Unit 05 – Accounting Principles

3. FINANCIAL REPORTS AND FINANCIAL STATEMENTS

By the end of this unit a student will be able to:

1. LO1 Examine the context and purpose of accounting.

2. LO2 Prepare basic financial statements for unincorporated
and small business organizations in accordance with
accounting principles, conventions and standards.
3. LO3 Interpret financial statements.
4. LO4 Prepare budgets for planning, control and decision-
making using spreadsheets.

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 Assessment Criteria
Pass Merit Distinction
LO2 Prepare basic financial statements for unincorporated
and small business organizations in accordance with
accounting principles, conventions and standards.

D2 Critically evaluate
financial statements to
P3 Prepare financial assess organizational
statements from a given trial performance using a range of
balance for sole traders, M2 Produce financial measures and benchmarks
partnerships and not-for-profit statements from a given to make justified
organizations, to meet trial balance, making conclusions.
accounting principles, appropriate adjustments.
conventions and standards.

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3. FINANCIAL REPORTS AND FINANCIAL STATEMENTS

3.1 Accounting Equation

3.2 Computerized Accounting Systems

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3.1 Accounting Equation
 Accounting Equation
▪ When a business comes into existence (incorporated), at the outset it has
nothing: No Assets and No Liabilities. It’s the owner(s) who first introduce assets
and liabilities to the business.
• Assets are things or value owned or
Assets possessed.

• Liabilities are debts, they are amounts

ASSETS=LIABILITIES+RESERVES+EQUITY Liabilities owed to creditors.

• Reserves are profit that have been

Reserves appropriated for a particular purpose.

• Equity is the excess of assets over

Equity liabilities and reserves.
Accounting Equation
 Principles of Double Entry System

▪ Thus according to the principles of ‘double entry’ book-keeping:

▪ When one account is being debited by a certain value, another

account needs to be credited by an equal value.

▪ Therefore the total value of all debits and credits should be

equal.
Accounting Equation and Rules of Debit
and Credit
 Accounting Cycle

The accounting cycle is the

step by step procedures
necessary to come out with
the end results of accounting
and which serves as a
communication tool of
cooperative to various
interested parties, the
Financial Statements.
 Accounting Cycle

1. Analysis of business transactions

All transactions must be supported with necessary
business documents (official receipts, vouchers, checks,
invoices).
 Accounting Cycle
2. Journalizing the transaction
The chronological recording of transactions in the books of
accounts following the principles of Debit Credit and the generally
accepted accounting principles.
 Accounting Cycle
3. Posting to ledger account
The transferring of journal entries from various books of
accounts to the General Ledger. The General Ledger is the
book where we classify or group similar items using
different accounts. Also known as a group of accounts and
the book of final entry.
 Accounting Cycle
4. Preparation of Trial Balance
It is a list of accounts with balances (open accounts) found in the general
ledger. It checks the equality of Value Received/Debit and Value Parted
With/Credit of the journal entries. Find the total debits and total credits
and the corresponding balance of each account.

5. Make adjusting entries

An adjusting entry is a type of journal entry. It is recorded to ,

▪ bring an asset or liability account balance to its proper amount

▪ to recognize a revenue or expenses.
 Accounting Cycle
6. Preparation of adjusted trial balance
▪ An adjusted trial balance is a testing of all company accounts that will appear on
the financial statements after year-end adjusting journal entries have been made.
▪ An adjusted trial balance is prepared after all adjusting entries have been
journalized and posted.
▪ It shows the balance of all accounts at the end of the accounting period and the
effects of all financial events that have occurred during the period.
▪ It proves the equality of the total debit and credit balances in the ledger after all
adjustments have been made.
▪ Financial statements can be prepared directly from the adjusted trial balance.
7. Preparation of Financial Statements
Financial Statements are prepared by transferring the account
balances on the adjusted trial balance to a set of financial statement
templates.

8. Make Closing Entries

The books of accounts are closed at the end of the accounting
period. Nominal Accounts (the accounts found in the Statement of
Operations) are closed while Real Accounts (the accounts found in
the Statement of Financial Condition) are carried forward to the next
business operation.

9. Post Closing Trial Balance

10. Reversing Journal Entries
A reversing entry is made at the beginning of the next
accounting period.
The purpose of reversing entries is to simplify the
recording of a subsequent transaction related to an
adjusting entry.
Reversing entries are most often used to reverse two
types of adjusting entries: accrued revenues and
accrued expenses.
 Books of Accounts
1. Cash Receipts Book/Journal
All cash received are recorded in this book.
2. Cash Disbursement Book/Journal
Used to record all payments of cash made.
3. Purchase Book/Journal
Goods bought and are intended for sale are recorded in this book.
4. Sales Book/Journal
Used to record the sales of goods.
5. General Journal
Non-cash miscellaneous transactions are recorded in this book.
6. General Ledger
Journal proper is book of original entry (simple journal) in which miscellaneous credit transactions which do not fit in any other books. It is
also called miscellaneous journal or General Journal. For example purchase assets on credit, Correcting Entries, Adjusting
Entries and Closing Entries etc.
7. Subsidiary Ledger
 Set of Financial Statements

1. Income statement
2. Balance sheet
3. Statement in changes in equity
4. Statement of cash flow
5. Notes to financial statements
 Accounting Cycle - Example

January 1 - started business with rs.3,000.

January 2 - bought goods worth rs.2,000.
January 9 - received order for half of the goods from “g”.
January 12 - delivered the goods, g invoiced rs.1,300.
January 15 - received order for remaining half of the total
goods purchased.
January 21 - delivered goods and received cash rs.1,200.
January 30 - g makes payment.
January 31 - paid salaries rs.210 - received interest rs.50
3.2 COMPUTERISED ACCOUNTING SYSTEM
 Computerized Accounting Systems

Computerized Accounting System refers to the processing of

accounting transaction through the use of hardware and software in
order to produce accounting records and reports. CAS takes
accounting transactions as inputs that are processed through
Accounting Software to generate the following reports:

• Day books/Journals
• Ledger
• Trial Balance
• Position Statement (Balance Sheet)
• Statement of Profit and Loss (Profit and Loss Account)
Computerized Accounting Systems
 Computerized Accounting Systems

A computerized accounting system is an accounting

information system that processes the financial transactions
and events as per Generally Accepted Accounting Principles
(GAAP) to produce reports as per user requirements.
Every accounting system, manual or computerized, has two
aspects.
1. It has to work under a set of well-defined concepts called
accounting principles.
2. A user -defined framework for maintenance of records and
generation of reports.
THANK YOU !