06b Introduction To Financial Accounting and Financial Statements Lecture

Accounting
Introduction to Financial Statements

Reading - Jones, 2013, Chs. 4,5 & 6
4 Main Financial Statements: The Income
Statement (Profit And Loss Account)
5 Main Financial Statements: The
Statement Of Financial Position (Balance
Sheet)
6 Preparing The Financial Statements
7 Partnerships And Limited Companies
1. MAJOR ACCOUNTING STATEMENTS
The major financial statements of an organisation try and answer the

following questions
· What cash movements took place?
· How much wealth was generated?
· What is the accumulated wealth of the business at the end of
the period and what form does it take?
To address each of the above questions, there is a separate financial
statement.
· the statement of cash flows,
· the Income statement (also known as the profit and loss
account), and
· the statement of financial position (also known as the balance
sheet).
Imperial College Business School Imperial means Intelligent Business 2

1.1 Example Bobby Byrd decided to set up a hotdog stall and sell in his local
high street. He began the venture with £60 of his own money, in cash. On
Monday, Bobby's first day of trading, he bought hotdogs for £60 and sold
three-quarters of it for £70 cash.
1.2 What cash movements took place in Bobby's business during

Monday?
For Monday, a statement of cash flows showing the cash movements (that
is, cash in and cash out) for the day can be prepared as follows:
Statement of cash flows for Monday
£
Cash introduced (by Bobby) 60
Cash from sales of hotdogs 70
Cash paid to buy hotdogs (60)
Closing balance of cash 70

1.3 How much wealth (profit) was generated by the business during
Monday?
An income statement can be prepared to show the wealth generated (profit)
on Monday. The wealth generated arises from trading and will be the
difference between the value of the sales made and the cost of the goods
(that is, hotdogs) sold.
Income statement for Monday

£
Sales revenue 70
Cost of goods sold (3/4 of £60) (45)
Profit 25
Note that it is only the cost of the hotdogs sold that is matched against
(and deducted from) the sales revenue

1.4 What is the accumulated wealth on Monday evening and what form
does it take?
To establish the accumulated wealth at the end of Monday's trading, we can
draw up a statement of financial position for Bobby's business. His
statement lists the forms of wealth held at the end of that day.
Statement of financial position as at

Monday evening
£
Cash (closing balance) 70
Inventories of goods for resale (of £60) 15
Total assets 85
Equity Original equity + New Profit = 85

£60 + £25

2. CLASSIFYING ITEMS
To produce a set of financial statements we need to group items

in the following categories
Income -the value of goods sold, at selling price
Expenses - costs incurred by the business in the course of
trading
Asset -an item owned by the business, either
1. for future use within the business, e.g. motor vehicle; or
2. which will be converted to money as part of the day to
day trading activities such as purchases for resale (inventory)
Liability - amounts owed to people other than the owner, e.g.
for loans

2. CLASSIFYING ITEMS
Capital - the amount of money owed by the business to the

owner.
Initially = money invested by the owner
Dividends - amounts taken out of the business by the owner for
their own use
other useful terms include:

Trade Receivable (Debtor) - a person who owes money to the
business for goods/ services supplied to them
Trade Payable (Creditor) - a person to whom money is owed
for goods or services

The Accounting Process
1. Transaction, e.g. bought computer for £1,000 by cheque, 4.

Income
State.
2. 3. Trial
Ledger balance
5.
State.
of Pos.
• 1. Transaction
• 2. Entry into the books (ledger)
• 3. Summarise the entries in the Trial Balance
• 4 Use summarised information to produce the final accounts

3. THE ACCOUNTING PROCESS
3.1 RECORDING TRANSACTIONS

In financial statements accounting transactions for the whole
accounting period (usually 1 year) are summarised, e.g. sales =
£500,000, but how is that information gathered?
The preparation of accounting statements is the final stage of
the accounting process, but where does it start?
The 1st stage in the process involves recording the transactions
in a book and adding them up at the end of period, (this is
known as bookkeeping)
So how exactly do we list these transactions?

