s 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 Expenses Expenses Expenses
Fees revenue Salaries exp Sundry exp Discount allowed
Sales revenue Rental exp Staff welfare exp
Interest earned Utilities exp Interest exp
Rent earned Advertising
exp
Bad debts exp
Commission
received
Insurance exp Repairs and
maintenance exp
Discount received Carriage
outwards exp
Entertainment exp
Carriage
inwards
Office supplies exp
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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 Current Assets
Land and building (Premises) Cash
Motor vehicle Stock/ Inventory
Office equipment Debtors/ Accounts receivable/ credit
customers
Furniture and fittings Prepaid expense
Plant and machinery Accrued revenue
Notes receivable
Liabilities: Resources owing by the business or Resources contributed by non-owners such
as bankers and credit suppliers.
Current Liabilities Non-current liabilities
Creditors/ Accounts payable/ credit
suppliers
Bank loan
Bank overdraft Mortgage loan
Short term loan Debenture bonds/Bonds payable
Unearned revenue Notes payable
Accrued expense/Expense due/
Expense owing/ expense outstanding
Notes payable
Capital/ Owner’s equity: Resources contributed by the owner into the business.
Drawings: Resources taken out by owner from business for personal use
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Recording business transactions using Accounting Equation
A business transaction is an economic event or condition that directly changes an entity’s
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 + Owner’s Equity
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Financial Statements
Statement of Comprehensive Income/ Income Statement: Shows the financial performance of a
business. Based on matching concept.
Statement of Owner’s 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 = Liabilities + Capital + Revenues - Expenses
Assets = Liabilities + Capital + Net Profit
Assets = Liabilities + Capital - Net Loss
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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 91,000
Less: Cost of Goods Sold
Opening Stock 12,000
Purchases 56,000
Less: Return outwards (11,000)
Carriage inwards
Customs duties
2,500
1,800
Less: Closing Stock (20,000)
Cost of Goods Sold (41,300)
Gross Profit 49,700
Add: Commission received 2,600
Discount received
Interest received
Rent received
Less: Expenses
1,600
3,400
10,800
68,100
Insurance 7,500
Bad debts expense 3,700
Increase in PFDD 5,700
Depreciation 4,500
Carriage outwards 2,450
Salaries and wages 12,800
Interest expense 1,500
Rent expense 6,500
Utilities expense 6,900
Discount allowed 1,060 (52,610)
Net Profit 15,390
Excel Company Statement of Owner’s 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 119,360
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Excel Company
Balance Sheet as at 30 April 2012
$ $ $
Current Assets
Stock 20,000
Trade receivable/Accounts receivable 45,000
Less: Allowance for doubtful debts (11,500) 33,500
Prepaid expense 6,890
Accrued revenue 5,670
Cash 13,600 79,660
Fixed Assets
Premises 100,000
Less: Accumulated depreciation (45,000) 55,000
Motor vehicle 55,000
Less: Accumulated depreciation (12,500) 42,500
Plant and machinery 60,000
Less: Accumulated depreciation (16,900) 43,100
Office Equipment 29,000
Less: Accumulated depreciation (9,800) 19,200
Furniture and fittings 23,000
Less: Accumulated depreciation (8,500) 14,500 174,300
253,960
Current Liabilities
Trade payables/Accounts payable
Accrued expense
Unearned revenue
Short term loan
Non Current Liabilities
Loan from OCBC /Mortgage loan
Owner’s Equity
37,000
8,700
10,500
8,400
64,600
70,000
Opening Capital 110,000
Add: Net Profit 15,390
Less: Drawings (6,030)
Closing Capital 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 2,900
Cash at Bank 1,600
Accounts receivable 4,100
Inventory 8,600 17,200
Fixed assets
Fixtures 9,600
Car 12,300 21,900
Total assets 39,100
Current liabilities
Accounts payable 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 Park’s 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. She bought a piece of furniture for $1,100 on credit.
b. One of the debtors paid her $450 by cheque.
c. She paid $60 for stationery expenses.
d. She put an extra $500 into the business in cash.
Show how the accounting equation is affected with the above transactions
Review Chapter Round up , Quick Quiz and Answers to Quick Quiz