FINANCIAL REPORTS

Chapter 3
 ACCOUNTING
CONVENTION/CONCEPT
• Used in construction of financial statements & recording of
a/cting transactions

1. Business entity
2. Going concern
3. Accruals
4. Prudence
5. Consistency
6. Materiality
7. Duality
8. Historical Cost
9. Realization
BUSINESS
ENTITY
• Business and
personal dealings
should be
separated.
GOING
CONCERN

• Assumption that
the business will
continue trading
into the future.
• Thus valuation of
assets should be
based on cost.
ACCRUALS
• The financial statements are constructed on
the basis that incomes & expenses are
linked to the period in which they are
incurred rather than when the money for the
income & expense changes hands.
PRUDENCE

• Is to be careful.
• Requires the
accounts to be
constructed with fair
degree of caution
• Always states a low
profit
• Do not anticipate
profit but do expect
loss
• Business should not
be over confident
CONSISTENCY

• Any accounting
methods that are
selected should
be used in a
consistent
manner
MATERIALITY

• “Material” amount
refers to a monetary
amount that is
significant enough to
be recorded
separately
DUALITY

• Ties in with
accounting equation
• Each transaction can
be viewed &
considered to have
two effects on the
business
• These effects will
always be equal to
one another
HISTORICAL COST
• Assets should be valued at the original cost
of the asset
REALIZATION

Sales should be
recognized when
goods passed to
customer or
services already
rendered.
CLASSIFICATION OF
TRANSACTIONS
• Assets
• Liability
• Capital or equity
ASSETS
• Assets are resources owned by a business
• All assets have the capacity to provide future
services and benefits
• E.g. property, equipment and cash.
LIABILITY
• Claims against assets
• Debts and obligation
• What is owed by the business to others
• Short term – need to be repaid soon
• Long term – outstanding and owing for many
years
• E.g. loan to bank
CAPITAL OR EQUITY
• Resources supplied to the business by the
owner(s) of the business
• Can be in the form of money or other assets
LETS DO IT TOGETHER Q1
EXAMPLE QUESTION 1

Classify the following into assets or liabilities:

(a) Business premises

(b) Bank overdraft
(c) Money owed by others to the business
(d) Equipment owned by the business
(e) Mortgage on premises
(f) Cash held in till
(g) Unpaid bill
ACCOUNTING EQUATION
• An introduction to the system of double-entry
book-keeping.
• Will use the duality concept.
• Classify the accounts into 2:
– What the business own
– What the business owes
WHAT THE BUSINESS OWNED
• Assets are the resources owned by a
business.
WHAT THE BUSINESS OWES
• Liabilities and capital (or owners’ equity) are
the claims against these assets.
 THE EQUATION
• This then form a relationship between
assets, liabilities and capital.
ASSETS = LIABILITIES + CAPITAL (or
OWNERS’ EQUITY)
THE EQUATION
• It’s actually the statement of financial
position of the business a.k.a Balance Sheet.
LET’S DO IT TOGETHER Q2
Complete the gaps in the table below:

Assets Liabilities Capital

(a) 4,100 1,300
(b) 3,870 2,680
(c) 9,875 8,680
(d) 543 637
(e) 6,767 1,107
THE BALANCE SHEET EQUATION
• Financial position of a business is reflected
in the relationship between the classification
of assets, liabilities and proprietorship.
EXAMPLE
1 APRIL
• Decide to establish a new restaurant
• Owners contribute personal funds of
RM15,000 which is placed in a bank
account.
•Two things are obvious:
 Funds need to be obtained to set up the operation.
 The business will have assets which represents the
funds contributed.
 1 APRIL

BALANCE SHEET AS AT 1 APRIL

ASSETS CAPITAL
Cash in bank 15,000 Owner’s
contribution 15,000
2 APRIL
• Commence the fitting out of the restaurant
• Purchase kitchen equipment for RM 8,000
with cash
• Purchase Furniture for RM 5,000 with cash
2 APRIL

