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TOPIC LIST
CHAPTER 2

✓ Assets, liabilities and the business entity concept

ACCOUNTING ✓ The accounting equation
✓ Credit transactions
EQUATION
✓ The statement of financial position
✓ Preparing the statement of financial position
✓ The statement of profit or loss

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Some definitions

ASSET
is a present economic resource
controlled by the entity as a result of
SOME DEFINITIONS
past events. An economic resource is a
right that has the potential to produce
economic benefits

Some assets are held and used in operations for a long time: Non-current assets
Some are held for only a short time: Current assets

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LIABILITY Some definitions

is a present obligation of the CAPITAL/ EQUITY
entity arising to transfer an economic is the residual interest in the assets of the entity after
resource as a result of past events deducting all its liabilities. Capital can be viewed as a measure
of the owner’s investment in the business

Capital which is called equity in the context of a company

GOOD DEBT IS A POWERFUL TOOL,

BUT BAD DEBT CAN KILL YOU
(Robert Kiyosaki)

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ASSETS LIABILITIES
ASSETS
Non - current assets Long-term liabilities
Long-term borrowings
Non-current assets Current assets • Loan from BANANABANK
Premises Inventory • Loan from CAKEBANK
HORIZON buildings Raw materials Notes payable
VERTICAL buildings Work in process Bonds payable
• RIGHT building Finished goods
Current liabilities
• LEFT building • Product 1 Short-term borrowings (bank overdraft)
Property, plant and equipment • Product 2 Trade payables
Trade receivables Accruals
Fixture and fittings
receivable – customer 1
Motor Vehicles EQUITY
receivable – customer 2
Cars Share capital (direct investm’t)
Cash
Trucks Retained earnings (indirect investm’t)
• Cash in hand
• Truck 1 Revenue
• Cash at bank
• Truck 2 Expenses
• VCBANK
(Dividends)
• AGRIBANK

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INCOME

+ increases in assets or decreases in

liabilities that result in increases in equity
WHERE DO PROFITS/ LOSSES FIT INTO (capital), other than those relating to
contributions from holders of equity claims
THE ACCOUNTING EQUATION?
+ It can include both revenue & gains

REVENUE GAINS
✓ arises in the course of the ✓ represent other items that meet the
ordinary activities of an entity definition of income and may, or may
✓ and is referred to by a variety not, arise in the course of the ordinary
of different names including activities of an entity.
sales, fees, interest, dividends, ✓ Gains represent increases in economic
royalties and rent. benefits and as such are no different
Refer to Section 2.3, page 12 in nature from revenue.

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EXPENSES
PROFIT or LOSS
are decreases in assets or increases in
liabilities that result in decreases in equity,
other than those relating to distributions to
PROFIT:
holders of equity claims
The excess of income over expenses
EXPENSES LOSSES
-> added to owners’ capital
that arise in the course of ✓ other items that meet the definition of LOSS:
the ordinary activities of the expenses and may, or may not, arise in the The excess of expenses over income
entity course of the ordinary activities
-> deducted from owners’ capital
✓ represent decreases in economic benefits and
as such they are no different in nature from
other expenses.
✓ Losses are often reported net of related
income.

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BUSINESS ENTITY CONCEPT

2. Legal position aspect:

- Sole trader: no legal separation

ACCOUNTING EQUATION - Partnerships: no legal distinction

- Company (limited liability): quite
1. Accounting aspect:
separate from its owners
- A business is a separate entity
from its owner
- It is called entity concept (the
convention adopted by
accountants) CONTEXT EXAMPLE
Refer to Section 1.2, page 9- 10

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BASIC ACCOUNTING EQUATION THE ACCOUNTING EQUATION

EQUITY
ASSETS = LIABILITY + (CAPITAL)
TOTALASSETS LIABILITIES CAPITAL

CAPITAL = Total assets – Total Liabilities = NET ASSETS

What I have What I owe What I own

Asset Liability CAPITAL/EQUITY

Equity (Capital)
a resource controlled a present obligation of
the residual interest in
by the entity as a the entity arising from
the assets of the entity Capital introduced Retained profits
result of past events past events, the
after deducting all its
and from which future settlement of which is
liabilities
economic benefits are expected to result in an
outflow from the entity of (Earned profit – Drawings)
expected to flow to the
entity resources embodying
economic benefits Assets = Liabilities + Capital – Drawings + Profit

