Chapter 1 Introduction to Accounting PDF

Introduction to Accounting  Effect of Income Statement Items on Profit and hence on Capital Every Credit item of Income Statement will increase the Profit and hence increase Capital because Profit and Capital are also of Credit Nature. Every Debit item of Income Statement will de...

Introduction to Accounting  Effect of Income Statement Items on Profit and hence on Capital Every Credit item of Income Statement will increase the Profit and hence increase Capital because Profit and Capital are also of Credit Nature. Every Debit item of Income Statement will decrease the Profit and hence decrease Capital because Profit and Capital are of Credit Nature then Debit item will decrease them. Sales Cr. Profit Capital Sales Dr. Profit Capital Purchase Return Cr. Profit Capital Purchase Return Dr. Profit Capital Other Income Cr. Profit Capital Other Income Dr. Profit Capital Sales Return Dr. Profit Capital Sales Return Cr. Profit Capital Purchase Dr. Profit Capital Purchase Cr. Profit Capital Expense Dr. Profit Capital Expense Cr. Profit Capital Drawings Dr. x Capital Drawings Cr. x Capital Question # 01: Debtor Office Creditor Acc. Mr. Ahmad has started a business on March 01, 2020. Following Date Cash Bank = Capital + transactions took place during the first month of operations. HK Furniture Asim Payable 01.03.20 = + Date Transaction Started in business with Rs. 600,000 in Cash & Rs. 01.03.20 = + 01.03.20 300,000 in cheque 03.03.20 = + 03.03.20 Bought goods on account from Asim Rs. 15,000. 04.03.20 = + 04.03.20 Cash Sales amounting Rs. 3,000 06.03.20 = + Took Rs. 30,000 of the cash and deposit it into the 06.03.20 08.03.20 = + bank. 08.03.20 Sold goods on credit to HK Rs. 20,000. 12.03.20 = + Return of goods amounting Rs. 4,000 which were sold 15.03.20 = + 12.03.20 on credit to HK 17.03.20 = + Goods amounting Rs. 1,000 purchased from Asim have 15.03.20 19.03.20 = + been returned. 17.03.20 Bought office furniture costing Rs. 20,000 on account. 24.03.20 = + 19.03.20 Cash purchases amounting to Rs. 5,000 26.03.20 = + 24.03.20 HK paid Rs. 2,000 Cash to the Business 27.03.20 = + 26.03.20 Mr. Owner draw Office Furniture 28.03.20 = + Took Rs. 10,000 out of the bank and put it in the cash 27.03.20 29.03.20 = + till. Paid Utility expenses amounting Rs. 4,000 through 31.03.20 = + 28.03.20 Cash = + Business paid Postage expense amounting Rs. 3,000 in 29.03.20 cheque 31.03.20 Business received Rs. 15,000 cash as an Other Income Required: Prepare Accounting equation  Mr. Iqbal Debtor Office Creditor Acc. Statement of Financial Position Date Cash Bank = Capital + HK Furniture Asim Payable As at 31.03.20 01.03.20 = + Rs. Assets 01.03.20 = + Non-Current assets 03.03.20 = + Office Furniture 04.03.20 = + 06.03.20 = + Current assets 08.03.20 = + Trade & Other Receivables Cash & Bank 12.03.20 = + Total Current assets 15.03.20 = + Total Assets 17.03.20 = + Equity & Liabilities 19.03.20 = + Closing Capital Non-Current Liabilities 24.03.20 = + Long-term Loan 26.03.20 = + Current Liabilities 27.03.20 = + Trade and Other Payables 28.03.20 = + Creditor Asim 29.03.20 = + Account Payable Total Current Liabilities 31.03.20 = + Total Equity and Liabilities = + 13. Mr. Ahmad starts a business with Rs. 80,000 Cash, buying inventory amounting Rs. 20,000 from Cash and paying business expenses of Rs. 2,000. Inventory is purchased on credit for Rs. 5,000. Rendered services for Rs. 3,000 and amount will be received next month. Following these transactions, What are the Assets of Ahmad’s business? (a) Rs. 81,000 (b) Rs. 86,000 (c) Rs. 5,000 (d) Rs. 83,000 Assets = Capital + Liability Account Description Cash Inventory Capital Creditor Receivable Starts Business 80,000 80,000 Inventory on Cash (20,000) 20,000 Paying Expense (2,000) (2,000) Inventory on credit 5,000 5,000 Rendered Services 3,000 3,000 Total 58,000 25,000 3,000 81,000 5,000  Chapter # 01 Accounting Fundamentals  Theory Introduction to accounting Book-keeping Accounting Interconnected but different terms Narrow term Broader term Recording financial Recording, classifying, transactions in books summarizing and then of accounts and interpreting the maintaining Ledgers results thereof Maintaining Recording accounting records & Financial accounting Cost and management information mainly then reporting and reporting accounting for planning, control Financial statements and decision making 1) Which of the following statements are true? (I) Accounting can be described as the recording and summarizing of transactions (II) Financial accounting describes the production of a statement of financial position and Statement of Profit or Loss for internal use (a) 1 only (b) 2 only (c) 1 and 2 both (d) Neither 1 nor 2 3) The main aim of financial accounting is to: (a) Record all transactions in the books of account. (b) Provide management with detailed analyses of costs. (c) Present the financial results of an organization by mean of financial statements. (d) Calculate profit.  