Slide 3.

Chapter 3
Financial statements from
the accounting equation

Weetman, Financial and Management Accounting, 7e © Pearson Education Limited 2016

Slide 3.2

Primary financial statements

Primary financial statement Purpose
is to report

Statement of financial position (balance Financial position

sheet)
Income statement Financial performance
(profit and loss account)

Statement of cash flows Financial adaptability

Weetman, Financial and Management Accounting, 7e © Pearson Education Limited 2016

Slide 3.3

Preparing financial statements

• TRANSACTIONS AND EVENTS
↓
• Practice of bookkeeping
↓
• ACCOUNTING RECORDS
↓
• Rules of measurement and disclosure
↓
• FINANCIAL STATEMENTS

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Slide 3.4

Statement of financial position

(balance sheet)
• The statement of financial position
(balance sheet) reflects the accounting
equation in the form:
− Assets minus Liabilities equals
Ownership interest

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Slide 3.5

Statement of financial position

is usually presented

Assets
minus
Liabilities
equals
Ownership interest

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Slide 3.6

Subdivisions
• Assets are subdivided into non-current
(fixed) assets and current assets.
• Liabilities are subdivided into current
liabilities (due within one year) and non-
current liabilities (due after one year).
• Ownership interest may also be
subdivided.
• Current assets and current liabilities are
grouped close to each other.

Weetman, Financial and Management Accounting, 7e © Pearson Education Limited 2016

Slide 3.7

Structure
Non-current (fixed) assets
plus
Current assets
minus
Current liabilities
minus
Non-current (long-term) liabilities
equals
Capital at start of year
plus/minus
Capital contributed or withdrawn
plus
Profit of the period

Table 3.1 Structure of a statement of financial position (balance sheet)

Weetman, Financial and Management Accounting, 7e © Pearson Education Limited 2016
Slide 3.8

Other forms of statement – horizontal

Liabilities plus
Assets equals

Ownership interest

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Slide 3.9

Other forms of statement – vertical

Assets

equals

Liabilities

plus

Ownership interest

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Slide 3.10

Income statement
(profit and loss account)
The income statement (profit and loss
account) reflects that part of the
accounting equation which defines profit:

Profit equals Revenue minus Expenses

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Slide 3.11

Income statement
(profit and loss account) (Continued)

Revenue

minus

Expenses

equals

Profit

Table 3.4 Structure of an income statement (profit and loss account)

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Slide 3.12

Statement of cash flows

Liquidity is measured by the cash and near-
cash assets and the change in those
assets, so a financial statement which
explains cash flows should be of general
interest to user groups.
Cash flow =
• Cash inflows to the enterprise
minus
• Cash outflows from the enterprise

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Slide 3.13

Statement of cash flows (Continued)

Cash inflows
minus
Cash outflows
equals
Change in cash and similar liquid assets

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Slide 3.14

Subdivisions of cash flow

• Operating activities: Provision of
services, and the manufacturing, buying
and selling of goods for resale.
• Investing activities: Buying and selling
non-current (fixed) assets for long-term
purposes.
• Financing activities: Raising and
repaying the long-term finance of the
business.

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Slide 3.15

Statement of cash flows

Operating activities
Cash inflows minus Cash outflows
plus
Investing activities
Cash inflows minus Cash outflows
plus
Financing activities
Cash inflows minus Cash outflows
equals
Change in cash assets

Table 3.6 Structure of a statement of cash flows

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Slide 3.16

Profit does not equal cash

Working capital
• Some sales are made on credit, customers
pay later.
• Some purchases are made on credit, pay
suppliers later.
• Cash is used to buy inventory (stock)
which is sold later.

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Slide 3.17

Working capital cycle

Inventory

Receivables
(debtors)
Payables
(creditors)

Cash

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Slide 3.18

Profit does not equal cash

(Continued)
• Cash is used to buy more non-current
(fixed) assets.
• Cash is used to buy investments.
• Cash is used to repay loans.
• Cash is raised from issuing shares.
• Cash is raised from borrowing.

Weetman, Financial and Management Accounting, 7e © Pearson Education Limited 2016

Slide 3.19

Practical illustration
See P. Mason illustration in Chapter 3 for:
• Statement of financial position
• Income statement
• Statement of cash flows
• Comparison of profit and cash flow.