3.1.1 Double entry bookkeeping
Bookkeeping is based on the principle that every transaction has
2 effects,
E.g., if you buy a chocolate bar from the shop, you have:
1. One more chocolate bar than before
2. Less money than before
You are giving on the one hand but receiving on the other
Consider the following:

The Case Study:
Maceo Parker formed a new company selling alternative healthcare

products. A company has a separate legal identity from its owner(s).The
shareholder’s liability is limited to the value of the owners investment.
At the beginning of the 2nd year, the business has the following:
£
Inventory (opening) 1,500
Bank 127,400
128,900
These assets (resources) have been funded through the following:
£
Equity Capital 90,000
Retained Earnings 38,900
128,900
The following transactions happened during the year (2025):
The Meeting:
Maceo asks their accountant Diana Ross to solve what seems like a
mystery for him. Maceo assumed he had been successful during the
year but is puzzled by the outcome.
Maceo: Can you tell how successful the business has been? I
thought I was doing well but I’ve got a lot less money in the bank
than when I started.
Diana: Is it the decrease in the bank balance you are worried about or
is it whether or not you have made a profit?
Maceo: Well aren’t the 2 things connected? I just have no idea how
well I have done this year and what I’ve spent my money on.
Diana: Don’t worry I’ll put all these transactions together, and come
up with some answers…

Accounts Item Type Up/down
Flames Ltd buys property Property Asset Up
for the business of
Bank Asset Down
£100,000 from the bank
01-Jan account
Flames Ltd buys machinery Machinery Asset Up
for the business of £25,000 Bank Asset Down
01-Jan from the bank account

Flames Ltd manages to
Bank Asset Up
raise a loan of £30,000
Loan Liability Up
01-Jan from Loan's 'R Us
Flames Ltd purchases Purchases Expense Up
02-Jan £25,000 inventory,on credit Trade Pay. Liability Up
Flames Ltd pays an Advertising Expense Up
advertising bill of £6,000, Asset
Bank Down
03-Jan from the bank account
Flames Ltd pays for £8,000 Rent
Expense Up
04-Jan rent of the shop, from the
business bank account. Bank Asset Down

Item Type
Flames Ltd pays wages of
Wages Expense Up
£3,000 to the staff, from the
05-Jan business bank account, Bank Asset Down
Flames Ltd pays dividends of
Dividends Equity Down
£5,000 from the business
bank account Bank Asset Down
06-Jan
Flames Ltd settles the Trade Pay. Liability Down
amount owing to trade
payable (£25,000) from the Bank Asset Down
08-Mar business bank account
Flames Ltd sells some of the
Sales Income Up
14-May products for £30,000 with the
customer paying immediately Bank Asset Up

Flames Ltd purchases Purchases Expense Up
06-Jun £34,400 inventory, on credit Trade Pay. Liability Up
Flames Ltd pays an electricity
bill of £3,000, from the Electricity Expense Up
26-Jun business bank account Bank Asset Down
Flames Ltd pays a telephone
Telephone Expense Up
bill of £500, from the business
24-Aug bank account. Bank Asset Down
Flames Ltd pays wages of Wages Expense Up
17-Sep £6,000 to staff, from the Bank
business bank account, Asset Down

Item Type
Flames Ltd pays dividends of Dividends Equity Down
£15,000 from the business
Bank Asset Down
23-Sep bank account
Flames Ltd sells some of the
healthcare products for Sales Income Up
24-Oct £70,000 with the customer Up
paying later (a debtor) Trade Rec. Asset
The debtor settles some of Trade Rec. Asset Down
the amount they owe
22-Dec (£30,000) Bank Asset Up
Flames Ltd settles some of Trade Pay. Liability Down
the amount owing to the
29-Dec creditors (£12,400) from the Bank Asset Down
business bank account

You will have seen that every transaction has 2 effects and that you
can have:
2 items increasing;
1 item increasing and 1 item decreasing or;
2 items decreasing
1 January 4 January 12 February

Bank Loan Rent Bank Bank Acc. Pay.

