Accounting Fundamentals PDF

CHAPTER 1 ACCOUNTING FUNDAMENTALS AT A GLANCE In this Chapter: Book-keeping and accounting are two different but inter-...

CHAPTER 1 ACCOUNTING FUNDAMENTALS AT A GLANCE In this Chapter: Book-keeping and accounting are two different but inter- connected functions which are integral part of business AT A GLANCE reporting. Book-keeping is concerned with only recording AT A GLANCE financial transactions of the business whereas Accounting is a SPOTLIGHT broader term that includes summarising, analysing and reporting these transactions in the financial statements. 1. Book-keeping and Accounting A business transaction is an economic event, involving a 2. Business Transactions business entity and other parties, and must be recorded by an accounting system. One important classification of business 3. Financial Statements transactions is capital vs revenue transactions which differentiate long term impacts from short term impacts of 4. Financial Reporting transactions, respectively. Financial statements are the concise reports based on financial 5. Double entry Book-keeping transactions over an accounting period of an entity which SPOTLIGHT reflect its financial performance and financial position. 6. Comprehensive Examples Statement of financial position has three elements namely assets, liabilities and equity. Statement of comprehensive 7. Objective Based Q&A income is made up from two elements i.e. income and expenses. STICKY NOTES The main objective of financial statements is to provide investors, lenders, creditors and other users with relevant and reliable information to help them make decisions regarding the business entity. The preparation and presentation of financial statements is regulated by Generally Accepted Accounting Principles which, in Pakistan, are mainly Companies Act, 2017 and International Financial Reporting Standards. STICKY NOTES Every business transaction has dual aspect and these aspects are recorded as debit and credit. The double entry book- keeping makes it possible to process large volume of transactions and maintains the accounting equation. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 1  CHAPTER 1: ACCOUNTING FUNDAMENTALS PRC 4: INTRODUCTION TO ACCOUNTING 1. BOOK-KEEPING AND ACCOUNTING BOOK-KEEPING Book-keeping is the process of recording financial transactions in the accounting records (the ‘books’) of an entity. All transactions are analysed into different types and are then recorded in a series of individual records called accounts. There is a separate account for each different type of transaction, or that is to say, for each type of asset, liability, income, expense and owners’ capital. Double entry book-keeping is used to record dual aspect of transactions in systems designed to allow the management of the business to monitor its progress and produce periodic financial statements and performance reports. AT A GLANCE ACCOUNTING Accounting is the process of recording, classifying, summarising the information of financial nature and interpreting the results thereof. There are two kinds of accounting: financial accounting and managerial accounting. Financial accounting (and reporting) is a term that describes:  maintaining a system of accounting records for business transactions and other items of financial nature; and  reporting the financial position and the financial performance (profit or loss) of an entity in a set of financial statements to the stakeholders. Cost and Management Accounting (covered at CAF Level) is the recording and communication of economic information to management for planning, control and decision making. SPOTLIGHT Accounting Cycle (or Accounting process)  Transactions: An event that has a monetary impact and needs to be recorded in books of accounts is called transaction. A business usually has thousands of transactions in an accounting period.  Books of prime entry: This is the first place where transactions are recorded according to the type of transactions.  Ledgers: Transactions (or transactions totals) are entered into the appropriate accounts in ledgers.  Trial balance: A list of balances can be extracted from the ledgers and this list is called trial balance.  Financial statements: The figures in trial balance are adjusted for period-end adjustments and financial statements are prepared. STICKY NOTES 2 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN PRC 4: INTRODUCTION TO ACCOUNTING CHAPTER 1: ACCOUNTING FUNDAMENTALS 2. BUSINESS TRANSACTIONS A transaction is an action or activity involving two parties or things that reciprocally affect or influence each other. A business transaction is an interaction between a business and customer, supplier or any other party with whom they do business. It is an economic event that must be recorded by the accounting system. Any transaction that has a monetary impact on the business’ accounts is a financial transaction. A financial transaction has an effect on the business’ assets and liabilities, etc. A business must record and account for all financial transactions. Few examples of financial business transactions are:  Cash sales of goods or services.  