FMA 1.pptx

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FINANCIAL and MANAGERIAL
ACCOUNTING
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Financial and Managerial Accounting
TABLE OF CONTENTS
FINANCIAL ACCOUNTING
CHAPTER ONE INFORMATION FOR DECISION MAKING
CHAPTER TWO BASIC FINANCIAL STATEMENTS
CHAPTER THREE THE ACCOUNTING CYCLE
CHAPTER FOUR FINANCIAL ASSETS
CHAPTER FIVE FINANCIAL STATEMENT ANALYSIS MANAGEMENT
ACCOUNTING,
CHAPTER SIX MANAGEMENT ACCOUNTING BASIC FRAMEWORK
CHAPTER SEVEN COST – VOLUME – PROFIT /CVP/ ANALYSIS
CHAPTER EIGHT INCREMENTAL ANALYSIS

Part I Financial Accounting
CHAPTER ONE INFORMATION FOR DECISION
MAKING
CHAPTER TWO BASIC FINANCIAL STATEMENTS
CHAPTER THREE THE ACCOUNTING CYCLE
CHAPTER FOUR FINANCIAL ASSETS
CHAPTER FIVE FINANCIAL STATEMENT ANALYSIS

CHAPTER – 1 CHAPTER ONE INFORMATION FOR DECISION MAKING
INTRODUCTION TO FINANCIAL ACCOUNTING
Contents
What is Accounting
Objectives of Accounting
Types of Accounting Information
Accounting Systems
Basic Functions of Accounting
Conceptual Framework for Financial Reporting
Basic Concepts of Financial Accounting and
Reporting