Every time a transaction is made, we enter the transactions in a book
(ledger).
The general/nominal ledger

Each page in the book contains a different account. An account is a place
where all the information relating to a particular asset, liability, income,
expense or capital (equity) is recorded.
e.g. there will be an account for buildings, electricity, sales, loans,

etc.

The double-entry system divides each page into 2 halves so that a
buildings account may look like:
Buildings
Debit (Dr.) Credit (Cr.)
This type of account is often referred to as a ‘T’ account.

The left-hand side of the page is called the ‘debit’ side. The right-
hand side of the page is called the ‘credit’ side.

We Drive on the
left and Crash on
the right
Every building bought will be listed in this account.
What side of the account will we make the entry on?

Out of the following, which items do we spend money on, and which
do we receive money from?
assets, liabilities, capital (equity), income, expenditure
The business spends money when

· increasing our assets (buying a new van)
· increasing our expenses (paying for advertising)
· decreasing our liabilities (paying off a loan)
Any such entry into one of these accounts will be on the debit side.

we receive money when we
· decrease our assets (e.g. selling one of our buildings)
· increase our liabilities (raising a loan)
· increase our sales (selling our inventory)
· increase our capital (injection of funds by the owner)
Any such entry into one of these accounts will be on the credit side.

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Consider the following example:
Paid rent of £8,000, paying from the bank

4 steps to double entry bookkeeping
•1. What 2 accounts are involved?

•2. What types of accounts are they? (assets, liabilities, income,
expenses, capital [equity])
•3. Are they going up or down?
•4. Do we debit or credit these accounts

Rent Bank
£ £
4/1 Cash 8,000 4/1 Rent 8,000
If you follow this method then you will find that every, transaction has an
equal amount of debits and credits. In other words, the books ‘balance’.

1 January
Bank
£ £
01/01/25 bal 127,400 01/01/25 Property 100,000
Property
£ £
01/01/25 Bank 100,000

1 January
Bank
£ ££
01/01/25 bal 127,400 01/01/25 Property 100,000
01/01/25 Machinery 25,000
Machinery
£ £
01/01/25 Bank 25,000

1 January
Bank
£ £
01/01/25 bal 127,400 01/01/25 Property 100,000
01/01/25 Loan 30,000 01/01/25 Machinery 25,000
Loan
£ £
01/01/25 Bank 30,000

2 January
Purchases
£ £
02/01/25 Creditors 25,000
Creditor
£ £
02/01/25 Purchases 25,000

3 January
Bank
£ £
01/01/25 bal 127,400 01/01/25 Property 100,000
01/01/25 Loan 30,000 01/01/25 Machinery 25,000
03/01/25 Advertising 6,000
Advertising
£ £
03/01/25 Bank 6,000

4 January
Bank
£ £
01/01/25 bal 127,400 01/01/25 Property 100,000
01/01/25 Loan 30,000 01/01/25 Machinery 25,000
04/01/25 Rent 8,000
Rent
£ £
04/01/25 Bank 8,000

5 January
Bank
£ £
01/01/25 bal 127,400 01/01/25 Property 100,000
01/01/25 Loan 30,000 01/01/25 Machinery 25,000
04/01/25 Rent 8,000
05/01/25 Wages 3,000
Wages
£ £
05/01/25 Bank 3,000

6 January
Bank
£ £
01/01/25 bal 127,400 01/01/25 Property 100,000
01/01/25 Loan 30,000 01/01/25 Machinery 25,000
04/01/25 Rent 8,000
05/01/25 Wages 3,000
06/01/25 Dividends 5,000
Dividends
£ £
06/01/25 Bank 5,000

