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Session 1/2

Clare Fay
Department of Accountancy, UCD

Dr. Ming Yen Tan


Presentation Outline
 The Nature of Accounting

 The Balance Sheet


 The Profit and Loss account
 The Double Entry accounting system
 The underlying principles of accounting
 Questions and discussion
Accounting

 Accounting is the language of


business
 It is a language that people within a firm can
use to:
 Record

 Summarise and

 Interpret financial information


What is ACCOUNTING?
 Accounting is the language of business
 Facilitates internal discussions

 Facilitates communication with outsiders

 Accounting is about recording, analysing, reporting,


and interpreting business transactions
 The provision of information to managers and owners
so that they can make business decisions
 Financial accounting: externally focused
 Management accounting: internally focused
Accounting: Financial and
Management
 Financial accounting
 concerned with recording, processing and presenting
economic information after the event to interested
people outside the organisation
Accounting: Financial and
Management

 Management accounting
 concerned with meeting the information needs of
management (internal users)
 particular emphasis on:
 Planning
 Controlling and
 Decision making
Example
Paul was unemployed and unable to find a job. He therefore
decided to embark on a business venture.
Christmas is approaching, and so he decided to buy gift wrapping
paper from a local supplier and to sell it on the corner of his local
high street.
He felt that the price of wrapping paper in the high street shops was
excessive. This provide him with a useful business opportunity.
He began the venture with £40 in cash. On Monday, Paul’s first day
of trading, he bought wrapping paper for £40 and sold three-
quarters of it for £45 cash.

a) What cash movement took place during Monday?


b) How much wealth was generated by the business during Monday?

c) What is the accumulated wealth at Monday evening?


Example
On Tuesday, Paul bought more wrapping paper for £20 in cash.
He managed to sell all of the new inventories and all of the earlier
inventories, for a total of £48 cash.

a) What cash movement took place during Tuesday?


b) How much wealth was generated by the business during Tuesday?

c) What is the accumulated wealth at Tuesday evening?


Example
On Wednesday, Paul bought more wrapping paper for £46 in cash.
However, it was raining hard for much of the day and sales were low.

After Paul had sold half of his total inventories for £32, he decided
to stop trading until Thursday morning.

a) What cash movement took place during Wednesday?

b) How much wealth was generated by the business during


Wednesday?

c) What is the accumulated wealth at


Wednesday evening?
Example
On Thursday, the fourth day of his business . Paul bought more
wrapping paper (inventories) for £53 in cash.
During the day, he sold inventories that had cost £33 for a total of
£47
Draw up the three financial statements for Paul’s business
venture for Thursday.
The Balance Sheet

 The Balance sheet is an ordered list of


assets and liabilities of the entity at a
particular date

 Lists resources of the entity and claims on


those resources
 Assets
 Liabilities
 Capital
Balance Sheet: Terms - 1

 Assets
 Items owned by the entity
 ‘Amounts’ based on cost or value
 Liabilities
 Amounts owed by the entity
 Part finance the assets of business
 Capital
 Long-term financing by owners
The Balance Sheet Equation
 Assets = Liabilities + Capital

 Assets – Liabilities = Capital

 Assets – Current Liabilities = Capital + Long


Term Liabilities

 Fixed Assets + Current Assets – Current


Liabilities = Capital + Long Term Liabilities
Balance Sheet: Terms - 2

 Fixed Assets
 Assets used on a continuing basis in the
business
 Examples:
 Land and Buildings
 Motor Vehicles
 Plant and Machinery
 Furniture and Fittings
 Long Term Investments
Balance Sheet: Terms - 3

 Current Assets
 Items of value owned by the business for short-
term use

 Examples:
 Stock/ Inventory
 Debtors/ Trade receivables
 Bank and Cash
 Short Term Investments
Balance Sheet: Terms - 4

 Current Liabilities
 Creditors: amounts due within one year
 Examples:
 Trade Creditors/ Trade Payables

 Bank Overdraft

 Accrued Taxes/ Tax payable

 Accruals/ Accrued expenses

 Long-term Liabilities
 Creditors: amounts due after more than one year
 Examples:
 Loans

 Lease obligations

 Debentures/ Bonds
Balance Sheet: Terms - 5

 Capital
 Financing provided by owners
 Amount of assets not financed by outsiders
 Pseudo liability:
Amount owed by the business to its owners
Classify the following items as either Asset (fixed or
current) or Liability (long-term or current).