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Accounting is the language of
business!
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• Is a composite activity of:
 identifying,
 recording, and
 communicating
the economic events of an organization to interested users.
• Accounting is often called the “language of business”
Accounting is the art of analyzing, recording, summarizing,
evaluating and reporting, if necessary, interpreting
information about business transactions.
What is Accounting?
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Three Activities
The accounting process includes
the bookkeeping function.
What is Accounting?
Financial Accounting and Management Accounting
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• Accounting can be defined as an information
system that provides reports to users about the
economic activities and condition of a
business.
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Accounting
information
The accounting
process
Decision makers
Economic
activities
Actions
(decisions)
Accounting “links”
decision makers with
economic activities
and with the results
of their decisions.
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Information
Users
 Investors
 Creditors
 Managers
 Owners
 Customers
 Employees
 Regulatory
agencies
Decision Support
 CVP analysis
 Performance
evaluation
 Incremental
analysis
 Budgeting
 Capital
allocation
 Earnings per
share
 Ratio analysis
Information System
Cost & Revenue
Determination
 Job costing
 Process costing
 ABC
 Sales
Assets & Liabilities
 Plant and
equipment
 Loans & equity
 Receivables,
payables & cash
Cash Flows
 From operations
 From financing
 From investing
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Management
There are two broad groups of users of
financial information: internal users
and external users.
Human Resources
Revenue
Offices
Labor Unions
Securities
controlling bodies
Marketing
Finance
Investors
Creditors
Customers
Internal Users
External Users
Who Uses Accounting Data
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Common Questions Asked User
1. Can we afford to give our
employees a pay raise?
Human Resources
2. Did the company earn a
satisfactory income?
3. Should any product lines be
eliminated?
4. Is cash sufficient to pay dividends to
stockholders?
5. What price for our product will
maximize net income?
6. Will the company be able to pay its
debts as they become due?
Investors
Management
Finance
Marketing
Creditors
Who Uses Accounting Data
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Its purpose is to communicate or report the results
of business operations and its various aspects.
It is the process of identifying, measuring and
communicating economic information to permit
informed judgments and decisions by users of the
information.
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 AICPA has defined accounting as“ is the art of recording, classifying
and summarizing in a significant manner and in terms of money
transactions and events which are, in part at least, of a financial
character and interpreting the results thereof.”
 AAA has defined accounting as “the process of identifying,
measuring and communicating economic information to permit
informed judgments and decisions by users of the information.”
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Objectives of Accounting
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1. To record the business transactions in a systematic manner.
2. To determine the gross profit and net profit earned by a firm
during a specific period.
3. To know the financial position of a firm at the close of the
financial year by way of preparing the balance sheet.
4. To facilitate management control.
5. To assess the taxable income and the sales tax liability.
6. To provide requisite information to different parties, i.e.,
owners, creditors, employees, management, government,
investors, financial institutions, banks etc.
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Accounting Information(AI): A Means to an End
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Accounting was developed as a system for reporting
information to the owners including shareholders & other
investors of the business
Accounting information is not an end , but is a means to an
end i.e. its final product is decision which is ultimately
enhanced by the use of accounting information, whether
that decision made by owners, management, creditors,
government bodies, labor unions ,etc.
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Accounting from a User’s Perspective
Many people think of accounting as simply a highly technical
field practiced only by professional accountants.
In reality, nearly every one uses accounting information daily
to measure & communicate economic events.
Whether you manage a business , make investments ,or
monitor how you receive & use your money, you are working
with accounting concepts & accounting information.
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Types of Accounting Information
 Financial, Managerial & Tax Accounting, are the 3 types of Accounting
Information used widely in the business community
1.Financial Accounting: financial accounting information appears in financial
statements that are intended for external use.
 Describes the financial resources, obligations,& activities of an economic entity.
 It is designed to primarily to assist investors & creditors in deciding where to
place their scarce investment resources.
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2. Management Accounting: management accounting
information is for internal use & provides special
information for managers.
Information managers use may range from broad, long-
range planning data to detailed explanations of why
actual costs varied from cost estimates.
Management accounting generates information that
managers can use to make sound decisions such as
financial, resource allocation, production & marketing
decisions.
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3.Tax Accounting- preparation of income tax returns
is a specialized field in accounting.
Tax returns are based on financial accounting
information.
However, the information is adjusted/ reorganized to
conform with income tax reporting requirements.
Income tax planning is the most challenging task of
tax accounting.
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Accounting Systems (AS)
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Accounting system consists of the personnel, procedures,
devices & records used by an organization:
 to develop accounting information &
 to communicate this information to decision makers.
The design & capabilities of these systems vary greatly
from very small business to large business organizations.
But, the basic purpose of accounting system remains the
same to meet the organization’s needs for accounting
information as efficient as possible.
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Factors affect the structure of accounting system in an
organization are:
the co.’s need for accounting information, &
the resources available for the operation of the system.
Determining the Information Needs
Information needs of an organization are affected by:
size of the organization,
ownership,(public or private), &
the philosophy of management.
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The Cost of Producing Accounting Information
Accounting system should be cost effective i.e. the
value of the information produced should exceed
the cost of producing it.