Credit sales of goods or services. AT A GLANCE  Receipt of cash from a customer to whom credit sales was made.  Cash purchase of raw materials or goods.  Credit purchase of raw materials or goods.  Payment of cash to a supplier from whom we had purchased on credit.  Receipt of loan proceeds.  Repayment of a loan.  Payments made to employees.  Payments made to the government (for example taxes).  Purchase of non-current assets.  Drawings (i.e. cash or goods taken by owner from the business) SPOTLIGHT CLASSIFICATION OF BUSINESS TRANSACTIONS The business transactions may be classified in following ways: Simple transactions and Complex transactions Transactions can be very simple like buying and selling items on cash. Transactions may also be complex involving long time and various parties, for example, selling an item through agent involving series of instalment payment including interest. One-off transactions and Ongoing transactions STICKY NOTES Transactions might occur on single occasion, for example, buying land and building for setting up a factory. Transactions may also occur on regular basis, for example, payment of monthly rent or electricity bill. Capital transactions and Revenue transactions Items of a long-term nature, such as property, plant and equipment used to carry out the operating activities of the business, are ‘capital items’. Items of a short-term nature, particularly items that are used or occur in the normal cycle of business operations, are ‘revenue items’. 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.’ THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 3  CHAPTER 1: ACCOUNTING FUNDAMENTALS PRC 4: INTRODUCTION TO ACCOUNTING Capital receipts and Revenue receipts Capital receipts are receipts of ‘long term’ nature, such as money from a bank loan, or new money invested by the business owner (which is called ‘capital’). Revenue income is income arising from the normal operations of a business from its investments, for example, revenue from sale of goods or interest received.  Example 01: Classify the following transactions as either ‘capital’ or ‘revenue’. Sr. # Transaction Capital /Revenue (i) Vehicle A engine is repaired Revenue expenditure (ii) Vehicle B engine is replaced Capital expenditure (iii) Loan borrowed from bank for five years Capital receipt AT A GLANCE (iv) Interest paid on loan Revenue expenditure (v) Cash received from customer Revenue receipt (vi) Cash paid to employees for their wages Revenue expenditure (vii) Wages paid by a building contractor to his own staff for Capital expenditure construction of an office room (viii) The purchase of machinery for use in the business Capital expenditure (ix) Carriage paid to bring the above-mentioned machinery to Capital expenditure the factory (x) Monthly electricity bill paid Revenue expenditure SPOTLIGHT (xi) The purchase of a soft drinks vending machine for the Capital expenditure canteen (xii) The stock of soft drinks purchased for resale, along with Revenue expenditure above-mentioned vending machine (xiii) Annual motor vehicle tax paid for existing car Revenue expenditure (xiv) Annual motor vehicle tax paid for new car Revenue expenditure (xv) Cost of alteration in office van to increase carrying capacity Capital expenditure (xvi) Small but expensive alterations to a manufacturing Capital expenditure machine which increased the output of that machine by 15% STICKY NOTES 4 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN PRC 4: INTRODUCTION TO ACCOUNTING CHAPTER 1: ACCOUNTING FUNDAMENTALS 3. FINANCIAL STATEMENTS Financial statements are reports of an entity to provide its stakeholders with necessary information for their decision making needs. The term entity is used to describe any type of organisation for which we do accounting e.g. a business, a company, a bank, a charity organisation. The business entity concept Financial reports are constructed as if the business entity is separate from its owners. In other words, the business entity and its owners are differentiated. This concept has legal substance in case of companies i.e. a company by law is a legal person separate from its owners (the shareholders). However, the concept is also applied to sole traders and partnership in accounting.  