(Conceptual framework for financial reporting)

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CONTEXT 1. Liza sets up her business, has put ₤2,500 into it 3. Liza has sold goods costing ₤ 650 to
EXAMPLE 2. Liza purchases a market stall from Len for ₤ 1,800 earn income of ₤ 900
- She purchases some flowers at a cost of ₤ 650 → She has earned a profit of ₤ 250
- She leaves ₤ 50 in cash (keeps ₤ 30 in the bank, holds (retained profit)
20 in small change for trading) Refer to Section 2.3, page 12

TOTALASSETS LIABILITIES CAPITAL

TOTALASSETS LIABILITIES CAPITAL
(1) Cash ₤ 2,500 = ₤ 2,500
(3) Stall ₤ 1,800 = Original capital ₤ 2,500
(2) Stall ₤ 1,800 = ₤ 2,500
Flowers ₤ 650 – 650 = 0 Retained profit 250
Flowers ₤ 650
Cash ₤ 30 + 20 + 900
Cash at bank ₤ 30
Cash in hand ₤ 20 ₤ 2,750 = ₤ 2,750

Refer to Section 2.2, page 11

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4. Liza decides to pay herself ₤ 180 in wages 5. Purchases flowers for

→ Withdrawals or appropriations of profits cash, at a cost of £740

Refer to Section 2.4, page 13 Refer to Section 2.2, page 14

TOTALASSETS LIABILITIES CAPITAL

TOTALASSETS LIABILITIES CAPITAL
(4) Stall ₤ 1,800 = Original capital ₤ 2,500
(5) Stall ₤ 1,800 = Original capital ₤ 2,500
Flowers = 0 Retained profit 250 – 180 = 70
Flowers = 740 Retained profit 70
Cash ₤ 950 – 180 =770
Cash ₤ 770 - 740

₤ 2,570 = ₤ 2,570
₤ 2,570 = ₤ 2,570

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6. Employ her cousin Ethel for a wage of £40

for the day. EXPANDED ACCOUNTING EQUATION
- Sell all their flowers for £1,100 cash. Liza
paid Ethel £40 and drew out £200 for herself.

Refer to Section 2.2, page 14 Assets = Liabilities + Owner’s Equity

TOTALASSETS LIABILITIES CAPITAL

(6) Stall ₤ 1,800 = Original capital ₤ 2,500 Owner _ Owner _

Flowers = 740 -740 Retained profit 70 + (360-40)-200 Capital Withdrawals + Revenues Expenses

Cash ₤ 30 + 1,100 - 40 - 200

₤ 2,690 = ₤ 2,690 Owner's Equity

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ACCOUNT STRUCTURE ACCOUNT STRUCTURE

EQUITY
= +
Assets Liabilities Equity
Owner’s _ Owner's _
LIABILITIES EQUITIES
Capital Withdrawals + Revenues Expenses
ASSETS
Owner’s Owner's Revenues Expenses
Capital Withdrawals

Debit Credit Debit Credit Debit Credit

+ - - + - +
Debit Credit Debit Credit Debit Credit Debit Credit
- + + - - + + -

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Subdivisions of Owner’s Equity: Subdivisions of Shareholder’s Equity:

1 Capital Investments by stockholders represent the total amount

2 Drawings / Withdrawals/ Appropriations paid in by stockholders for the shares they purchase.
3 Revenues
4 Expenses
Common stocks
Dividends to
Investments Drawings by Shareholders
Retained Shareholder’s
by Owner Owner
Owner’s earnings Equity
Equity
Expenses
Revenues Expenses Revenues

INCREASE DECREASE INCREASE DECREASE

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COMMON STOCK:
Issued in exchange for the owners’ investment paid into corporation STOCKHOLDERS’ EQUITY

REVENUES EXPENSES
Common Retained _ _
result from business activities entered
into for the purpose of earning
are the cost of assets consumed or
services used in the process of
Stock + Earnings + +
Dividends Revenues Expenses

income. earning revenue.