Development and installation of computer based
accounting system have increased greatly the types
and amount of accounting information that can be
produced in a cost effective way.
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Recording: Accounting records business transactions in terms
of money. It is essentially concerned with ensuring that all
business transactions of financial nature are properly recorded.
Recording is done in journal, which is further subdivided into
subsidiary books from the point of view of convenience.
Classifying: Accounting also facilitates classification of all
business transactions recorded in journal. Items of similar
nature are classified under appropriate heads. The work of
classification is done in a book called the ledger.
Basic Functions of Accounting
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 Summarizing: Accounting summarizes the classified information. It is done
in a manner, which is useful to the internal and external users. Internal
users interested in this information are the persons who manage the
business. External users of information are the investors, creditors, tax
authorities, labor unions, trade associations, shareholders, etc.
 Interpreting: It implies analyzing and interpreting the financial data
embodied in final accounts. Interpretation of the data helps the
management, outsiders and shareholders in decision making.
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Financial Accounting Information
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 Financial accounting information provides information about the financial
resources, obligations, & activities of an enterprise that is intended for use
primarily by external decision makers i.e. investors and creditors.
 External Users of Accounting Information
 Investors
 Creditors
 Customers
 Government Agencies
 Labor Unions
 Suppliers
 Trade Associations
 General Public
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Objectives of Financial Reporting
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To provide information useful in making investment & credit
decisions.( General)
To provide information useful in assessing amount, timing,
& uncertainty of future cash flows. ( Specific)
To provide information about economic resources, claims to
resources & changes in resources & claims.( Specific)
=met in large part by a set of financial statements
( balance sheet, income statement & statements of cash
flow).
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Characteristics of Externally Reported Information
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• Financial Reporting-A Means- it is a means to an end-ultimate outcome is
to improve the quality of decision making by external parties.
• Financial Reporting vs. Financial Statements
 Financial reporting is broader than financial statements
 Financial reporting includes press release, articles in a journal,
communication via internet
 Financial statements includes balance sheet, income statement and
statements of cash flow
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• Historical in nature: looks back in time & reports the
results of events & transactions that already happened.
• Inexact & approximate measure: have a great look of
precision but in fact much of it is based on estimates,
judgment & assumptions that must be made about both
the past & future.
e.g. allocation of depreciation expenses
• General purpose assumptions: for multiple users ( “
one size fits all).
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Management Accounting Information
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 Management accounting is the design & use of accounting information system to achieve
the orgn’s objectives by supporting decision makers inside the enterprise.
 Internal Users of Accounting Information
 BODs, CEO, CFO
 Business unit managers
 Plant mangers
 Store managers
 Line supervisors
 Other employees and any level of management
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Objectives of Management Accounting
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 To provide information useful to help the enterprise achieve its
goals, objectives & mission.( General)
 To provide information useful in assessing both the past
performance & future directions of the enterprise & information
from internal & external sources. ( Specific)
 To provide information about decision making authority, for
decision making support, & for evaluating & rewarding decision
making performance. ( Specific)
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Characteristics of Management Accounting Information
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 Importance of timeliness- should occur at good time
without delay.
 Identity of decision makers-for those who have decision
making authority.
 Oriented towards the future-to motivate management to
make future decisions that are in the best interest of the
enterprise, consistent with its goals, objectives & missions.
 Measures of efficiency and effectiveness of resource
utilization.
 Management accounting information a means-not an end
in and of it self.
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Financial Accounting Vs Management
Accounting
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Financial Accounting Managerial Accounting
 It describes the performance
of the business over a
specific period. This specific
period referred to as
“accounting period”. It has
one year long.
It is used to help management
record, plan and control the
activities of a business and to
assist in the decision making
process. It can be prepared for
any period (for daily, quarterly or
annually).
It is required by law to prepare
and publish financial statements.
There is no legal requirement
to prepare management reports.
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The format of published
financial statement is
determined by several different
regulatory bodies: Company
Law, Accounting standards,
Stock exchange etc.
There is no pre-determined
format for managerial
accounting. It can be as
detailed or brief as
management wish.
Financial accounting
concentrate on the business as
a whole rather than analyzing
the component parts of the
business.
For example, sales are
aggregated to provide a figure
for total sales rather than
published product wise.
Management Accounting can
focus on specific areas of a
business activities.
For example, it can provide
insight into performance of
products, departments,
markets etc.
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includes information that
can only be expressed in
monetary terms.
Managerial accounting
usually include a wide variety
of financial and non-financial
information.
Example, number and
productivity of employees,
sales volumes (units sold) etc.
Its focus is on reporting
to external users of
accounting information.
Its focus is on reporting to
internal users (Management).
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It provides financial
statements based on
Generally Accepted
Accounting Principle
(GAAP).
It is not guided by
Generally Accepted
Accounting Principles
(GAAP).
presents a historic perspective
on the financial performance
of the business.
Managerial accounting
emphasis on the future, e.g.,
sales budget and on
influencing the behavior of
managers.
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Conceptual Framework for Financial
Reporting
Conceptual Framework sets out the concepts that
underlie IFRS financial statements.