Example 02: AT A GLANCE Discuss whether you would consider the following events as business transactions. (i) A businessman purchased a vehicle for his private use by drawing cash from business. However, he also uses it for coming to the office. (ii) ABC & Company has paid the electricity bill of one of its partners. However, the amount is recoverable from that partner. (iii) Furniture and 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. (iv) 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. Previously the generator was lying in the proprietor’s house. SPOTLIGHT (v) Balance recoverable from an employee was written off after his death.  ANSWER: (i) Purchase of a vehicle is not a business transaction. However, the cash withdrawal is a business transaction. (ii) Payment on behalf of the partner is recoverable by the business. Hence this is a business transaction. (iii) It is not a business transaction as the ownership of furniture does not belong to the business entity but to one of the partners. (iv) It is a business transaction and it is required to be recorded as capital invested in business in the form of generator. STICKY NOTES (v) This is a business transaction as the employee was working for the business and such waiver is a form of benefit to the employee. Accounting period Financial statements relate to given period of time, known as the ‘financial year’, ‘accounting period’ or ‘reporting period’. COMPONENTS OF FINANCIAL STATEMENTS A complete set of financial statements usually comprises:  A statement of financial position;  A statement of comprehensive income;  A statement of changes in equity (not examinable at this level);  A statement of cash flows (not examinable at this level); and  Notes to the financial statements (not examinable at this level). THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 5  CHAPTER 1: ACCOUNTING FUNDAMENTALS PRC 4: INTRODUCTION TO ACCOUNTING Statement of financial position A statement of financial position (also called balance sheet) reports the financial position of an entity as at a particular date, usually the end of a financial year. The financial position of an entity is shown by its assets, liabilities and equity (owner’s capital). Statement of Comprehensive income This statement provides information about the performance of an entity in a period. It consists of two parts:  A statement of profit or loss – a list of income and expenses which result in a profit or loss for the period; and  a statement of other comprehensive income – a list of other gains and losses that have arisen in the period (not in syllabus). AT A GLANCE ELEMENTS OF FINANCIAL STATEMENTS The statement of financial position consists of three elements i.e. assets, liabilities and equity. These three elements form an accounting equation i.e. Assets = Liabilities + Equity The statement of comprehensive income consists of two elements i.e. income and expenses. The difference of these two elements determines the profit or loss for an accounting period. Assets An asset is defined as:  a present economic resource  controlled by the entity SPOTLIGHT  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. STICKY NOTES  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. Liabilities 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. 6 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN PRC 4: INTRODUCTION TO ACCOUNTING CHAPTER 1: ACCOUNTING FUNDAMENTALS 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.  Example 03: Identify the following items as either an asset or a liability. Sr.# Item Element (i) Loan to another business Asset (ii) Bank overdraft Liability AT A GLANCE (iii) Fixture and fittings Asset (iv) Computers Asset (v) We owe a supplier for inventory bought Liability (vi) Warehouse we own and control Asset (vii) Motor vehicles Asset (viii) Premises Asset (ix) Accounts receivables Asset (x) Inventory Asset (xi) Accounts payable for inventory Liability SPOTLIGHT (xii) Owing to bank Liability (xiii) Cash in hand Asset (xiv) Loan from a friend for business use Liability (xv) Machinery Asset  Example 04: Identify the following items as elements of financial statements and classify them as either current or non-current. Sr. # Item Element Classification STICKY NOTES (i) Land and buildings Asset Non-current asset (ii) Receivables (Trade debts) Asset Current asset (iii) Cash Asset Current asset (iv) Loan repayable in two years’ time Liability Non-current liability (v) Payables (Trade creditors) Liability Current liability (vi) Delivery trucks Asset Non-current asset THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 7  CHAPTER 1: ACCOUNTING FUNDAMENTALS PRC 4: INTRODUCTION TO ACCOUNTING 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  Example 05: Complete the gaps in following table using accounting equation. AT A GLANCE Assets Liabilities Owner’s Capital Sr. # Rs. Rs. Rs. (i) 60,000 15,000 ? (ii) 80,000 ? 