Alexander manufactures and sells biscuits to supermarkets


and grocery stores.
 Cash kept in a tin in a factory office

 Oven

 Bank loan, repayable over 5-years

 Plastic packaging for biscuits

 Flour and sugar

 Amount payable to supplier of dried fruit


Solution

Alexander manufactures and sells biscuits to supermarkets and


grocery stores.
 Cash kept in a tin in a factory office (CA)

 Oven (FA)

 Bank loan, repayable over 5-years(LTL)

 Plastic packaging for biscuits (CA)

 Flour and sugar (CA)

 Amount payable to supplier of dried fruit (CL)


Compute the missing amount in each of the following
situations.

 Brenda’s business has fixed assets of €12,000, current assets


of €8,500, and total liabilities of €17,300. What is Brenda’s
capital?
12,000 + 8,500 – 17,300 = 3,200
 Basil’s capital in his business is €43,650. The business assets
total €188,365. What are Basil’s total liabilities?
188,365 – L = 43,650; L = 144,715
 Blanche’s balance sheet showed fixed assets of €36,609,
current assets of €38,444, current liabilities of €26,300, and
capital of €39,477. What are the total long-term liabilities?
36,609 + 38,444 – 26,300 – LTL = 39,477; LTL = 9,276
Example Limited
Balance sheet
As at 31 December 2011

2011 2010
€'000 €'000 €'000 €'000
Fixed assets
Land and buildings 1,000 750
Plant and machinery 2,500 2,250
Motor vehicles 875 950
4,375 3,950
Current Assets
Stock 1,000 900
Debtors 1,230 1,200
Bank and cash 340 490
2,570 2,590
Current Liabilities
Creditors 850 780
Taxation 500 670
Bank overdraft 600 -
1,950 1,450
Net Current Assets 620 1,140
Total Assets – Current liabilities 4,995 5,090
Example Limited
Balance sheet at 31 December 2011
2011 2010
€'000 €'000 €'000 €'000
Financed by:
Long term Liabilities
Bank term loan 1,000 1,000

Capital:
Share capital 3,000 3,000
Profit and loss account 995 1,090
3,995 4,090
4,995 5,090
Profit and Loss Account

 Profit
 The difference between revenues and
expenses
 Revenues
 Value of goods sold or services rendered during the
accounting period

 Expenses
 All costs of running the business
Example Limited
Trading, Profit and Loss account
for the year ended 31 December 2011

€'000 €'000
Sales 5,000
Cost of sales
Opening stock 500
Purchases 4,500
Closing stock (1,000) (4,000)

Gross profit 1,000


Exercise
 Jackie sells garden furniture in sets comprising a dining
table and four chairs. She purchases each set for €75
from the manufacturer and retails a set for €132. At the
beginning of June 2009, Jackie has 30 sets in stock. At
30st June 2009, the stock room contains 42 sets. She
sells 35 sets during the month.
 How many sets of dining table and chairs has Jackie

purchased during June?


 What is Jackie’s cost of sales for June?

 What is Jackie’s gross profit for June?


Solution
 How many sets of dining table and chairs has Jackie
purchased during June?
Open stock + Purchased units – Close stock = Sold
units; Purchased units = 47
 What is Jackie’s cost of sales for June?

35 x €75 = 2,625;
 What is Jackie’s gross profit for June?

(35 x €132) – (35 x €75) = 1,995


Example Limited
Trading, Profit and Loss account
for the year ended 31 December 2011
2011 2010
€'000 €'000 €'000
Sales 5,000 C
Cost of sales
Opening stock 500 O
Purchases 4,500
Closing stock (1,000) (4,000) M
Gross profit 1,000
Rents received 200 P
Interest received 50
Total income 1,250 A
Less expenses
Salesmen's salaries 250 R
Advertising 50 A
Salaries 300 T
Stationery 50 I
Interest paid 100 V
Bank charges 20 770 E
Profit before tax 530
Accounting System: Double
Entry
 Every transaction has two effects:
 Increase assets and increase liabilities
– Increase one asset and reduce another asset
 Increase assets and increase capital
 Reduce assets and reduce liabilities
– Reduce assets and reduce capital
SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources (OWN) Claims (OWE)