Purpose of the Conceptual Framework
1. To assist IASB in setting and revising standards
2. To assist preparers to make the judgements that are
necessary to apply IFRSs
3. To assist auditors and regulators assess judgments of
preparers
4. To assist users to consider those judgments when using
IFRS financial information to inform their decisions
5. To assist in understanding of standard-setting by IFRS
6. To reduce conflicts between Framework and Standards
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• Conceptual Framework comprises of:
1. the objective of general purpose financial
reporting
2. qualitative characteristics
3. elements of financial statements
4. recognition
5. measurement
6. presentation and disclosure
7. Other concepts all flow from the objective.
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1. Objective of General Purpose Financial
Reporting
“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”
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• To provide information about
 Economic resources and claims (SFP)
 Changes in economic resources and claims
(SPLOCI)
 Financial performance reflected by past cash flows
(SCF)
 Changes in economic resources and claims not
resulting from financial performance (SCE)
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2. Qualitative Characteristics of Useful Financial Information
• Fundamental
 Relevance
 Faithful representation
• Enhancing
 Comparability
 Verifiability
 Timeliness
 Understandability
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• Relevance: Capable of making a difference in
users’ decisions
predictive value
confirmatory value
materiality (entity-specific)
• Faithful representation: Faithfully represents the
phenomena it purports to represent
completeness (depiction including numbers
and words)
neutrality (unbiased)
free from error (ideally)
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• Comparability: like things look alike; different
things look different
• Verifiability: knowledgeable and independent
observers could reach consensus, but not
necessarily complete agreement, that a
depiction is a faithful representation
• Timeliness: having information available to
decision-makers in time to be capable of
influencing their decisions
• Understandability: Classify, characterize, and
present information clearly and concisely
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3. Elements of financial statements
Asset
• resource controlled by the
entity
• result of past event
• expected inflow of economic
benefits
Liability
• present obligation
• arising from past event
• expected outflow of
economic benefits
Equity = assets less liabilities
Income
• recognised increase in
asset/decrease in liability in
current reporting period
• that result in increased
equity except contributions
from owners
Expense
• recognised decrease in
asset/increase in liability in
current reporting period
• that result in decreased
equity except distributions
to owners
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4. Recognition
• Accrual basis of accounting used
• Recognise element when:
– The element satisfies definition
– probable that benefits will flow to/from the
entity
– has cost or value that can be measured
reliably
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– What does probable mean?
It means “more likely than not”
The meaning of probable is determined at the
standards level. Therefore, inconsistent use
across IFRSs (usually more than 50%)
– What does measure reliably mean?
 To a large extent, financial reports are based
on estimates, judgements and models rather
than exact depictions.
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5. Measurement
• Measurement is the process of determining
monetary amounts at which elements are
recognised and carried.
• To a large extent, financial reports are based on
estimates, judgements and models rather than
exact depictions.
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Measurement methods include
1. Historical cost: cash paid or fair value of
consideration given
2. Current cost: Cash that would be paid if
acquired now
3. Realisable (settlement) value: cash that could
be obtained by selling the asset now
4. Present value: present discounted value of
future net cash inflows that the item is
expected to generate
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6. Constraints
– Cost vs. benefit: cost of information is justified
by the benefits of reporting that information.
 Benefits include more efficient functioning of
capital markets and a lower cost of capital for
the economy.
 Costs include collecting, processing, verifying
and disseminating financial information and
the costs of analysing and interpreting the
information provided.
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7. Underlying assumptions of financial reporting:
 Going concern, and
 Accruals accounting
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Financial Statements
• A statement of financial position as at the end of
the period
• A statement of profit or loss and other
comprehensive income for the period
• A statement of changes in equity for the period
• A statement of cash flows for the period
• Notes, comprising
– A summary of significant accounting policies
– Other explanatory information
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Generally Accepted Accounting
Principles(GAAP)
The Accounting Equation
Basic Concepts of Financial
Accounting and Reporting
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• Generally Accepted Accounting Principles
– Rules that govern accounting
– Based on a conceptual framework
• Goal:
– To provide useful information to those making
investment and lending decisions
GAAP
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Economic entity
• A business is separate from its owners
Going concern
• A company continues in business indefinitely.
Monetary Unit
• Money is the common denominator of economic
activity
1.1 Assumptions
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Periodicity
•A company can divide its economic
activities into artificial time periods.
1.1 Assumptions…
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Measurement Principle
• Historical cost-requires that companies account for and
report many assets and liabilities on the basis of acquisition
price.
• Fair Value- the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction
between market participants at the measurement date
Revenue Recognition Principle
• Revenue is recognized when realized and when earned.
1.2 Principles
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Expense Recognition Principle
• Expenses are recognized when they are incurred-when
assets are consumed in the process of generating revenue.
• Period costs Vs Product costs.
Full Disclosure Principle
• Requires that firms supply information that is of sufficient
importance to influence the judgment and decisions of an
informed user.
• Information is disclosed through (1) main body of financial
statements (2) notes to FS ,and (3)
Supplementary information.
1.2 Principles…
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Matching Principle
• Deducting expenses from revenues arrives at
accounting profit.
• However, accountants carry forward expenses until
they can be identified with the revenue of particular
accounting year and carry forward receipts until
they can be regarded as revenue of the particular
year.
• Thus, this principle is very important for correct
determination of profit, which is also a measure of
performance.