Common sources of revenue are: Common expenses are: salaries Common Retained Dividends Revenue Expense
sales, fees, services, commissions, expense, rent expense, utilities Stock Earnings
interest, dividends, royalties, and rent. expense, tax expense, etc.

DIVIDENDS
are the distribution of cash or other assets to stockholders. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Dividends reduce retained earnings. - + - + + - - + + -
Dividends are not an expense.

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CREDIT TRANSACTION

TRADE TRADE
PAYABLES RECEIVABLES

CREDIT TRANSACTIONS CREDITOR DEBTOR

• Party to whom a business owes money. • Party who owes money to the business

A TRADE CREDITOR A TRADE DEBTOR

•is a party to whom abusiness owes •is a party who owes money to the
money for trading debts business for tradingdebts

TRADE PAYABLES TRADE RECEIVABLES

•The amounts due to credit suppliers. • The amounts owed by credit customers

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WORKED EXAMPLE
1. Liza invests a further £250 of her own capital. She persuades her
(CONTINUED….) Uncle Henry to lend her £500, interest of £5 each week at the end
of the market day.
Refer to Section 3, page 16

1. Liza invests a further £250 of her own capital. She persuades her Uncle TOTALASSETS LIABILITIES CAPITAL
Henry to lend her £500, interest of £5 each week at the end of the market day.
2. She decides to buy a van on credit for £700, pay after 30 days’ trial use.
(0) Stall ₤ 1,800 = Opening capital ₤ 2,690

3. Lisa buys garden furniture for £300 in cash and sells to Uncle George for Goods = 0
£350, but he will pay later Cash ₤ 890
4. Liza buys flowers costing £800, £750 are paid in cash, with the remaining
(1) Stall ₤ 1,800 = Loan 500 + Open capital ₤ 2,690
£50 on seven days’ credit. Hire Ethel at an agreed wage of £40 for the day.
Goods = 0 Addition 250
5. On 17 July, Liza sells all her goods, for £1,250 (cash), withdraw £240 for
her week’s work. She also pays Ethel £40 in cash. She decides to make Cash ₤ 890 + 750

the interest payment to her Uncle Henry the next time she sees him.
6. There are no van expenses for the week. ₤ 3,440 = ₤ 500 + ₤ 2,940

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2. She decides to buy a van on credit for £700, pay after 30

3. Lisa buys garden furniture for £300 in cash and sells to Uncle
days’ trial use.
George for £350, but he will pay later

TOTALASSETS LIABILITIES CAPITAL TOTALASSETS LIABILITIES CAPITAL

(2) Stall ₤ 1,800 = Loan 500 + Open capital ₤ 2,690 (3) Stall ₤ 1,800 = Loan 500 + Open capital ₤ 2,690

Van = 700 Payables 700 Addition 250 Van = 700 Payables 700 Addition 250

Cash ₤ 1,640 Receivables 350 Profit (350 – 300) = 50

Cash ₤ 1,640 – 300=1,340

₤ 4,140 = ₤ 1,200 + ₤ 2,940

₤ 4,190 = ₤ 1,200 + ₤ 2,990

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5. On 17 July, Liza sells all her goods, for £1,250 (cash),

Liza buys flowers costing £800, £750 are paid in cash, with the
withdraw £240; she also pays Ethel £40 in cash. She decides to
remaining £50 on seven days’ credit. Hire Ethel at an agreed
make the interest payment to her Uncle Henry the next time she
wage of £40 for the day.
sees him.

TOTALASSETS LIABILITIES CAPITAL TOTALASSETS LIABILITIES CAPITAL

(4) Stall ₤ 1,800 = Loan 500 + Open capital ₤ 2,690 (4) Stall ₤ 1,800 = Loan 500 + Open capital ₤ 2,690
Van = 700 Payables 700 Addition 250 Van = 700 Payables 700 Addition 250
Goods = 800 Payables 50 Goods = 800 -800 Payables 50
Receivables 350 Profit (350 – 300) = 50 Payables 5
Cash ₤ 1,340 – 750=590 Receivables 350 Profit 50+1,250-800-40-200-5= 215
Cash ₤ 590 + 1,250 – 240 -40 =1,560
₤ 4,240 = ₤ 1,250 + ₤ 2,990
₤ 4,410 = ₤ 1,255 + ₤ 3,155