Transaction Cash Debtors Other assets Outsiders Owner


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100

Assets = Liabilities + Capital


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100
2 Borrowing +50 +50

Assets = Liabilities + Capital


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100
2 Borrowing +50 +50
3 Buy property -50 +50

Assets = Liabilities + Capital


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100
2 Borrowing +50 +50
3 Buy property -50 +50
4 Buy stock for cash -45 +45

Assets = Liabilities + Capital


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100
2 Borrowing +50 +50
3 Buy property -50 +50
4 Buy stock for cash -45 +45
5 Sell stock on credit +35 -15 +20

Assets = Liabilities + Capital


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100
2 Borrowing +50 +50
3 Buy property -50 +50
4 Buy stock for cash -45 +45
5 Sell some stock +35 -15 +20
6 Pay wages -4 -4

Assets = Liabilities + Capital


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100
2 Borrowing +50 +50
3 Buy property -50 +50
4 Buy stock for cash -45 +45
5 Sell some stock +35 -15 +20
6 Pay wages -4 -4
7 Customer pays +16 -16

Assets = Liabilities + Capital


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100
2 Borrowing +50 +50
3 Buy property -50 +50
4 Buy stock for cash -45 +45
5 Sell some stock +35 -15 +20
6 Pay wages -4 -4
7 Customer pays +16 -16
8 Buy stock on credit +25 +25

Assets = Liabilities + Capital


SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS

Resources Claims
Transaction Cash Debtors Other assets Outsiders Owner
1 Original capital +100 +100
2 Borrowing +50 +50
3 Buy property -50 +50
4 Buy stock for cash -45 +45
5 Sell some stock +35 -15 +20
6 Pay wages -4 -4
7 Customer pays +16 -16
8 Buy stock on credit +25 +25
TOTALS +67 +19 +105 +75 +116
191 191
Assets = Liabilities + Capital
Balance sheet
€'000
Property 50
Stock 55
Debtors 19
Cash 67
191

Financed by: €'000


Capital 100
Retained earnings 16
Shareholders' funds 116
Loan 50
Creditors 25
191
Accruals Concept
In order to meet their objectives, financial statements are
prepared on the accrual basis of accounting

Under this basis, the effects of transactions and other events


are recognised when they occur (and not as cash or its
equivalent is received or paid)

and they are recorded in the accounting records and reported


in the financial statements of the periods to which they
relate.

Costs can be included before cash is paid out


 Expenses typically paid in arrears: e.g., electricity,

wages, audit fees, telephone, etc


Accruals Example

Light and heat due for the year ended 31 December 2010
= €12,000
Expense in profit and loss account for year ended 31
December 2010 = €12,000

Light and heat paid during the year = €8,000

Accrued light and heat at 31 December 2010


(current liability in Balance sheet) = €4,000
Accruals Example

– Connect Ltd. rented premises on 1 January 20X1

– On 31 December 20X1 (the date of its year end) it had


not made any rent payments

– Rent for the year is €1,000

– Expense for the year is €1,000

– To record this transaction, both the expense and the


liability for the rent due must be created, hence accrual.
Prepayments Example

 Rent for the year ended 31 December 2008 =


€24,000
 Expense in profit and loss account for year
ended 31 December 2008 = €24,000

 Rent paid during the year = €30,000

 Prepaid rent at 31 December 2008


(current asset in Balance sheet) = €6,000
Prepayments Example

 Stationery paid during year €80,550;


 Stock of stationery at year end €20,550

 How much should be charged for stationery in


the P/L?
 How much must be prepaid?
Depreciation

Depreciation is the systematic allocation


of the depreciable amount of an asset
over its useful life

The amount of depreciation refers to the loss of value


that the asset suffers due to factors such as wear
and tear and passage of time.
Depreciation

Useful life is:


(a) the period over which an asset is expected to be
available for use by an entity; or
(b) the number of production or similar units expected to
be obtained from the asset by an entity
Depreciation

A business buys a car for €50,000. It expects to keep the


car for 5 years.
The business uses the straight-line method of depreciation

Calculation of depreciation

Cost of car 50,000


5 year life
Depreciation each year 10,000
Bad Debts
 Debtors may not pay what they owe us, hence bad debt
 Bad debts are an expense in P&L
 Bad debts reduce Debtors
 EXAMPLE
 Sales to A Ltd €50
 Sales to B Ltd €240
 Cash received: €200 from B Ltd
 Bad debts to be written-off for year:
 A Ltd €50
 B Ltd €40