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• All expenses that generate revenue in the current
accounting period are recognized as expenses of
the current period.
• Cost of goods sold and operating expenses
incurred during the current period are recognized as
expenses of the current period and will be matched
with the revenue of the current period. Incomes
received in advance or relating to earlier periods
must not be taken into account.
• Similarly, expenses paid in advance are also to be
ignored while computing the income of current
accounting period.

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The Materiality Principle
• According to this principle, financial statements
should disclose all material items, i.e., items the
knowledge of which might influence the decisions of
the user of the financial statements.

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• Materiality can be defined as ‘the characteristic
attaching to a statement, fact or item whereby its
disclosure or the method of giving it expression
would be likely to influence the judgment of a
reasonable person”.
• Thus when the event is material, it should be
disclosed.
• But if the item or event is immaterial, it may not be
disclosed.

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• It is on the basis of materiality concept that items of
stationery are considered to have been used up
either at the time of purchase or at the time of their
issue from stores.
The Consistency Principle
• States that, a firm should follow same accounting
methods & procedures from year to year.
• However, it is permitted to change them if it has a
sound reason to do so.

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• But the effect of such a change must be disclosed
in the financial statements of the year in which
change took place to enable the users to be aware
of the lack of consistency.
The Conservatism (Prudence) Principle
• The traditional approach of playing safe or being
cautious in recognizing all the possible losses but
ignoring all probable profits.

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• This is also known as prudence concept implying
the common & accepted behavior of accounting or
providing for future losses.
• Though this approach leads to creation of secret
reserves & understatement of income; it also of
safeguards the interest of outsiders by preventing
the management from recognizing unrealized profits
& providing for all future losses.

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Duality Principle
• Every transaction entered into by a firm has two
aspects, viz., debit & credit.
• Debit represents creation of or addition to an asset
or an expense or the reduction or elimination of a
liability.
• Credit means reduction or elimination of an asset
or an expense or the creation of or addition of a
liability.
• Therefore, according to dual aspect concept, at any
time, the total assets of a business are equal to its

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• The system of accounting, which records both the
aspects of a transaction ever, is based on Double
Entry System .

Cost
•Firms should weigh the costs of
providing information against the
benefits that can be derived from using
it.
1.3 Constraints
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2. The Accounting Equation
Economic
Resources
Claims to
Economic
Resources
Assets = Liabilities + Stockholders’ equity
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• Economic resources that have a future benefit
• Examples:
– Cash
– Accounts receivable
– Merchandise inventory
– Furniture
– Land
2.1 Assets
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• Liabilities
– Debts payable to
outsiders
– Examples:
• Accounts payable
• Bank loans
• Owners’ equity
– Owners’ claims to the
assets of the business
– In a corporation,
stockholders’ equity
2.2 Claims to Assets
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The Accounting Equation
Assets = Liabilities + Stockholders’ equity
Paid-in
capital
Retained
earnings
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Stockholders’ equity
Paid-in capital Retained earnings
Common stock + Net income
- Dividends
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Retained earnings
+ Net income
- Dividends
Revenues
- Expenses
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CHAPTER - 2
BASIC FINANCIAL
STATEMENTS
•Forms of business
organizations
•Basic financial statements
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Forms of Business Organizations
Accountants frequently refer to a business
organization as an accounting entity or a business
entity.
For accounting purpose, each business
organization or entity has an existence separate
from its owner(s), creditors, employees, customers
& other business
This separate existence of business organization is
called business entity concept.
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Thus , in the accounting records of the business entity,
the activities of each business should be kept separate
from the activities of other businesses & from the
personal & financial activities of the owner(s).
In modern business world, most business enterprises
are organized as:
1. Sole proprietorships,
2. Partnerships,&
3. Corporations
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1. Sole proprietorship
 Is unincorporated business owned by an individual & often
managed by that same person.
 No legal formalities are necessary to organize such businesses, &
usually business operations can begin with only a limited
investment.
 From an accounting view point, a sole proprietorship is a business
entity separate from the other affairs of its owner.
 From the legal point of view, however, the business& its owner are
not regarded as separate entities.
 Thus, the owner is personally liable for the debts of the business.
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2. Partnership
 Is an unincorporated business owned by two or more persons
associated as partners.
 As in case of the sole proprietorship, the owners of a
partnership are personally responsible for all debts of the
business.
 From an accounting stand point, a partnership is viewed as a
business entity separate from the personal affairs of its owners.
 A benefit of partnership form over sole proprietorship form is the
ability to bring together large amount of capital investment
from multiple owners.
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3. Corporation
 A corporation is a business incorporated under the law of a
state and owned by a few stockholders or thousands of
stockholders.
 It is unique in that it is a separate legal business entity.
 The owners of the corporation are stockholders or
shareholders.
 The corporate form of business protects the personal
assets of the owners from the creditors of the corporation.
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Introduction to Financial Statements
 Business entities may have many objectives & goals.
 The two primary objectives of every business are profitability
and solvency.
 Profitability is the ability to generate income.
 Solvency is the ability to pay debts as they become due.
 Unless a business can produce satisfactory income & pay its
debts as they become due , the business can’t survive to
realize its other objectives.
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 The financial statement that reflects a co.’s profitability is the
income statement.
 The statement of retained earnings shows the change in
retained earnings between the beginning and end of a period.
 The balance sheet reflects the company’s solvency.
 The statement of cash flows shows the cash inflows and
outflows for a co. over a period of time
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A Starting Point: Statement of Financial
Position (Balance Sheet)
• Is a list of balances in the assets, liability & owners’ (
stockholders’) equity accounts.
• This “list depicts the position of assets , liabilities,& owners’ (
stockholders’) equity of a specific business at a specific point of
time.”
• It is prepared on a specified date because the figure shown in
the balance sheet is true on that date only.
• The totals of the assets should be equal to the totals of
liabilities & owners’ ( stockholders’) equity. If it is not so, it
means that there is some error.
1/1/2023 87