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INTERACTIVE
QUESTION 2

THE ACCOUNTING EQUATION

How would each of these transactions affect the accounting
equation in terms of increase or decrease in asset, capital or
liability?
(1) Purchasing 800 worth of goods on credit
4 STATEMENT
OF FINANCIAL POSITION

(2) Paying the telephone bill 25

(3) Selling 450 worth of goods for 650
(4) Paying 800 to a supplier
Refer to Section 3, page 18

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THE STATEMENT OF FINANCIAL POSITION CLASSIFICATION

VALUE & LIQUIDATION OF ASSETS

WEALTH ??? WHO CONTRIBUTED ???

(assets)

TÀI SẢN

NON - CURRENT ASSETS CURRENT ASSETS

The financial position of a business at a given moment in time ARE ACQUIRED FOR LONG-TERM USE, WITH ARE EXPECTED TO BE CONVERTED
❖ Show the forms in which the wealth of the business is held A VIEW TO EARNING INCOME/MAKING INTO CASH WITHIN 1 YEAR
PROFITS FROM THEIR USE, OVER MORE
❖ How much wealth is held in each form
THAN 1 REPORTING PERIOD
❖ Who contributed that wealth

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NON - CURRENT ASSETS CLASSIFICATION CURRENT ASSETS CLASSIFICATION

CURRENT ASSETS
NON - CURRENT
ASSETS
CURRENT
NON-CURRENT ASSETS ASSETS

PROPERTY, TRADE &

PREMISES FIXTURE & LONG-TERM SHORT-TERM
PLANT AND VEHICLES… INVENTORY OTHER PREPAYMENTS
CASH & CASH
FITTINGS INVESTMENTS EQUIVALENTS
EQUIPMENT INVESTMENT
RECEIVABLES

LIQUIDATION

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CLAIMS CLASSIFICATION CLAIMS CLASSIFICATION

LIABILITIES CAPITAL CURRENT

LIABILITIES
(claims of outsiders) (owner’s claim)

LOAN STOCKS OR
LOANS ( > 1 year)
DEBENTURES

CURRENT
Current liabilities
LIABILITIES
are debts which are CAPITAL
payable within 1 year or RESERVES… TRADE &
LOANS ( within BANK TAXATION
1 operating cycle 1 year) OVERDRAFT
OTHER ACCRUALS
PAYABLE
Non-current liabilities Retained earnings PAYALBES
are debts which are payable
after 1 year…

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CAPITAL Capital (sole trader) NCA and depreciation

The sole trader's capital is usually analysed into its component parts. Non-current assets are held and used by a business
'Brought forward' for a number of years, but they wear out or lose
means that the amount is brought forward from the previous period. their usefulness in the course of time.
'Carried forward'
Every tangible non-current asset has a limited life.
means carried forward to the next period.
INTERACTIVE The only exception is freehold land.
QUESTION 3
£ £
Capital at the beginning of the reporting period X
(ie capital brought forward) Suppose a business buys a car for £ 10,000. It expects to keep the car for
Add additional capital introduced during the period X 3 years and then to sell it for £ 3,400. How much depreciation should be
X accounted for in each year of the car’s useful life?
Add profit earned during the period X
(or less losses incurred in the period)
Less drawings (X)
Retained profit for the period X
Capital as at the end of the reporting period (ie capital carried forward) X
Refer to Section 4, page 21

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PREPARING THE STATEMENT OF FINANCIAL STATEMENT

Step 1 •Gather the needed information

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Step 2 •Prepare the heading
PREPARING THE STATEMENT OF Step 3 •Report all company assets
FINANCIAL POSITION Step 4 •Report all liabilities
Step 5 •Report the ending balance of capital
after total liabilities

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THE STATEMENT OF FINANCIAL POSITION layout