BALANCE SHEET AS AT 2 APRIL

ASSETS CAPITAL
Cash in bank 2,000 Owner’s
contribution 15,000
Kitchen equipment 8,000
Furniture & Fittings 5,000
15,000 15,000
10 APRIL
• Need to purchase RM 3,000 of foodstuffs
• Need to maintain RM2,000 in the bank
• Negotiate with bank to give us an overdraft
of RM 3,000 to buy the food stock
10 APRIL

BALANCE SHEET AS AT 10 APRIL

ASSETS CAPITAL
Cash in bank 2,000 Owner’s
contribution 15,000
Kitchen equipment 8,000
Furniture & Fittings 5,000 LIABILITIES
Stock of foodstuff 3,000 Bank overdraft 3,000
18,000 18,000
THE BALANCE SHEET EQUATION
• Each transaction will affect assets on one
side of the equation and liabilities or capital
on the other
• This form the basis of double-entry book
keeping techniques of recording
• The Balance Sheet can also be presented in
the statement form.
BALANCE SHEET IN STATEMENT
FORM
BALANCE SHEET AS AT 10 APRIL

ASSETS:
Cash in bank 2,000
Kitchen equipment 8,000
Furniture & fittings 5,000
Stock 3,000 18,000

LIABILITIES:
Bank overdraft 3,000
15,000
CAPITAL:
Owner’s contribution 15,000
COMPONENTS OF BALANCE
SHEET
1. Assets
2. Liabilities
3. Capital or equity
ASSETS
a) Current Assets
b) Fixed or Non-current Assets
c) Other Non-current Assets (Intangible
Assets)
CURRENT ASSETS
• Cash or items that normally be converted to
cash during a 12-month period of business
trading
FIXED OR NON-CURRENT
ASSETS
• Items are owned by the business and used
to run the business.
• Have longer life span
• Would not be used up in the normal trading
process within the short term
FIXED OR NON-CURRENT
ASSETS IN HOTELS
FIXED OR NON-CURRENT
ASSETS IN TRAVEL AGENCIES
FIXED OR NON-CURRENT
ASSETS IN RESTAURANTS
OTHER NON-CURRENT ASSETS
LIABILITIES
a) Current Liabilities
b) Non-current Liabilities
CURRENT LIABILITIES
• Claims on the business that will be
addressed within a year.
• Trade creditors
• Short-term loans
NON-CURRENT LIABILITIES
• Claims by outsiders on the business that
would fall due in excess of 1 year.
• Long-term loans
CAPITAL OR OWNER’S EQUITY
1) Original contribution of shareholder’s funds
2) Drawings or withdrawals
PROFIT STATEMENT REPORTING
• Formula for calculating profit:
Profit = Revenue – Expense
• Requires a matching of the revenue with the
expense for the same period :
Accruals Concept
• Each transaction will have 2 effects, one on
assets or liabilities & one on revenue or
expense :
Duality Concept
COMPONENTS OF PROFIT OR
LOSS STATEMENT REPORT
1. Sales
2. Cost of goods sold
3. Gross profit
4. Operating expenses
5. Net profit
SALES
• Trading income arising from both cash and
credit sale activity.
COST OF GOODS SOLD
• Cost of trading stocks used in the selling
process
Stock on hand at beginning
+ Purchases during period
- Stock on hand at end
= Cost of stock used during period
GROSS PROFIT
• Difference between sales and the cost of
stock sold
• Reflects the profit from trading activity after
selling the physical product without taking
into account other expenses
OPERATING EXPENSE
• Other costs of running the business apart
from cost of stock used
NET PROFIT
• Reflects the operating result after taking into
account all expense.
 EXAMPLE