56,000 (iii) ? 18,000 58,000 (iv) 120,000 27,000 ? (v) 150,000 ? 97,000 (vi) ? 36,000 95,000 SPOTLIGHT  ANSWER (i) Owner’s Capital = 60,000 – 15,000 = Rs. 45,000 (ii) Liabilities = 80,000 – 56,000 = Rs. 24,000 (iii) Assets = 18,000 + 58,000 = Rs. 76,000 (iv) Owner’s Capital = 120,000 – 27,000 = Rs. 93,000 (v) Liabilities = 150,000 – 97,000 = Rs. 53,000 (vi) Assets = 36,000 + 95,000 = Rs. 131,000 Income STICKY NOTES 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. 8 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN PRC 4: INTRODUCTION TO ACCOUNTING CHAPTER 1: ACCOUNTING FUNDAMENTALS 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. FORMAT OF FINANCIAL STATEMENTS Name of Entity Statement of Comprehensive Income for the year ended 30 June 2021 Rs’000 Revenue 950 Cost of Sales (750) AT A GLANCE Gross Profit 200 Other income: Gain on disposal 100 300 Operating expenses Salaries and wages (140) Repair and maintenance (60) Depreciation (20) Other expenses (10) SPOTLIGHT (230) Net profit 70 Name of Entity Statement of Financial Position as at 30 June 2021 Rs’000 Non-current assets Land and building 200 STICKY NOTES Plant and machinery/equipment 100 Furniture and fixture 50 Motor vehicles 50 400 Current assets Inventories 110 Trade Receivables 40 Cash and bank balances 50 200 600 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 9  CHAPTER 1: ACCOUNTING FUNDAMENTALS PRC 4: INTRODUCTION TO ACCOUNTING Capital Rs’000 Balance at beginning 100 Add: additional capital invested 50 Add: net profit 70 Less: drawings (20) 200 Non-current liabilities Bank loan 100 AT A GLANCE Loan from friend 100 200 Current liabilities Trade payables 100 Salaries payables 100 200 600 SPOTLIGHT Relationship between above financial statements  The statement of financial position shows the equity of a business at a point in time.  The statement of comprehensive income ends with a figure showing net profit for the period.  Profit belongs to the owner (or owners) of the business. It is, therefore, added to equity. ACCOUNTING TERMS Recognition This refers to putting an item into the bookkeeping system (performing double entry on it). STICKY NOTES Cost The amount of cash or cash equivalents paid, or the value of the other consideration given to acquire an asset at the time of its acquisition or construction. Gross amount This is presenting an asset, liability, income or expense without deducting any related amount. Illustration: Rs. ‘000 Sales 580,000 Trade receivables 63,000 10 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN PRC 4: INTRODUCTION TO ACCOUNTING CHAPTER 1: ACCOUNTING FUNDAMENTALS Net amount This refers to the result of adding a positive and negative number together. The result might be a net asset, net liability, net income or net expense. Illustration: Rs. ‘000 Sales 580,000 Less: Sales return (46,000) Less: Settlement discount allowed (3,000) Net sales 531,000 AT A GLANCE Trade debts 63,000 Less: Allowance for doubtful debts (3,500) Net trade debts 59,500 SPOTLIGHT STICKY NOTES THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 11  CHAPTER 1: ACCOUNTING FUNDAMENTALS PRC 4: INTRODUCTION TO ACCOUNTING 4. FINANCIAL REPORTING The objective of financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. The information explains the financial position of an entity at the end of a period (usually a year) and the financial performance of the entity over that period. RESPONSIBILITY FOR PREPARING FINANCIAL STATEMENTS Sole trader and partnership businesses There may be no obligation to prepare financial statements, other than for tax purposes or obtaining loan from AT A GLANCE bank, for which the owner/partners are responsible. They might employ a person or persons to maintain the accounting records and prepare financial statements. Companies Companies must prepare financial statements for shareholders and for filing with relevant regulatory bodies. It is the responsibility of the directors to ensure that this is done. Usually the work is delegated to employees. REGULATION FOR PREPARING FINANCIAL STATEMENTS Sole trader and partnership businesses The financial statements are private and do not have to be disclosed, except to the tax authorities (and possibly also to a lending bank). These must be prepared according to accepted accounting principles and practices but SPOTLIGHT need not conform to all the requirements of accounting standards. Companies The financial statements of a company are prepared for the shareholders of the company and are usually subject to audit. Audit is the