Business Accounting Lecture 2 PDF

BUSFF026 Business Accounting Lecture 2 Accounting Equation & Transaction Analysis 1  Outline 2.1 The accounting equation 2.1.1 Assets 2.1.2 Liabilities 2.1.3 Equity or capital 2.2 Transaction analysis...

BUSFF026 Business Accounting Lecture 2 Accounting Equation & Transaction Analysis 1  Outline 2.1 The accounting equation 2.1.1 Assets 2.1.2 Liabilities 2.1.3 Equity or capital 2.2 Transaction analysis 2  Learning Objectives After studying this topic, you should be able to:  Explain the accounting equation  Define assets, liabilities and capital  Describe the effect of profit or loss and drawings on capital  Describe how transactions affect the items in the accounting equation 3  The accounting equation Assets = Liabilities + Equity/Capital What it owns/ What it owes control Resources: Resources: What they are Who supplied them  The two sides of the equation will have the same totals 2.1 4  Resources in the Resources supplied by business the owner Assets = Capital But if someone else has provided some of the assets: Assets − Liabilities = Capital 5  Assets  An asset is a present economic resource controlled by the entity as a result of past events  An economic resource is a right that has the potential to produce economic benefits Produce cash inflows Avoid cash outflows Receive cash by selling it 2.1.1 6  Classification of assets Current assets Non-current assets Inventory (stock) Land and buildings Trade receivables Fixtures and fittings (debtors) Machinery Cash at bank Motor vehicles Cash in hand Brand name Prepaid expenses Copyright To change For long term ≤ a year use in business 7  Liabilities  A liability is a present obligation of the entity to transfer an economic resource as a result of past events  Amount owed by the business for assets supplied to a business or expenses incurred not yet paid To pay cash To deliver goods To provide services 2.1.2 8  Classification of liabilities Current liabilities Non-current liabilities Trade payables Bank loan (creditors) Mortgage Rent payable Bond/debenture Salaries payable Lease Bank overdraft Hire purchase Unearned revenue Pension benefit obligations To be settled To be settled ≤ a year > a year 9  Equity  Equity is the residual interest in the assets of the entity after deducting all its liabilities Equity = Assets - Liabilities  Is often called the net assets or net worth  Equity of a sole proprietorship or partnership is called capital  Equity of a company usually consists of share capital, retained earnings and other reserves 2.1.3 10  Capital  Total of resources invested and left in a business by its owner Capital = Assets - Liabilities  Is often called the owner’s equity  Increased by: Owner’s investment Income Profit  Decreased by: or Owner’s drawings Expenses Loss 11  Income  Revenue & gains  Not contributed by owner Sales revenue Interest Rent revenue revenue Gain on Gain on disposal of disposal of shares properties 12  Expenses  Cost of assets and services that were used up in obtaining the income  Losses  Not distribution to owner Salaries / Wages Interest Rent Insurance Audit fees Training Maintenance Printing & stationery Loss on disposal of motor vehicles 13  Profit or loss When income > expenses Profit Effect on capital? When expenses > income Loss Effect on capital? 14  Drawings  Amounts withdrawn from the business by the owner for private use  Drawings of money – reduce cash or bank  Drawings of goods – reduce purchases or inventory  Normal practice: To have a separate drawings account & deduct the total of the drawings account from capital at the end of each period 15  The basic accounting equation: Assets = Liabilities + Capital The expanded accounting equation: Assets = Liabilities + Owner’s _ Owner’s _ Expenses Drawings + Income Investment Profit/(loss) Statement of profit or loss Statement of financial position 16 Exercise 1: Presented below is the basic accounting equation. Determine the missing amounts. Assets = Liabilities + Capital (a) £80,000 £50,000 ________ (b) ________ £43,000 £90,000 (c) £96,000 ________ £60,000 17 Exercise 2: Moodle Classify the following items into assets (A) and liabilities (L): (a) Loan to Eric (b) Loan from Jenny (c) Equipment (d) Bank overdraft (e) Inventory (f) Computers (g) Buildings (h) Trade payables (i) Trade receivables (j) Cash in hand 18 Exercise 2 (cont’d): (k) Mortgage on office building (l) Warehouse (m) Van (n) Office supplies (o) Lorries (p) Taxes payable (q) Cash at bank (r) Fixtures and fittings (s) Loan from bank (t) Rent payable (u) Short-term investment (v) Wages payable 19 Exercise 3: Moodle If we supplied goods and services valued for sale at £100,000 to customers, and the expenses incurred by us in order to supply those goods and services amounted to £60,000, the result would be a profit of £________. 20 Exercise 4: Moodle Basil Yamey is setting up a new business. Before selling anything, he bought a van for £9,000; a transportable market stall for £1,800; a computer for £280; and an inventory of goods for £11,200. He did not pay in full for his inventory of goods and still owes £5,000 for them. He borrowed £8,000 from Luca Pacioli. After the events just described, and before trading starts, he has £900 cash in hand and £6,300 in the bank. Calculate the amount of his capital. 21  Transaction analysis Assets = Liabilities + Capital  Every transaction affects at least two items in the accounting equation  Sometimes it changes two assets by reducing one and increasing the other  The two sides of the equation must always be equal 2.2 22  Examples of transaction (1) Owner pays capital into the bank (2) Buy inventory by cheque (cash basis) (3) Buy inventory on time (credit basis) (4) Sell inventory on time (credit basis) (5) Receive cheque for selling inventory (cash basis) (6) Pay creditor by cheque (7) Receive cheque from debtor (8) Owner takes money out of the business bank account for own use (drawings) (9) Owner pays creditor from private money outside the firm 23  Effect upon Assets Liabilities Capital 1 (Bank) 2 (Bank) (Inventory) 3 (Inventory) (Trade payables) 4 (Inventory) (Trade receivables) 5 (Inventory) (Bank) 6 (Bank) (Trade payables) 7 (Bank) (Trade receivables) 8 (Bank) 9 (Trade payables) 24 Exercise 5: Describe how the following transactions affect the items in the accounting equation: (a) We pay a creditor £310 by cheque. (b) Bought fixtures £175 paying in cash. (c) Bought goods on time £630. (d) The proprietor introduces another £1,200 cash into the business. 25 Exercise 5 (cont’d): (e) J. Walker lends the business £2,500 in cash. (f) A debtor pays us £50 in cash. (g) We return goods costing £90 to a supplier whose bill we had not paid. (h) Bought an office computer paying £610 by cheque. 26 Exercise 5 answer: Assets Liabilities Capital a b c d e f g h 27  Readings Frank Wood’s Business Accounting, Alan Sangster & Lewis Gordon, 15th ed.  Chapter 1: The background and the main features of financial accounting  Chapter 4: The effect of profit or loss on capital and the double entry system for expenses and revenues  Chapter 8: Balance sheets The IASB Conceptual Framework for Financial Reporting 28