Transactions Financial Transactions Any transaction which Business Transactions has monetary impact Any transaction involving two parties that reciprocally affect each other Simple One-off Capital transactions transactions transactions Complex Ongoing Revenue transactions transactions transactions Buying and Occur at single Purchasing items of selling of occasion, Capital Long-term nature items on Cash Purchasing such as Fixed assets Payment on Daily, regular Purchasing items of installments, basis business Short-term nature Various parties transactions in normal cases 02. Which of the following is a business transaction? (I) Bank set the limit of overdraft of Rs 10 million (II) Interest charged by bank on overdraft a) Only Statement I is correct b) Only Statement II correct c) Both are correct d) None is correct 03. Which TWO of the following are business transactions? a) A businessman purchased a vehicle for his private use; however, he also uses it for coming to the office. b) Furniture & fixtures lying in the office were destroyed by fire. Furniture was owned by one of the partner and it was not in the use of business. c) Electricity bill of one of firm's partners was paid from business cash. d) The proprietor provides a generator to the office. The generator is presently not working and it would have to be repaired before it can be used. 04. Which of these TWO transactions would cause immediate change in equity: a) Delivery truck bought on credit b) Borrowing from bank @ 12% c) Repayment of loan from personal cash to save interest expense d) Written down of inventory to its NRV.  Expenditure Revenue Capital expenditure expenditure Any expenditure made Any expenditure made to for day-to-day expenses acquire Fixed asset Always expensed out/Less from G.P Acquire/Improve Long-term asset Except When Revenue expenditure incurred & results in; The term ‘capitalisation’ means ➔ Asset’s life increases recognising a cost as an asset or part of ➔ Asset’s capacity increases the cost of an expenditure as an asset. ➔ Quality of output from Asset has improved So, when an item of cost is ‘capitalised’ ➔ Asset’s part replaced it is treated as an asset rather than as ➔ Asset’s production time decreases an ‘expense.’ It will be capitalised and considered as asset Capital expenditure and Revenue expenditure Capital expenditure is expenditure made to acquire or improve long term assets that are used by the business. Revenue expenditure is expenditure on day-to-day operating expenses. The term ‘capitalisation’ means recognising a cost as an asset or part of the cost of an expenditure as an asset. So, when an item of cost is ‘capitalised’ it is treated as an asset rather than as an ‘expense.’ Conditions to be met for an expense to be a capital expenditure: If business incurred an expense and result is in following styles then it will be a capital expenditure and considered as an asset: → Asset’s life increases → Asset’s capacity increases → Quality of output from Asset has improved → Asset’s part replaced → Asset’s production time decreases Determination of Cost of an asset: Purchase price Less Trade discounts Less cash discounts Less Rebate/subsidy (Govt. assistance) Add carriage inward Add freight Add octroi charges Add assembling cost Add insurance in transit Add clearing agent charges Test cost Non-refundable taxes Replacement of part Site preparation cost Dismantling cost Modification cost any costs directly attributable to bringing the asset to the location and condition necessary. Examples of directly attributable costs are: o wages for the construction or acquisition; o costs of site preparation including material and labour costs; o initial delivery and handling costs (i.e. loading, unloading, carriage, freight); o installation and assembly costs; o costs of testing whether the asset is functioning properly; and o professional fees such as architect and surveyor fee. Operating expenses-not treated as cost but expensed out: (Page # 10) General overheads Apportioned overheads Staff training cost Repair cost Maintenance cost Overhauling cost Warranty cost Administrative costs Costs relating to errors or wastage Example # 01: An entity purchased some heavy machinery. The invoice for the machinery showed the following items: Rs. in “000” Cost of machinery 46,000 Cost of delivery 900 Cost of 12-month warranty on the machinery 1,600 Total amount payable 48,500 In addition, the entity incurred Rs.3.4 million in making modifications to its factory so that the heavy machinery could be installed. Required: What should be the cost of the machinery in the entity’s machinery account? Example # 02: A business acquired new premises at a cost of Rs. 400 million on 1 January 2015. In the period to the year end of 31 March 2015 the following further costs were incurred. Rs. in “000” Costs of initial adaptation of the building 12,000 Legal costs relating to the purchase 2,500 Monthly cleaning contract 3,400 Cost of air conditioning unit necessary for machinery to be used 2,800 Cost of machinery 12,300 Required: What amount should appear as the cost of premises in the entity’s statement of financial position as on 31 March 2015? 