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Fundamentals of Business Accounting
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Business Accounting theory, transaction examples, equations, and worked equation examples.
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Fundamentals of Business Accounting30/09/20
Accounting
Defined as ‘the process of identifying, measuring, and communicating economic information to permit informed
judgements and decisions by users of that information’.
- Decides what amounts of money are, were, or will be involved in transactions
- Organising information and presenting it in a useful way for decision making
- Economic events can be measured in terms of money; name given to actual transactions carried out by
the business (sales of goods or services, payment of expenses)
A business is a commercial organisation that aims to make a profit by providing members of society with
goods/services; business activity includes manufacturing organisations, trading organisations and service
organisations while business entities include sole tradership (business that is owned and run by one individual),
partnership (owned and run by two or more individuals), and limited liability companies (private limited liability
companies (cannot register for stock exchange/cannot sell shares) and public limited liability companies (can sell
shares)).
Differences Sole Tradership Partnership Companies
Formation One person Two or more people Number of persons
(shareholders) registering
the company under the
Companies Act
Management Managed by owner Managed by partners Managed by professional
managers separate from
shareholders
Liability for unpaid debts Personal liability of owner Personal liability of partners Liability of shareholders is
and other obligations of the limited to their investment
business in the company
Status in law Not separate legal entity Not separate legal entity Separate legal entity from
from owner from owner shareholders
Status in accounting Separate business entity Separate business entity Separate business entity
from owner from partner from shareholders
Financial accounting and Some financial accounts are Financial accounts are Fairly strict regulation of
auditing requirements needed for tax purposes needed for the benefit of financial reporting by
the partner companies
Internal users are those who manage the business of a day to day basis (manager). Need management accounting
– analyses data to provide information as a basis for managerial action (present accounting information)
External users are those who are not directly involved in the operation of the business (investors, employees,
lenders, suppliers and customers, tax authorities, financial analysts and advisers). Need financial accounting –
report financial information to external users (financial statements provide information about the financial
position, performance and changes in financial position of entity that is useful to a wide range of users in making
economic decisions).
Shareholders want to assess how well its management is performing; want to know how profitable the
company’s operations are and how much profit they can afford to withdraw from the business
Trade contracts include suppliers who provide goods to the company on credit and customers who
purchase the goods or services provided by the company – want to know about the company’s ability to
pay its debts (secure source of supply and not in danger of having to close down)
Company lenders want to ensure that the company is able to keep up interest payments and eventually
repay the amounts advanced
Taxation authorities want to know about business profits in order to assess the tax payable by the
company including sales taxes
,Financial statements are comprised of
1. Income statement or profit or loss account
2. Statement of financial position or balance sheet (assets, property, loan etc)
3. Statement of changes in capital/equity
4. Statement of cash flow (money that goes out, and money that comes in)
Board of directions are responsible for preparing financial statements.
Regulation of financial accounting
- Accounting concepts/assumptions/conventions (subjective)
- International Financial Reporting Standards (IFRSs) developed by International Accounting Standards
Board (IASB) to deal with subjective matters
Qualitative characteristics of financial information
- Understandable, must be able to understand financial statements
- Relevant, influences economic decisions of users by helping them evaluate past, present, future (buying
shares, important to know whether company is making profit or loss)
- Reliable, free from material error and bias and can be depended upon by users
- Comparability, users must be able to compare financial statements through time to identity trends and
with other entity’s statements to evaluate relative position
- Consistent, presentation of financial statements should stay the same from one period to another
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07/10/20
Statement of Financial Position (Balance Sheet)
Inventory (Stock)
Receivables (Debtors)
Ownership Interest (Capital/Equity)
Payables (Creditors)
Assets
Property or item owned and controlled by the owner to generate future economic benefits. Examples are plant
and machinery, motor vehicle, builders, equipment etc. Two categories:
Current Assets (Short-term)
Assets that are expected to be realised within 12 months after the date of the financial year-end in the
entity’s normal operating cycle
E.g. Inventory/stock, receivables, pre-payments, bank or cash
Non-current Assets (Long-term)
Assets that are expected to be realised in more than 12 months after date of financial year-end in the
entity’s normal operating cycle
E.g. Land, builders, equipment, computers etc
Liabilities
Present obligations of the entity arising from past events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic benefits
Current Liabilities (Short-term)
Liabilities that are expected to be settled within 12 months after the date of the financial year-end in the
entity’s normal operating cycle
E.g. bank overdraft, payables, and accruals/ownings
Non-current Liabilities (Long-term)
Liabilities that are expected to be settled in more than 12 months after the date of the financial year-end
in the entity’s normal operating cycle
E.g. bank loan, mortgage, debenture (loan notes)
,Ownership Interest
The residual interest in the assets of the entity after deducting all its liabilities
Assets – Liabilities = Ownership Interest
Assets = Ownership Interest + Liabilities
To increase an asset you debit it, to decrease you credit it.