Objective of Balance Sheet
 Principal Objective: The main purpose of preparing balance
sheet is to know the financial position of the business at a
particular date.
 Subsidiary Objectives: Though the main aim is to know the
exact financial position of the firm at a particular date, yet it
serves other purpose as well such as:
1. It gives information about the actual and real owner’s(
stockholders’) equity.
2. It helps the firm to make provisions against possible
future losses. A provision is made in the form of the
Reserves.
1/1/2023 88

Characteristics of Balance Sheet:
 It is a statement and not an account.
 It is always prepared on a particular date, & thus shows the
position at that date & not for a period.
 It has no debit side & credit side.
 It shows the financial position of the business concern.
 It shows what the firm owes to others & also what others
owe to the firm
 The totals of assets always are equal with the totals of
liabilities & owners’(SH) equity.
1/1/2023 89

 Uses of balance Sheet
 The balance sheet is described as a snapshot/photograph/picture of the financial
position of a business entity.
 The various groups interested in the company can draw useful inferences from an
analysis of the information contained in the balance sheet.
 It proves that the accounting equation (Assets = Liabilities + Owner's Equity) is in
balance.
 It shows the nature & value of the assets.
 It shows what the firm owes to others and also what others owe to the firm.
1/1/2023 90

Elements of the Balance Sheet
1. Assets: An asset is something of value the company owns
such as cash, marketable securities, accounts receivable,
inventory, prepaid expenses, property, plant, equipment,
long-term investments, patents, copyrights, trademarks, &
franchise licenses.
2. Liabilities: Liabilities are the company's existing debts
owed to third parties.
 Examples include amounts owed to suppliers for goods or
services received (accounts payable), to employees for work
performed (wages payable), and to banks for principal &
interest on loans (notes payable & interest payable).
1/1/2023 91

3. Owner's equity (OE): represents the amount owed to the owner or
owners by the company.
 In a corporation, ownership is represented by shares of stock, so the
owner’s equity is called stockholders' equity or shareholders' equity
(SHE).
 Because creditors’ claim have legal priority over those of owners,
OE/SHE is a residual amount.
 Therefore, OE/SHE is always equal to total assets minus total liabilities.
1/1/2023 92