8 March
Bank
£ £
01/01/25 bal 127,400 01/01/25 Property 100,000
01/01/25 Loan 30,000 01/01/25 Machinery 25,000
04/01/25 Rent 8,000
05/01/25 Wages 3,000
06/01/25 Dividends 5,000
08/03/25 Creditors 25,000
Creditors
£ £
08/03/25 Bank 25,000 02/01/25 Purchases 25,000

3.2 THE TRIAL BALANCE
You have already seen that with double entry bookkeeping:
for each debit entry there is a credit entry
1.for each credit entry there is a debit entry
Therefore the total the items recorded on the debit side of the
accounts should equal the total of the items recorded on the
credit side of the accounts.
To see if the 2 sides ‘balance’ (are equal), a trial balance may
be drawn up at the end of the period.

A trial balance is drawn up by listing all the t-accounts in the
ledger and listing their debit or credit balances.
A trial balance may look like this:
TRIAL BALANCE AS AT 31/08/15

DR. CR.
£ £
Sales 500
Purchases 400
Office Equipment 1,000
Cash 100
Bank 500
Ordinary Shares 1,500
2,000 2,000
This trial balance does balance, which suggests that our double
entry bookkeeping may be correct. If the trial balance did not
balance, our double entry bookkeeping would definitely contain
an error and we would need to find that error.
The transactions of Flames Ltd lead to the following trial balance
T. B. of Flames Ltd as at 31/12/25
DR. CR.
£ £
Retained Earnings 38,900
Sales 100,000
Purchases 59,400
Advertising 6,000
Rent 8,000
Electricity 3,000
Telephone 500
Wages & Salaries 9,000
Buildings 100,000
Machinery 25,000
Stock (opening) 1,500
Trade Receivables 40,000
Bank 8,500
Trade Payables 22,000
Dividends 20,000
Equity 90,000
Loan 30,000
280,900 280,900
3.3 THE FINANCIAL STATEMENTS
3.3.1 Profit & Loss Account / Income Statement
Income Statement of Flames Ltd year end 31/12/25
£ £
Sales 100,000
Less: Cost of sales
Opening inventory 1,500
Purchases 59,400
60,900
Closing inventory* (900)
(60,000)
Gross Profit 40,000
Closing inventory counted at the end of the year = £900

*
This starts by only considering the data relating to the product being sold.
Sales = income generated from the products/services of the business.
Cost of sales = the cost of the products/services sold.
Sales - Cost of Sales = Gross Profit. This section is often called the trading account.
£ £
Sales 100,000
Less: Cost of sales
Opening inventory 1,500
Purchases 59,400
60,900
(60,000)
Gross Profit 40,000
How do we calculate cost of goods sold?
To find out the cost of goods sold we need to know the following:
How much inventory did we have at the beginning of the accounting year (opening
inventory)?
How much inventory did we buy during the year (purchases)?
Therefore how much inventory did we have in total during the year?
Of this inventory, how much was still in inventory/unused at the end of the year (closing
inventory)?
Therefore how much inventory was used (sold) during the year, at cost price?
£ £
After the gross profit
Sales
has been calculated,
100,000
Less: Cost of sales we then include all
Opening inventory 1,500 other income (not
Purchases 59,400 arising from the main
60,900 products/services of the
organisation) and all
other costs ‘expenses’
(60,000)
Gross Profit 40,000
Less: Expenses
Advertising 6,000
Rent 8,000
Electricity 3,000
Telephone 500
Wages & Salaries 9,000
(26,500)
Net profit (Operating Profit) 13,500
3.3.2 Balance Sheet / Statement of Financial Position
Statement of Financial Position of Flames Ltd
as at 31/12/25 - a statement showing the
ASSETS
£ £ £ financial position of a
Non-Current Assets
Land & Buildings
business at a point in time,
Machinery (what does it own, what does
Current Assets it owe at the end of the year?)
Inventory
Trade Receivables
Bank
Assets should be listed
Total Assets
LIABILITIES starting with the most
Current liabilities
Trade Payables permanent, e.g. Land &
Non-current liabilities Buildings, ending with the
Loan
Total Liabilities least permanent, e.g. cash.
Net Assets
EQUITY
Ordinary Shares
Retained Earnings