£ £ EXERCISE JERRY PART 2
ASSETS
Non Current Assets Xxxx
# 1- 1st March, Jerry Company start a business: depositing ₤ 20,000 in a bank
Current Assets account (capital was raised partly from the owner ₤ 6,000 and from borrowing ₤
Trade receivables Xxxx 14,000)
Cash at bank Xxxx
# 2- 2nd March, bought a motor van for ₤ 5,000, paying by cheque
Total current assets Xxxx
Total Assets Xxxxx # 3- 3rd March, bought inventories (goods to be sold) on one month’s credit for ₤ 3,000
CAPITAL & LIABILITIES
# 4- 4th March, repaid ₤ 2,000 of the amount borrowed to the lender, by cheque
Capital Xxxx
# 5- 6th March, owner introduced another ₤ 4,000 into the business bank account
Non Current Liabilities Xxxx
Current Liabilities
Bank overdraft Xxxx # 6- 7 th March, sold all of the inventory for ₤5,000 &
Trade payables Xxxx received a cheque immediately from the customer for
Total current liabilities Xxxx
this amount
Total Capital and Liabilities Xxxxx

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# 7 th March, sold all of the Jerry Company Jerry Company

STATEMENT OF FINANCIAL POSITION
inventory for ₤ 5,000 & received STATEMENT OF FINANCIAL POSITION
as at 6 March as at 7 March
a cheque immediately from the PROFIT ???
ASSETS ₤ ASSETS ₤
customer for this amount
- Motor van 5,000 - Motor van 5,000
DECREASE 3,000 - Inventories 3,000 - Inventories (3,000 - 3,000) 0
Jerry Company
INCREASE 5,000 - Cash at bank 17,000 - Cash at bank (17,000 + 5,000) 22,000
STATEMENT OF PROFIT OR LOSS
Total 25,000 Total 27,000 From 1st – 7th March
₤
INCREASE EQUITY & LIABILITIES ₤ EQUITY & LIABILITIES ₤
PROFIT - Sales revenue 5,000
- Equity 10,000 - Equity 10,000 + (5,000 – 3,000) 12,000 - Cost of goods sold 3,000
(Rev 5,000 – Ex 3,000) - Liabilities – borrowing 12,000 - Liabilities – borrowing 12,000 - Profit 2,000
- Liabilities – trade payable 3,000 - Liabilities – trade payable 3,000

Total equity and liabilities 25,000 Total equity and liabilities 27,000

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PREPARING THE SOFP

INTERACTIVE You are given the following information about
QUESTION 5 Liza Doolittle at the end of her first full month of
DISCUSSION 1
trading, 31 July 20X6:

₤
✓ Capital at 1 July 20X6 2,500
✓ Additional capital 250
introduced Requirement
✓ Profit for the month 3,620 Prepare SOFP for Liza Doolittle
What would have been the effect on The statement of as at 31 July 20X6.
✓ Stall at cost 1,800
✓ Van at cost 700
financial position & The statement of profit or loss if
✓ Drawings in month 960
✓ Loan 50
the inventory had been sold on 7th March for ₤1,000 ✓ Inventories 1,250
✓ Cash in hand 20
rather than ₤ 5,000 ? ✓ Trade payables 675
✓ Cash at bank 1,475 Refer to Section 5, page 26
✓ Trade receivables 890

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Statement of
Profit or Loss ❖ Is a statement in which two key
elements of financial statements –
income and expenses – are matched

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to arrive at profit or loss
STATEMENT ❖ Many businesses distinguish between:
❖ Gross Profit earned on trading
OF PROFIT OR LOSS (revenue – cost of sales)
❖ Profit for the year (Net Profit/Net
Income) after other income and
expenses

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1- THE INCOME STATEMENT layout EXERCISE JERRY PART 2

It is used to calculate the Profit or Loss of a business over a period of time
No.#1 - 1st March, Jerry Company start a business: depositing ₤ 20,000 in a bank
account (capital was raised partly from the owner ₤ 6,000 and from borrowing ₤
£ 14,000)
1. Revenue (sales) xx,xx No. #2- 2nd March, bought a motor van for ₤ 5,000, paying by cheque

No. #3- 3rd March, bought inventories (goods to be sold) on one month’s credit for ₤ 3,000
2. Less Cost of Sales (Purchases) (xx,xx)
No. #4 - 4th March, repaid ₤ 2,000 of the amount borrowed to the lender, by cheque
3. Gross Profit xx,xx No. #5- 6th March, owner introduced another ₤ 4,000 into the business bank account
No.#6- 7 th March, sold all of the inventory for ₤5,000 & received a cheque
4. Less running Expenses (e.g., Advertising (x,xx) immediately from the customer for this amount
& Wages)
5. Profit/loss for the year xx,xx/(xx,xx) No.#7- SELLING & ADMINISTRATIVE EXPENSE ₤ 500,
PAID BY CASH

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Jerry Company
STATEMENT OF FINANCIAL POSITION ELEMENTS OF P/L REVENUE
as at 7 March
ASSETS ₤ PROFIT ???