Assets = Liabilities+ Owners’ Equity/SHE
 Assets: things of value owned by the business or the economic resources
of the business.
 Liabilities: are debts owed by the business.
 Equities: are claims to, or interests in assets.
Assets –Liabilities= Owners Equity/SHE
Owners’ Equity/SHE= Net Assets
 Example
A = L + OE/ SHE
a) $300,000 = 150,000 + 150,000
b) ? = 562,500 + 375,000
c) 307,500 = ? + 142,500
1/1/2023 93

Effects of Business Transactions(BT) on Accounting Equation
 Business transactions/economic events are any events that
directly affects the financial position of an organization.
 BT can be classified as external & internal
 External business transaction involve an exchange between the
co. & other external separate business entity.
 Internal transaction directly affect the financial position of a co. but
don’t involve an exchange transaction with an other entity.
1/1/2023 94

 These events must be recorded to properly
reflect a co.’s financial position & results of
operations.
Each transaction affecting the accounting
equation will have a dual effect because
resources always must equal claims to those
resources.
1/1/2023 95

 Example
1.Mr. X invested $50,000 to open a law office.
A = L + OE
+50,000 (cash) - + 50,000 (investment)
2. $40,000 was borrowed from a bank & a note payable was signed.
A = L + OE
+40,000(cash) +40,000 (Notes Payable) -
3. Supplies Costing $3,000 were purchased on account.
A = L + OE
+3,000( supplies) +3,000(Accounts Payable) -
4.Services were performed on account $10,000.
A = L + OE
+10,000 (A/R) - +10,000 (Revenue)
5.Salaries of $ 5,000 were paid to employees.
A = L + OE
-5,000 (Cash) - - 5,000( salary exp.)
6. $ 500 of supplies were used:
A = L + OE
- 500 (supplies) - -500 (supplies exp.)
7. $ 1,000 was paid on account to supplies vendor.
A = L + OE
-1000(cash) -1,000 (A/p) -
1/1/2023 97

X Co.
Balance Sheet
On December 31,2009
Assets Liabilities & Owner’s Equity
Cash 84,000 Liabilities:
Supplies 2,500 A/P 2,000
A/R 10,000 N/P 40,000
Total L. 42,000
Owner’s E quity :
X Capital 54,500
Total Assets 96,500 Total L & OE $ 96,500
1/1/2023 98

The Greener Landscape Group
Balance Sheet
December 31,2010
ASSETS
Current Assets
Cash $ 6,355
Accounts Receivable 200
Supplies 25
Prepaid Insurance 1,100
Total Current Assets 7,680
Property, Plant, and Equipment
Equipment $18,000
Less: Accumulated Depreciation (235) 17,765
Total Assets $25,445
1/1/2023 99

LIABILITIES AND OWNER'S EQUITY
Current Liabilities
Accounts Payable $ 50
Wages Payable 80
Interest Payable 79
Unearned Revenue 225
Total Current Liabilities 434
Long-Term Liabilities
Notes Payable 10,000
Total Liabilities 10,434
Owner's Equity
J. Green, Capital 15,011
Total Liabilities & Owner's Equity $25,445
1/1/2023 100

Income Statement
 It lists revenues & expenses & calculates the company's net
income or net loss for a period of time.
 Net income means total revenues are greater than total
expenses.
 Net loss means total expenses are greater than total
revenues.
Greener Landscape Group
Income Statement
For the Year Ended on Dec.31,2009
Revenues:
Lawn Cutting Revenue $845
Expenses:
Wages Expense $280
Depreciation Expense 235
Insurance Expense 100
Interest Expense 79
Advertising Expense 35
Gas Expense 30
Supplies Expense 25
Total Expenses (784)
1/1/2023 101

Income Statement
Revenues:
Lawn Cutting Revenue $845
Expenses:
Wages Expense $280
Depreciation Expense 235
Insurance Expense 100
Interest Expense 79
Advertising Expense 35
Gas Expense 30
Supplies Expense 25
Total Expenses (784)
Net Income $ 61
1/1/2023 102

Statement of Owner's Equity
 The statement of owner's equity is prepared after the
income statement.
 It shows the beginning & ending owner's equity
balances & the items affecting owner's equity during
the period.
 These items include investments, the net income or loss
from the income statement, & withdrawals/drawings.
 Because the specific revenue & expense categories that
determine net income or loss appear on the income
statement, the statement of owner's equity shows only
the total net income or loss.
1/1/2023 103