RM
Cash sales 10,000
Cash payments for:
Rent 1,500
Advertising 500
Printing and stationery 1,000
Wages 3,000
Purchases of stock 2,000
 EXAMPLE
Transaction Amount RM Effect
Cash sales 10,000 Increase asset cash
Increase revenue
Rent 1,500 Decrease asset cash
Increase expense
Advertising 500 Decrease asset cash
Increase expense
Printing and 1,000 Decrease asset cash
stationery Increase expense
Wages 3,000 Decrease asset cash
Increase expense
Purchase stock 2,000 Decrease asset cash
Increase asset stocks
 PROFIT REPORT FOR MONTH ENDING 30 APRIL

RM RM
Sales 10,000
Less Cost of goods sold
Opening stock -
+ Purchases 5,000
- Closing Stock 2,000 3,000
Gross Profit 7,000
Less Operating Expenses
Rent 1,500
Advertising 500
Printing and stationery 1,000
Wages 3,000 6,000
Net Profit 1,000
 BALANCE SHEET AS AT 30 APRIL

ASSETS:
Current:
Cash in bank 4,000
Stock 2,000 6,000
Fixed:
Kitchen equipment 8,000
Furniture & fittings 5,000 13,000
19,000

LIABILITIES:
Current:
Bank overdraft 3,000
16,000
CAPITAL:
Owner’s contribution 15,000
Net profit 1,000
16,000
ANSWER 1
a) Liability
b) Asset
c) Asset
d) Asset
e) Current Liability
f) Current Liability
ANSWER 2

a) Asset l) Asset
b) Expense m) Expense
c) Asset n) Expense
d) Liability o) Expense
e) Asset p) Liability
f) Revenue q) Expense
g) Expense r) Expense
h) Asset s) Revenue
i) Asset t) Expense
j) Asset u) Asset
k) Revenue
ANSWER 3
a) 4,344
b) 5,122
c) 74,423
d) 45,434
e) 11,209
ANSWER 4
a) 64,564
b) 100,113
c) 9,871
d) 65,375
e) 55,557
ANSWER 5

a) Asset g) Capital
b) Expense h) Asset
c) Liability i) Revenue
d) Asset j) Expense
e) Asset k) Expense
f) Asset l) Expense
ANSWER 6
a) Asset f) Asset
b) Liability g) Liability
c) Asset h) Asset
d) Expense i) Liability
e) Revenue j) Revenue
ANSWER 7

PROFIT REPORT
RM RM
Sales 50,000
Less Cost of Goods Sold (30,000)
GROSS PROFIT 20,000
Less Operating Expenses
Wages paid to staff 4,000
Administration expenses 9,000
Sales promotion 1,000 (14,000)
NET PROFIT 6,000
ANSWER 7
BALANCE SHEET
RM RM RM
FIXED ASSETS:
Land & building 200,000
Equipment 10,000 210,000

CURRENT ASSETS:
Cash in bank 15,000
Debtors 6,000
Stocks 8,000 29,000

LESS CURRENT LIABILITIES:

Creditors (10,000) 19,000
229,000
CAPITAL:
Owner’s investment 223,000
(+) Profit 6,000
229,000
ANSWER 8

PROFIT STATEMENT FOR THE MONTH ENDED 31 DECEMBER

RM RM
Sales 240,000
Less: Cost of Sales
Opening stock 42,000
(+) Purchases 138,000
(-) Closing stock (45,000) (135,000)
GROSS PROFIT 105,000
Less: Operating Expenses
Wages 72,000
Expenses 24,000
Administration expenses 5,000 (101,000)
NET PROFIT 4,000
ANSWER 8

BALANCE SHEET AS AT 31 DECEMBER

ASSETS: RM RM
Land and building 205,000
Cash in bank (25,000 + 240,000 –
239,000) 26,000
Equipment 80,000
Stock 45,000
Furniture 22,000 378,000
Less : LIABILITIES
Bank loan (144,000)
234,000
FINANCED BY:
Capital 180,000
Accumulated profit (50,000 + 4,000) 54,000 234,000