Weetman, Financial and Management Accounting, 7e © Pearson Education Limited 2016

Slide 3.20

Chapter 3
Bookkeeping supplement

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Slide 3.21

Debit and credit recording

Debit entries in a Credit entries in a
ledger account ledger account

Left-hand side of the

equation
Asset Increase Decrease
Right-hand side of the
equation
Liability Decrease Increase
Ownership interest Expense Revenue
Capital withdrawn Capital contributed

Table 3.9 Rules for debit and credit recording

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Slide 3.22

Analysis of transaction
September 1: P. Mason deposits £140,000 in a
bank account to commence the
business under the name P.
Mason’s legal practice.

Transaction Debit Credit

number: 1
Asset Bank £140,000
Ownership interest Capital contributed
£140,000

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Slide 3.23

Analysis of transaction (Continued)

September 1: P. Mason’s legal practice
borrows £150,000 from a finance
business to help with the
intended purchase of a property
for use as an office. The loan is
to be repaid in five years’ time.
Transaction Debit Credit
number: 2
Asset Bank £150,000
Liability Long-term loan
£150,000

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Slide 3.24

Analysis of transaction (Continued)

September 1: A property is purchased at a cost
of £75,000 for the land and
£175,000 for the buildings. The
full price is paid from the bank
account.

Transaction Debit Credit

number: 3
Asset Land and buildings Bank £250,000
£250,000

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Slide 3.25

Analysis of transaction (Continued)

September 3: Office furniture is purchased from
Stylecraft at a cost of £30,000.
The full price is to be paid within
90 days.

Transaction Debit Credit

number: 4
Asset Furniture £30,000
Liability Trade payable
(Stylecraft) £30,000

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Slide 3.26

Analysis of transaction (Continued)

September 5: An insurance premium of £540 is
paid in advance. The insurance
cover will commence on 1 October.

Transaction Debit Credit

number: 5
Asset Prepayment £540 Bank £540

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Slide 3.27

Analysis of transaction (Continued)

September 8: An applicant is interviewed for a
post of legal assistant. She
agrees to start work on 10
September for a salary of
£24,000 per annum.
No accounting recognition takes place until the
payment has occurred. It is the expense of the
past which is recognised, rather than the asset of
benefit for the future.

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Slide 3.28

Analysis of transaction (Continued)

September 11: Invoices are sent to some clients
showing fees due for work done in
preparing contracts for them. The
total of the invoiced amounts is
£8,820. Clients are allowed up to
30 days to pay.
Transaction Debit Credit
number: 6
Asset Trade receivables
£8,820
Ownership interest Fees for work done
(revenue) £8,820

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Slide 3.29

Analysis of transaction (Continued)

September 19: Cheques received from clients in
payment of invoices amount to
£7,620.

Transaction Debit Credit

number: 7
Asset Bank £7,620 Trade receivables £7,620

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Slide 3.30

Analysis of transaction (Continued)

September 26: Payment is made to Stylecraft for
the amount due for office
furniture, £30,000.

Transaction Debit Credit

number: 8
Asset Bank £30,000
Liability Trade payable:
(Stylecraft) £30,000

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Slide 3.31

Analysis of transaction (Continued)

September 28: Bills are received as follows:
for computer rental and online
searches, £1,500; gas, £100;
electricity, £200 and telephone/fax
£1,000 (total £2,800).

Transaction Debit Credit

number: 9
Liability Trade payables £2,800
Ownership interest Expenses £2,800

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Slide 3.32

Analysis of transaction (Continued)

September 30: Legal assistant is paid salary of
£1,800 for period to end of month

Transaction number: 10 Debit Credit

Asset Bank £1,800
Ownership interest Expense £1,800

Weetman, Financial and Management Accounting, 7e © Pearson Education Limited 2016

Slide 3.33

Trial balance
Trial balance Debit Credit
£ £
Assets
Land and buildings 250,000
Office furniture 30,000
Traders receivables (debtors) 1,200
Prepayment 540
Cash at bank 15,280
Liabilities
Trade payables (creditors) 2,800
Long-term loan 150,000
Summary of debit and credit entries for each category of asset, liability
Table 3.11
and ownership interest
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Slide 3.34

Trial balance (Continued)

Ownership interest

Revenue 8,820

Expenses 4,600

Capital contributed 140,000

Totals 301,620 301,620

Summary of debit and credit entries for each category of asset, liability and
Table 3.11
ownership interest (Continued)
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