- Motor van 5,000 • Cost of Sales: the purchase or production cost of the goods sold
- Inventories (3,000 -3,000) 0 • Gross Profit = Revenue – Cost of Sales
- Cash at bank (17,000 + 5,000 -500) 21,500 Jerry Company
STATEMENT OF PROFIT OR LOSS • Profit for the year = Gross profit – expenses + non-trading income
Total 26,500 From 1st – 7th March
• Gross profit margin = Gross Profit x 100
₤
EQUITY & LIABILITIES ₤ Revenue
- Sales revenue 5,000
- Equity 10,000 + (5,000 – 3,000 -500) 11,500 - Cost of goods sold (3,000)
- Liabilities – borrowing 12,000 - Gross Profit 2,000
- Liabilities – trade payable 3,000 - Selling & Admin Ex (500)
- Net income 1,500
Total equity and liabilities 26,500

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STATEMENT OF PROFIT OR LOSS Relationship between

Gross Profit XXXX The statement of profit or loss and The statement of financial position
Plus any other income from source other than the sale of goods X
Minus other business expenses, not included in the cost of good sold (XX)
▪ Net profit is the profit for the ▪ Drawings are appropriations of
XXX
period. A net loss would be profit and not expenses.
Income from other sources: Business expense, other than COS:
- Profit on disposals of non-current assets - Distribution costs/selling expense: transferred as a deduction from

- Dividends or interest received from salaries, wages, commission of capital in the statement of
investments employees; marketing costs, financial position.
- Rental income from property owned but depreciation
not otherwise used by the business - Administrative costs/expense:
- Amounts due in respect of insurance management & office staff salaries, rent,
claims insurance, telephone and postage, …
- Cash Discounts received - Finance costs/financial expense:
interest on loans, bank overdraft interest

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CONTEXT
EXAMPLES (6) He purchased his ice cream from a local manufacturer, Floors Co.
The purchase cost in the three months to 31 August 20X5 was £6,200,
On 1 June 20X5, Jock Heiss commenced trading
as an ice cream salesman, using a van.
and at 31 August he had sold every item. He still owed
£700 to Floors Co for unpaid purchases on credit.
(7) One of his credit sale customers has gone bankrupt (insolvent),
(1) He borrowed £2,000 from his bank, and the interest cost of the loan was
£25 per month.
owing jock £250. Jock has decided to write off the debt in full, with no
(2) He rented the van for £1,000 for three months. Running expenses for the prospect of getting any of the money owed.
van averaged £300 per month. (8) He used his own home for his office work. Telephone and postage
(3) He hired an assistant for £1 00 per month. expenses for the three months to 31 August were £150, which he paid
(4) His main business was to sell ice cream to customers in the street, but he in cash.
also did special catering for business customers, supplying ice creams for (9) During the period he paid himself £300 per month. A statement of
office parties. Sales to these customers were usually on credit. profit or loss can be presented in various formats, but here we will use
(5) For the three months to 31 August 20X5, his total sales were as follows.
a vertical format similar to the one used in IAS 1. (It is not exactly the
• Cash sales £ 8,900
same.)
• Credit sales £ 1,100 Refer to Section 6, page 28 - 29 Refer to Section 6, page 28 - 29 40

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Jock Heiss
STATEMENT OF PROFIT OR LOSS
for the three months ended 31 August 20X5
£
Revenue (8,900 + 1,100) £ 10,000
Cost of sales (6,200)
Gross profit 3,800
Expenses
Wages (3x 100) 300
Van rental 1,000
Van expenses (3 x 300) 900
Irrecoverable debt written off 250
Telephone and postage 150
Interest charges (3 x 25) 75 (2,675)

Profit for the period 1,125

Refer to Section 6, page 28 - 29

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