examination of the financial statements by an independent expert who expresses an opinion as to whether they are fairly presented (show a true and fair view). Company law requires that financial statements are filed with a government agency, where they can be accessed and read by any member of the general public. Listed companies are even required to make their financial statements available on their websites. The concepts, principles, conventions, laws, rules and regulations that are used to prepare and present financial STICKY NOTES 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) The accountancy profession has developed a large number of regulations and codes of practice that professional accountants are required to use when preparing financial statements. These regulations are accounting standards. 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). INFORMATIONAL NEEDS OF USERS OF FINANCIAL STATEMENTS Financial statements are drafted to provide information that should be useful to most users but will not necessarily satisfy all of their needs. 12 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN PRC 4: INTRODUCTION TO ACCOUNTING CHAPTER 1: ACCOUNTING FUNDAMENTALS Investors They need information to assess whether to buy, hold or sell investment in the business. Financial statements also give some indication of the ability of a company to pay dividends to its shareholders out of profits. Lenders Financial statements can help lenders to assess the continuing ability of the borrower to pay interest, and its ability to repay the loan principal at maturity. Suppliers They can use the financial statements to assess how much credit they might safely allow to the entity. Government AT A GLANCE They might use this information for the purpose of business regulation or deciding taxation policies. The public In some cases, members of the general public might have an interest in the financial statements of a company. The IASB Framework comments: ‘For example, entities may make a substantial contribution to the local economy in many ways including the number of people they employ and their patronage of local suppliers.’ Employees Employees need information about the financial stability and profitability of their employer. An assessment of profitability can help employees to reach a view on the ability of the employer to pay higher wages, or provide more job opportunities in the future. SPOTLIGHT Customers Customers might be interested in the financial strength of an entity, especially if they rely on that entity for the long-term supply of key goods or services. Managers Management should have access to all the financial information they need, and in much more detail than financial statements provide. However, management is responsible for producing the financial statements and might be interested in the information they contain. STICKY NOTES THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 13  CHAPTER 1: ACCOUNTING FUNDAMENTALS PRC 4: INTRODUCTION TO ACCOUNTING 5. DOUBLE ENTRY BOOK-KEEPING Every transaction that affects assets, liabilities, capital, income or expenses must have an offsetting effect to maintain the accounting equation. Every transaction must be recorded (entered) in at least two places. The process of doing this is called double entry book-keeping. RULES OF DEBIT AND CREDIT Each business transaction has two aspects which are named as debit and credit by norm in accounting. By convention, the terms ‘debit’ and ‘credit’ are shortened to ‘Dr’ and ‘Cr’ respectively. Total debit entries and total credit entries must always be equal, this maintains the accounting equation. An account is a record of an individual type of asset, liability, income, expense or equity. For example, a record of amounts owed by an individual customer (an asset) or a record of utility bills (an expense). AT A GLANCE Account type Increase Decrease Assets, Expenses and Drawings Debit Credit Liabilities, Income and Capital Credit Debit  Example 06: Identify the accounts to be debited and credited for the following transactions: (i) Bought motor vehicle for cash. (ii) Paid creditor, Nawabshah Traders, by cash. (iii) Repaid Bank loan by cheque. (iv) Sold Motor vehicle for cash. SPOTLIGHT (v) Paid office rent by cheque. (vi) A debtor, Multan Traders, pays us by cash. (vii) Paid electricity bill for the month by cash. (viii) Proprietor puts a further amount into the business by cheque. (ix) A loan in cash is received from Sahiwal Bank. (x) Paid a creditor, Peshawar Enterprise, by cash. (xi) Bought office machinery on credit from Lahore Limited (xii) The proprietor paid a creditor, Layyah Enterprises, from his private funds. STICKY NOTES (xiii) A debtor, Islamabad