05. Which of the following are examples of capital expenditure? (i) Purchase of a new company car for a member of staff (ii) Purchase of a second-hand company car for a member of staff (iii) Repairs to company cars (iv) Cost of insuring company cars (a) (i) only (b) (i) and (ii) (c) (i), (ii) and (iv) (d) All four Answer: Purchase of new car is capital expenditure and second hand car is a new car for business too. So, both are Capital expenditure. 06) Which of the following will capitalize the cost of vehicle? a) Engine Repair b) Filling of petrol c) Replacement of tyres d) Replacement of engine oil  Accounting Concepts used Business-entity Prudence Matching Concept Concept Principal Going Concern Accrual Materiality Concept Concept Concept Business entity Don’t Overstate Expense related to is separate Income & Assets earn the revenue of from owners Don’t Understate an Year should be Expenses & Liabilities recorded in that Year Owner changes Report Incurred expense & Always Capitalise It’s Valid in case of; but business Income in Financial the material items Sole traders continues statements instead of paid Don’t consider Partnership; & always; Business & Received amount immaterial items Companies is Perpetual as asset Entity have a control to use Present Obligation of Residual Interest in assets Decrease in assets, Increase in while can restrict others an entity as a result of after deducting Liabilities Liability (Dividend is not expense) past events Equity = Assets – Liabilities Increase in assets, decrease in Liability Present economic resource (Capital is not Income) Liability Equity Expense controlled by an entity Reports of an Assets Financial Statements Income entity given to stakeholders for decision making needs Statement of Financial position/ A complete set of financial statements Statement of Comprehensive Balance sheet usually comprises: Income/Trading & Profit & Loss a/c A statement of financial position (SOFP); Reports the Financial Position A statement of comprehensive income Reports the Financial Performance as on particular date (SOCI); For the particular period A statement of changes in equity (SOCE) Assets = Capital + Liabilities A statement of cash flows (SOCF); Revenue – expenses = Profit Notes to the financial statements Last three are Not examinable  Assets An asset is defined as: a present economic resource controlled by the entity as a result of past events. The definition clarifies that the potential economic benefits no longer need to be ‘expected’ to flow to the entity and they do not need to be certain or even likely. An economic resource is a right that has the potential to produce economic benefits. In simple words, an asset is something the business owns or controls and is available or will be available for use in the business. The assets are classified into current assets and non-current assets: Current assets: assets that provide economic benefits in the short term (usually one year). For example, cash and trade receivables. Non-current assets: assets that have a long useful life and provide future economic benefits for an entity over a period of several years. For example, buildings and plant & machinery.  Liability A liability is: a present obligation of the entity to transfer an economic resource as a result of past events. The definition clarifies that a liability is the obligation to transfer an economic resource and not the ultimate outflow of economic benefits. The outflow also no longer needs to be ‘expected’. In simple words, a liability is something owed by the business to someone else. The liabilities are classified into current and non-current, as well: Current liabilities: amounts payable by the entity within 12 months. For example, trade payables and utilities bills payable. Non-current liabilities: amounts payable more than 12 months after the reporting date. For example, long term bank loan.  