To increase expense you debit it, to decrease you credit it.
To increase liability you credit it, to decrease you debit it.
To increase revenue you credit it, to decrease you debit it.
Ownership Interest increases through investment and revenues, decreases by drawings and expenses therefore:
Assets = (Capital + Revenues – Expenses) + Liabilities
Revenue/Sales/Income/Turnover: income generated by the business for a specific period
Expenses: cost of running the business for the same period (expenses are expired assets)
E.g. electricity, telephone bills, salary
Income Statement (Profit or Loss Account) = Revenues – Expenses = Net Profit
The Accounting Cycle
Step 1. Transaction Analysis
Step 2. Recording in Books of Prime Entry (e.g. credit sale - sales daybook, sales return daybook)
Step 3. Summarising in Ledger Accounts (e.g. double entry records of all transactions and events)
Step 4. Preparing Trial Balance (e.g credit purchases, purchases returns daybook – shows accuracy of all totals in
ledger account)
Step 5. Adjusting the Accounts (e.g cash book – all bank transactions)
Step 6. Preparing Adjusted Trial Balance (e.g petty cash book – all small cash transactions)
Step 7. Preparing Financial Statements (e.g journal – all transactions not recorded elsewhere)
Steps 1-3 during accounting period. Steps 4-7 at the end of the accounting period.
The Going Concern (continuity) Concept
Financial statements are normally prepared on the assumption that an entity is a going concern and will continue
in operation for the foreseeable future
Historical Cost Concept
Requires transactions to be recorded at the price ruling at the time, and for assets to be valued at original cost
Accrual Basis
The effect of transactions and other events are recognised when they occur (not as cash or equivalent
received/paid) and they are recorded in the accounting records and reported in financial statements of the periods
to which they relate.
Monetary Concept
Transactions must be measurable in terms of money. Accountants do not account for items unless they can be
quantified in monetary terms; items not accounted for include workforce skill, morale, market leadership, brand
recognition, quality of managements etc.
Transaction 1.
During September, Mason deposits £140,000 in a bank account to create a legal practice.
Transaction 2.
Mason borrows £150,000 from a finance business. Loan is to be repaid in five years’ time.
, Transaction 3
Property purchased at a cost of £75,000 for the land and £175,000 for the buildings. Full price is paid.
Transaction 4
Office furniture is purchased at a cost of £30,000. Full price paid within 90 days.
Transaction 5
Monthly insurance premium of £540 is paid in advance. Insurance cover will commence next month.
Transaction 6
Applicant is reviewed as legal assistant; agrees to start work for £1,800.
Transaction 7
Invoices are sent to RDBS for work done in preparing contracts. Total of invoiced amounts is £8,820.
Transaction 8
Cheques received from clients in payment of invoices amount to £7,620.
Transaction 9
Payment made to stylecraft for office furniture, £30,000
Transaction 10
Bills received: Computer rental, £1500; gas, £100; electricity, £200; and telephone, £1000
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