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Topic 1:
Introduction to Financial
Accounting

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Learning outcomes
What is a business?
Business transactions
Asset and Liabilities and Capital

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Learning outcomes
Accounting Principles and Characteristics
Accounting Equation
Financial Statements

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What is a business?
Business
The purpose of a business is to make a profit for
its owner(s)
Profit = income less expenditure

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What is a business?
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

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Types of Business Entity

What is a business ?
A business of whatever size or nature exist to
make a profit.
Types of business entity
Sole traders refers to ownership, sole traders
can have employees

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Types of Business Entity

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.

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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.

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Assets and liabilities 1

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.

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Assets and liabilities 2

Liabilities represent amounts that are owed by the
business.
Liabilities are categorised as either non-current or
current.

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Assets and liabilities 2

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 1

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:

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The accounting equation 2

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

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Accounting principles and characteristics 1

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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Accounting principles and characteristics 2

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

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Accounting principles and characteristics 2

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
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Accounting principles and characteristics 3

Other accounting principles and characteristics:
Business entity principle (a business is separate
from its owners or managers)
Double entry bookkeeping (every transaction
gives rise to a debit and a credit entry)

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Accounting principles and characteristics 3

Money measurement (accounts only deal with
items to which a monetary value can be attributed)

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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

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Statement of profit or loss

Net Profit = Gross profit + Other income Other
expenses
Cost of goods sold represents the purchase or
production costs of goods sold
Other expenses are overheads incurred in running
the business e.g. advertising costs, office building
rental costs, postage costs etc.

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Statement of financial position

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.
The Statement of Financial Position ( or balance
sheet) shows the assets, liabilities and capital of
the business at the period end.

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Statement of financial position

It represents the accounting equation:
ASSETS = CAPITAL + LIABILITIES

It distinguishes between non-current and current

assets, and non-current and current liabilities

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The Accounting Equation

The Accounting Equation:
Assets

Liabilities +

Capital

Assets: Resources owned by the business.

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The Accounting Equation

Fixed Assets
Land and building (Premises)
Motor vehicle
Office equipment
Furniture and fittings
Plant and machinery

Current Assets
Cash
Stock/ Inventory
Debtors/ Accounts receivable/ credit
customers
Prepaid expense
Accrued revenue
Notes receivable

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The Accounting Equation

Liabilities:
Resources owing by the business or Resources
contributed by non-owners such as bankers and
credit suppliers.

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The Accounting Equation

Current Liabilities
Creditors/ Accounts payable/
credit suppliers
Bank overdraft
Short term loan
Unearned revenue
Accrued expense/Expense
due/ Expense owing/
expense outstanding
Notes payable

Non-current liabilities
Bank loan
Mortgage loan
Debenture bonds/Bonds payable
Notes payable

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The Accounting Equation

Capital/ Owners equity :
Resources contributed by the owner into the
business.
Revenue:
Resources earned by the business. Increases in
owners equity as a result of selling services or
products to customers.

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The Accounting Equation

Expenses :
Resources used up to earn revenue. Using up of
assets or consuming services in the process of
generating revenues.

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The Accounting Equation

Drawings: Resources taken out by owner from business for personal use.
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

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The Accounting Equation

Drawings: Resources taken out by owner from business for personal use.

Revenue

Expenses

Expenses

Expenses

Commission Insurance exp Repairs and

received
maintenance
exp
Discount
Carriage
Entertainment
received
outwards exp exp

Carriage
inwards

Office supplies
exp
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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 Owners Equity
Statement of Financial Position/ Balance Sheet:
Shows the financial position of a business.
Based on the accounting equation.
Cash Flow Statement (Topic 9).

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Financial Statements
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
Purchases
Less: Return outwards
Carriage inwards
Customs duties
Less: Closing Stock
Cost of Goods Sold
Gross Profit
Add: Commission received
Discount received
Interest received
Rent received
Less: Expenses
Insurance
Bad debts expense
Increase in Allowance for Doubtful Debts
Depreciation
Carriage outwards
Salaries and wages
Interest expense
Rent expense
Utilities expense
Discount allowed
Net Profit

12,000
56,000
(11,000)
2,500
1,800
(20,000)
(41,300)
49,700
2,600
1,600
3,400
10,800
68,100
7,500
3,700
5,700
4,500
2,450
12,800
1,500
6,500
6,900
1,060

(52,610)
15,390

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Excel Company
Statement of Owners 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
Trade receivable/Accounts receivable
Less: Allowance for doubtful debts
Prepaid expense
Accrued revenue
Cash
Fixed Assets
Premises
Less: Accumulated depreciation
Motor vehicle
Less: Accumulated depreciation
Plant and machinery
Less: Accumulated depreciation
Office Equipment
Less: Accumulated depreciation
Furniture and fittings
Less: Accumulated depreciation
Current Liabilities
Trade payables/Accounts payable
Accrued expense
Unearned revenue
Short term loan

20,000
45,000
(11,500)

100,000
(45,000)
55,000
(12,500)
60,000
(16,900)
29,000
(9,800)
23,000
(8,500)

33,500
6,890
5,670
13,600

55,000
42,500
43,100
19,200
14,500

37,000
8,700
10,500
8,400

Non Current Liabilities

Loan from OCBC /Mortgage loan
Owners Equity
Opening Capital
Add: Net Profit
Less: Drawings
Closing Capital

79,660

174,300
253,960

64,600

70,000

110,000
15,390
(6,030)
119,360
253,960

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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. Parks 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.
b.
c.
d.

She bought a piece of furniture for $1,100 on credit.

One of the debtors paid her $450 by cheque.
She paid $60 for stationery expenses.
She put an extra $500 into the business in cash.

Show how the accounting equation is affected with the above transactions
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Go through
Chapter Round up,
Quick Quiz and
Answers to Quick Quiz at the end of
Topic in the E book

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