Limited, paid us in cash. (xiv) Repaid part of loan from Quetta Bank by cheque. (xv) Returned some of office machinery to Lahore Limited. (xvi) A debtor, Karachi Port, pays us by cheque. (xvii) Interest on bank deposit received in bank account. (xviii) Bought goods on credit from Arslan Traders (xix) Returned good to supplier Amjad Enterprises (xx) Sold goods to Habib Mall on credit (xxi) Customer Rizwan Stores returned goods to us (xxii) Owner took cash for his personal use 14 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN PRC 4: INTRODUCTION TO ACCOUNTING CHAPTER 1: ACCOUNTING FUNDAMENTALS  ANSWER: Sr. # Account Element Effect Debit / Credit (i) Motor vehicle Asset Increase Debit Cash Asset Decrease Credit (ii) Nawabshah Traders: payables Liability Decrease Debit Cash Asset Decrease Credit (iii) Bank Loan Liability Decrease Debit Bank Asset Decrease Credit (iv) Cash Asset Increase Debit Motor vehicle Asset Decrease Credit (v) Office rent expense Expense Increase Debit Bank Asset Decrease Credit AT A GLANCE (vi) Cash Asset Increase Debit Multan Traders: receivables Asset Decrease Credit (vii) Electricity expenses Expense Increase Debit Cash Asset Decrease Credit (viii) Bank Asset Increase Debit Capital Equity Increase Credit (ix) Cash Asset Increase Debit Loan from Sahiwal Bank Liability Increase Credit (x) Peshawar Enterprises: payables Liability Decrease Debit Cash Asset Decrease Credit (xi) Office machinery Asset Increase Debit Payable to Lahore Limited Liability Increase Credit (xii) Layyah Enterprises: payables Liability Decrease Debit SPOTLIGHT Capital Equity Increase Credit (xiii) Cash Asset Increase Debit Islamabad Limited: receivables Asset Decrease Credit (xiv) Loan from Quetta Bank Liability Decrease Debit Bank Asset Decrease Credit (xv) Payable to Lahore Limited Liability Decrease Debit Office machinery Asset Decrease Credit (xvi) Bank Asset Increase Debit Karachi Port: receivables Asset Decrease Credit (xvii) Bank Asset Increase Debit Interest income (other income) Income Increase Credit STICKY NOTES (xviii) Purchases Expense Increase Debit Arslan Traders: payables Liability Increase Credit (xix) Amjad Enterprises: payables Liability Decrease Debit Purchases return Expense Decrease Credit (xx) Habib Mall: receivables Asset Increase Debit Sales Income Increase Credit (xxi) Sales return Income Decrease Debit Rizwan Stores: receivables Asset Decrease Credit (xxii) Drawings Equity Decrease Debit Cash Asset Decrease Credit THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 15  CHAPTER 1: ACCOUNTING FUNDAMENTALS PRC 4: INTRODUCTION TO ACCOUNTING  Example 07: In respect of each of the following, give example of a transaction which would result in: (i) Decrease in a liability and increase in another liability (ii) Increase in an asset and decrease in another asset (iii) Decrease in an asset and decrease in a liability (iv) Decrease in capital and decrease in asset  ANSWER: (i) Payment of creditors by using bank overdraft / loan. (ii) Purchase of a machine against cash. AT A GLANCE (iii) Payment of creditors through bank balance. (iv) Cash withdrawal by owner of the business. SPOTLIGHT STICKY NOTES 16 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN PRC 4: INTRODUCTION TO ACCOUNTING CHAPTER 1: ACCOUNTING FUNDAMENTALS 6. COMPREHENSIVE EXAMPLES  Example 08: Identify the accounts to be debited and credited for the following transactions: (i) We pay a creditor in cash. (ii) Bought fixtures paying by cheque. (iii) Bought goods on credit. (iv) The proprietor introduces further cash into the business. (v) A bank lends us in cash. (vi) A debtor pays us by cheque. AT A GLANCE (vii) We return goods costing to a supplier whose bill we had not paid. (viii) Bought additional shop fixtures paying by cheque. (ix) Bought a van on credit. (x) Repaid by cash a loan owed to Bank.  ANSWER: Sr. # Account Element Effect Debit / Credit (i) Trade creditors (payables) Liability Decrease Debit Cash Asset Decrease Credit (ii) Fixtures Asset Increase Debit SPOTLIGHT Bank Asset Decrease Credit (iii) Purchases Expense Increase Debit Trade creditors (payables) Liability Increase Credit (iv) Cash Asset Increase Debit Capital Equity Increase Credit (v) Cash Asset Increase Debit Bank Loan Liability Increase Credit (vi) Bank Asset Increase Debit Trade debtors (receivables) Asset Decrease Credit STICKY NOTES (vii) Trade creditors (payables) Liability Decrease Debit Purchase return Expense Decrease Credit (viii) Fixtures Asset Increase Debit Bank Asset Decrease Credit (ix) Van Asset Increase Debit Payable for Van Liability Increase Credit (x) Bank Loan Liability Decrease Debit Cash Asset Decrease Credit THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 17