BASICS OF BUSINESS AND ACCOUNTING

CHAPTER 2
ROLE OF FINANCIAL REPORTING

“The objective of general purpose 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. Those decisions involve buying, selling or
holding equity and debt instruments, and providing or settling loans and
other forms of credit.
- IASB Conceptual Framework
CHAPTER 1 – PROBLEMS
DISBURSEMENTS BY A BUSINESS – CASH OR CREDIT
Payments
SUPPLIERS
(Material, Services)

EMPLOYEES
(Salaries/Benefits)

LENDERS
COMPANY (Principle and Interest)

GOVERNMENT
(Taxes)

OWNER
(Dividends)
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 FINANCIAL STATEMENTS

Balance Sheet Statement of Profit and loss

Tied together

Statement of Changes in
Statement of Cash flow
Equity
I’M GOING TO START A NEW RESTAURANT (BUSINESS)

What is the first thing I’ll need to do?

I will raise my money; bring my own capital or borrow

from creditors
ASSETS

Assets are resources controlled by the company. These resources

lead to the flow of future benefit.

Examples:
Trades/Bills
Cash Inventory Building Patents Goodwill
receivable
 Current
(Less than 12 months)
Non-current
Cash and Cash
Tangible
Equivalents

Short term
Intangible
ASSETS
Investments

Receivables Financial

Inventories Deferred
Whatever the company OWNS or
the company is OWED
Financial

Prepaid Expenses
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LIABILITIES

Liabilities are amounts owed to lenders and other creditors

(third parties).

Examples:
Current
Salaries Accounts Income tax Unearned
Mortgages portion of long
payable payable payable Revenue
term debt
 Current Non-current
(Less than 12 months)
(more than 12 months
to pay) LIABILITIES
Accounts payables Mortgages

Financial obligations Financial loans

Whatever the company OWES to
Tax payables Deferred Tax others
(Income/Sales/Property)

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EQUITY (OWNER’S EQUITY OR SHAREHOLDERS’ EQUITY)

Equity of a business enterprise increases through investments by

owners and profits from operations and decreases through
distributions to owners and losses from operations or Residual
Interest.

Equity is the amount collected from the shareholders and owed to

the shareholders.
ELEMENTS of Equity

Share Capital
EQUITY
Securities
Premium

Net Profit/Loss Equity is the residual interest in

the net assets of an entity that
Dividends remains after deducting its
liabilities.
Retained Earnings
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 ACCOUNTING EQUATION

Assets = Liabilities + Equity

OR
Assets – Liabilities = Equity
OR
Assets – Liabilities = Residual interest

Equity is also referred to as Net Assets or Net Worth

SIMPLISTIC USE OF THE
ACCOUNTING EQUATION

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 EFFECTS OF TRANSACTIONS

 Assets: Increase, decrease, no effect

 Liabilities: Increase, decrease, no effect
 Equity: Increase, decrease, no effect
EFFECTS OF TRANSACTIONS
ACCOUNTING PRINCIPLES (CONCEPTS)

 Matching
 Accrual
 Consistency
 Conservatism
 Revenue recognition
BALANCE SHEET

This statement presents the status of Assets, Liabilities and Equity of a

business at a point of time.
For eg: Balance Sheet as on March 31st 2019

Simple Format: Vertical or Horizontal statements

Matching Accruals Consistency

STATEMENT OF PROFIT AND LOSS

This statement summarizes the revenues and expenses of the business

for a period.
For eg: For the year ended March 31st 2019

Matching Accruals Consistency

STATEMENT OF CHANGES IN EQUITY

This statement encapsulates the changes in the equity items of a business in a

period.
For eg: during March 31st 2019

5 instances of change:
1) Receiving capital, 2) Disbursement of capital*, 3) Earning revenue,
4) Paying expenses and 5) Returning capital# *Payment of Dividend is not an expense
#Drawing cash from business for personal use
STATEMENT OF CASH FLOW

This statement reports the cash transactions of the

business in a period. Including:
1) Operations: Providing goods and services
2) Investments: Buying and selling assets
3) Financing: Raising and repaying funds
EFFECT OF TRANSACTIONS
Most transactions are likely to effect more than one financial statement.
1) Mahe started business with Rs. 50,000 cash
BS (Cash and Equity), SoE and CFS (Financing)
2) Sold goods for cash
BS (Cash and Equity), IS (Revenue) and CFS (Operations)
3) Purchased machinery worth Rs. 60,000 on credit
BS (Assets and Liabilities), CFS (Investing)
4) Paid office rent Rs. 5,000
IS (Expenses), CFS (Operations), BS (Cash)
PROBLEM 2.3
PROBLEM 2.11
PROBLEM 2.11
 FINANCIAL STATEMENTS

How are the financial statements interrelated?