as at 31/12/25
ASSETS
£ £ £
Non-Current Assets
Land & Buildings 100,000
Machinery 25,000
125,000
Current Assets
Inventory 900
Trade Receivables 40,000
Bank 8,500
49,400
Total Assets 174,400

as at 31/12/25
LIABILITIES
Current liabilities
Trade Payables 22,000
Non-current liabilities
Loan 30,000
Total Liabilities 52,000
Net Assets 122,400
EQUITY
Ordinary Shares 90,000
Retained Earnings 32,400 (£38,900 + £13,500 - £20,000)
122,400 (opening retained earnings +
net profit - dividends)

06b Introduction To Financial Accounting and Financial Statements Lecture

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Accounting

Introduction to Financial Statements

The major financial statements of an organisation try and answer the

Imperial College Business School Imperial means Intelligent Business 2

1.2 What cash movements took place in Bobby's business during

Imperial College Business School Imperial means Intelligent Business 3

Income statement for Monday

Imperial College Business School Imperial means Intelligent Business 4

Statement of financial position as at

Equity Original equity + New Profit = 85

Imperial College Business School Imperial means Intelligent Business 5

To produce a set of financial statements we need to group items

Imperial College Business School Imperial means Intelligent Business 6

Capital - the amount of money owed by the business to the

other useful terms include:

Imperial College Business School Imperial means Intelligent Business 7

1. Transaction, e.g. bought computer for £1,000 by cheque, 4.

Imperial College Business School Imperial means Intelligent Business 8

3.1 RECORDING TRANSACTIONS

Imperial College Business School Imperial means Intelligent Business 9

Imperial College Business School Imperial means Intelligent Business 10

Maceo Parker formed a new company selling alternative healthcare

Imperial College Business School Imperial means Intelligent Business 12

Imperial College Business School Imperial means Intelligent Business 13

Imperial College Business School Imperial means Intelligent Business 14

Imperial College Business School Imperial means Intelligent Business 15

Imperial College Business School Imperial means Intelligent Business 16

Imperial College Business School Imperial means Intelligent Business 17

1 January 4 January 12 February

Imperial College Business School Imperial means Intelligent Business 18

The general/nominal ledger

e.g. there will be an account for buildings, electricity, sales, loans,

Imperial College Business School Imperial means Intelligent Business 19

Debit (Dr.) Credit (Cr.)

This type of account is often referred to as a ‘T’ account.

Imperial College Business School Imperial means Intelligent Business 20

Every building bought will be listed in this account.

What side of the account will we make the entry on?

Imperial College Business School Imperial means Intelligent Business 21

assets, liabilities, capital (equity), income, expenditure

The business spends money when

Imperial College Business School Imperial means Intelligent Business 22

Imperial College Business School Imperial means Intelligent Business 23

Imperial College Business School Imperial means Intelligent Business 24

Paid rent of £8,000, paying from the bank

•1. What 2 accounts are involved?

Imperial College Business School Imperial means Intelligent Business 25

Imperial College Business School Imperial means Intelligent Business 26

Imperial College Business School Imperial means Intelligent Business 27

Imperial College Business School Imperial means Intelligent Business 28

Imperial College Business School Imperial means Intelligent Business 29

Imperial College Business School Imperial means Intelligent Business 30

Imperial College Business School Imperial means Intelligent Business 31

Imperial College Business School Imperial means Intelligent Business 32

Imperial College Business School Imperial means Intelligent Business 33

Imperial College Business School Imperial means Intelligent Business 34

Imperial College Business School Imperial means Intelligent Business 35

Imperial College Business School Imperial means Intelligent Business 36

TRIAL BALANCE AS AT 31/08/15

Closing inventory counted at the end of the year = £900

Imperial College Business School Imperial means Intelligent Business 42

Statement of Financial Position of Flames Ltd