Equity (owner’s capital) Equity is the residual interest in the assets of the entity after deducting all its liabilities. Equity claims are claims against the entity that do not meet the definition of a liability i.e. the entity has no obligation to pay or distribute its profits to its shareholders but most of the profitable companies distribute it as to gain the investor confidence. Equity is often referred as owner’s capital in sole trader businesses. Income and investing further capital increases the equity while expenses and drawings decrease the equity. Equity is sometimes referred to as the ‘net assets’ of the business. This is represented by accounting equation i.e. Equity (net assets) = Assets – Liabilities  Income Income arise from: increase in assets or decrease in a liability, resulting in increase in equity other than contribution from owners (more capital invested in the business). Income is usually classified into revenue and other items of income: Revenue: it is income arising in the course of the ordinary activities of the entity. For example, revenue from sale of goods and fee for providing services. Other income: Income arising other than in the course of ordinary activities. For example, interest received on bank deposits and gain from disposal of non-current assets.  Expenses Expenses arise from: decrease in assets or increase in liability, resulting in decrease in equity other than distributions (drawings or dividends) to owners. Expenses arise in the normal course of activities, such as the cost of goods sold, salaries, rent and other operational costs. Expenses also include losses such as the loss on disposal of a non-current asset, and losses arising from damage caused by fire or flooding. 08. In which of the following case both transactions would decrease owner’s equity? a) Purchase of an asset on credit Payment of liabilities b) Purchase of assets Payment of expenses c) Distribution of assets to owner Payment of expenses d) Payment of liabilities Sale of goods 09. Which TWO of the following will have effect on assets and liabilities? a) Purchase of asset on credit b) Payment of loan in cash c) Credit sale of inventory d) Receipt from customers 10. Which TWO of the following will have effect on assets and liabilities at the same time? a) Purchase of office furniture on credit b) Repayment of principal amount of loan. c) Credit sale of inventory d) Receipt of cash from customers 11. Which one of the following statements are correct? (I) All revenues are income but all incomes are not revenue (II) Distribution of profit is also expense as it decreases the asset of business. a) Only Statement I is correct b) Only Statement II correct c) Both are correct d) None is correct  Listed companies are even required to Financial Reporting make their financial statements available on their websites. Responsibility Regulation Sole trader & Sole trader & Companies Companies partnership businesses partnership businesses no obligation to Companies must The financial Statements are prepare financial prepare financial statements are filed with a govt. statements, other statements for private and do not agency, where than for; Responsibility shareholders and have to be Source they can be Tax purposes for filing with disclosed, except accessed and read Obtaining loan relevant to the tax by any member of from bank regulatory bodies authorities. the general public. owner/partners Directors are Accepted acc. GAAPs are responsible responsible principles Company Law  GAAPs The concepts, principles, conventions, laws, rules and regulations that are used to prepare and present financial statements are known as Generally Accepted Accounting Principles (GAAPs). GAAP AND IFRS The main sources of GAAPs in Pakistani jurisdiction are: Companies Act, 2017; and International Financial Reporting Standards (IFRSs) Many countries and companies whose shares are traded on the world’s stock markets have adopted IFRSs issued by the International Accounting Standards Board (IASB).  Financial Reporting Objective provide financial information about the reporting entity to Investors Suppliers The Public Customers Need Lenders Government Employees Managers to assess the number of interested in the Financial to assess how much credit people they financial strength statements are whether to buy, drafted to provide they might employ if they rely for the hold or sell information that safely allow to their patronage long-term supply investment should be useful the entity of local suppliers of key goods to most users to assess for the purpose of financial stability responsible for the continuing the continuing and profitability of producing the ability of the business their employer financial borrower to regulation to pay higher wages, statements and pay interest Deciding the or provide more job interested in the ability to repay taxation opportunities in the information they the loan policies future. contain.