Statement of Owner’s Equity
J. Green, Capital, Jan.1 $ 0
Additional Investments 15,000
Net Income 61
Increase in OE 15,061
Withdrawals (50)
J. Green, Capital, Dece.31,2009 $ 15,011
1/1/2023 104

Statement of Retained Earnings
 It explains the changes in retained earnings between two
balance sheets.
 These changes usually consists of the addition of NI ( or
deduction of NL) & the deduction of dividends.
 Dividends are the means by which a corporation rewards its
shareholders (owners) for providing it with the investment
funds.
 A dividend is a distribution of income to owners rather than
an expense of doing business.
1/1/2023 105

XYZ Corporation
Statement of Retained Earnings Format
For the Year Ended on December 31,2009
RE, Jan.1, 2009 $ xx
Add/Less: NI/NL of the year xx
Less: Dividend (xx)
Increase /decrease in RE xx
RE , Dec.31,2009 $ xxx
1/1/2023 106

Statement of Cash Flows
The statement of cash flows tracks the movement
of cash during a specific accounting period.
It assigns all cash exchanges to one of three
categories operating, investing, or financing to
calculate the net change in cash and then
reconciles the accounting period's beginning &
ending cash balances.
As its name implies, the statement of cash flows
includes items that affect cash.
1/1/2023 107

Statement of cash flows has 3 sections
1. Cash flows from the operating activities are the cash
effects revenues & expense transactions that are
included in the income statements.
2. Cash flows from the investing activities are the cash
effects of purchasing & selling assets.
3. Cash flows from financing activities are the cash
effects of
– Owners investing in the company,
– Owners withdrawal from the company &
– Creditors loaning money to the co. &
– Repayment of either or both.
1/1/2023 108

Statement of Cash Flows
Cash Flows from Operating Activities:
Cash from Customers $ 870
Cash to Employees (200)
Cash to Suppliers (1,265)
Cash Flow Used by Operating Activities (595)
Cash Flows from Investing Activities:
Purchases of Equipment (8,000)
Cash Flows from Financing Activities:
Investment by Owner 15,000
Withdrawal by Owner (50)
Cash Flow Provided by Financing Activities 14,950
Net Increase in Cash 6,355
Beginning Cash, Jan.1 0
Ending Cash, Dece.31,2009 $6,355
1/1/2023 109

Presentations of Owner’s Equity in Balance Sheet
 Sole proprietorship
 Owner’s Equity:
Mr. X, Capital…………………………….. xx
 Partnership
 Partners’ Capital:
Partner A, Capital…………………….xx
Partner B, Capital……………………..xx
Total partners’ equity xxx
 Corporation
 Stockholders’ Equity:
Capital Stock……………………………………xx
Retained Earnings…………………………….xx
Total Stockholders’ Equity xxx
1/1/2023 110

Relationships among Financial Statements
____________________TIME_________________
B/Sheet Income St’t B/S
St’t of CF
 At the beginning & ending point in time, a co. prepare a st’t
of financial position (B/S) that gives a static look in
financial terms of where the co. stands.
 The other 2 FSs of IS & SCF cover the intervening period
of time b/n the two B/Ss & explain the important changes
that occurred during the period.
1/1/2023 111

Illustration
1. United communications was organized on December 1 of
the current year and had the following account balances at
December 31, listed in tabular form.
Assets = liabilities + Owners Equity
Cash + Land + Building + office equipment = Notes Payable + Accounts Payable + Capital Stock
Balances $37000 95000 125000 51250 80000 28250 200000
1/1/2023 112

Early in January, the following transactions were carried out by United
Communications;
1. Sold capital stock to owners for 35000
2. Purchased land and a small office building for a total price of 90,000, of
which 35000 was the value of the land and 55000 was the value of the
building . Paid 22500 in cash and signed a note payable for the
remaining 67500
3. Brought several computer systems on credit for 9500(30 day open
account)
4. Obtained a loan from Capital bank in the amount of 20000. signed a
note payable
5. Paid the 28,250 account payable as of December 31.
Instructions
a. Record the effects of each of the five transactions in the format given
above and show the totals for all columns after each transaction.
b. Prepare a balance sheet at the end of the five transactions(January 31)
1/1/2023 113

The End
Of Chapter 2
1/1/2023 114

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