1. Slide 3.1 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 3 Financial statements from the accounting equation

2. Slide 3.2 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Primary financial statementPurpose is to report Statement of financial position (balance sheet) Financial position Income statement (profit and loss account) Performance Statement of cash flowsFinancial adaptability Primary financial statements

3. Slide 3.3 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Preparing financial statements TRANSACTIONS AND EVENTS ↓ practice of bookkeeping ↓ ACCOUNTING RECORDS ↓ rules of measurement and disclosure ↓ FINANCIAL STATEMENTS

4. Slide 3.4 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Statement of financial position (balance sheet) The statement of financial position (balance sheet) reflects the accounting equation in the form: − Assets minus Liabilities equals Ownership interest

5. Slide 3.5 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Assets minus Liabilities equals Ownership interest Statement of financial position is usually presented

6. Slide 3.6 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Subdivisions Assets are subdivided into non-current (fixed) assets and current assets. Liabilities are subdivided into current liabilities (due within one year) and longer- term liabilities (due after one year). Ownership interest may also be subdivided. Current assets and current liabilities are grouped close to each other.

7. Slide 3.7 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Non-current (fixed) assets Plus Current assets Minus Current liabilities Minus Non-current (long-term) liabilities equals Capital at start of year plus/minus Capital contributed or withdrawn plus Profit of the period Structure Table 3.1 Structure of a statement of financial position (balance sheet)

8. Slide 3.8 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Other forms of statement – horizontal AssetsequalsOwnership interest plus Liabilities

9. Slide 3.9 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Assets equals Ownership interest plus Liabilities Other forms of statement – vertical

10. Slide 3.10 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Income statement (profit and loss account) The income statement (profit and loss account) reflects that part of the accounting equation which defines profit. Profit equals Revenue minus Expenses

11. Slide 3.11 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Revenue minus Expenses equals Profit Income statement (profit and loss account) (Continued)

12. Slide 3.12 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Statement of cash flows Liquidity is measured by the cash and near- cash assets and the change in those assets, so a financial statement which explains cash flows should be of general interest to user groups. Cash flow = cash inflows to the enterprise minus cash outflows from the enterprise

13. Slide 3.13 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Change in cash and similar liquid assets equals Cash outflows minus Cash inflows Statement of cash flows (Continued)

14. Slide 3.14 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Subdivisions of cash flow Operating activities: Provision of services, and the manufacturing, buying and selling of goods for resale. Investing activities: Buying and selling non-current (fixed) assets for long-term purposes. Financing activities: Raising and repaying the long-term finance of the business.

15. Slide 3.15 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Operating activities Cash inflows minus Cash outflows plus Investing activities Cash inflows minus Cash outflows plus Financing activities Cash inflows minus Cash outflows equals Change in cash assets Statement of cash flows Table 3.6 Structure of a statement of cash flows

16. Slide 3.16 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Profit does not equal cash Working capital Some sales are made on credit, customers pay later. Some purchases are made on credit, pay suppliers later. Cash is used to buy inventory (stock) which is sold later.

17. Slide 3.17 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Inventory Receivables (debtors) Cash Payables (creditors)

18. Slide 3.18 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Profit does not equal cash (Continued) Cash is used to buy more non-current (fixed) assets. Cash is used to buy investments. Cash is used to repay loans. Cash is raised from issuing shares. Cash is raised from borrowing.

19. Slide 3.19 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Practical illustration See P. Mason illustration in Chapter 3 for Statement of financial position. Income statement. Statement of cash flows. Comparison of profit and cash flow.

20. Slide 3.20 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 3 Bookkeeping Supplement

21. Slide 3.21 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 DEBIT ENTRIESCREDIT ENTRIES Left-hand side of the equation AssetIncreaseDecrease Right-hand side of the equation LiabilityDecreaseIncrease Ownership interestExpenseRevenue Capital withdrawnCapital contributed Debit and Credit recording Table 3.9 Rules for debit and credit recording

22. Slide 3.22 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 1 Sept:P. Mason deposits £140,000 in a bank account to commence the business under the name P. Mason’s legal practice Transaction number: 1 DEBITCREDIT AssetBANK £140,000 Ownership interestCAPITAL CONTRIBUTED £140,000 Analysis of transaction

23. Slide 3.23 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 1 Sept:P. Mason’s legal practice borrows £150,000 from a finance business to help with the intended purchase of a property for use as an office. The loan is to be repaid in five years’ time. Transaction number: 2 DEBITCREDIT AssetBANK £150,000 LiabilityLONG-TERM LOAN £150,000

24. Slide 3.24 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 1 Sept:A property is purchased at a cost of £75,000 for the land and £175,000 for the buildings. The full price is paid from the bank account. Transaction number: 3 DEBITCREDIT AssetLAND & BUILDINGS £250,000 BANK £250,000

25. Slide 3.25 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 3 Sept:Office furniture is purchased from Style craft at a cost of £30,000. The full price is to be paid within 90 days. Transaction number: 4 DEBITCREDIT AssetFURNITURE £30,000 LiabilityTRADE PAYABLE (STYLECRAFT) £30,000

26. Slide 3.26 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 5 Sept:An insurance premium of £540 is paid in advance. The insurance cover will commence on Oct 1. Transaction number: 5 DEBITCREDIT AssetPREPAYMENT £540BANK £540

27. Slide 3.27 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 8 Sept:An applicant is interviewed for a post of legal assistant. She agrees to start work on Sept 10 for a salary of £24,000 per annum. No accounting recognition takes place until the payment has occurred. It is the expense of the past which is recognised, rather than the asset of benefit for the future

28. Slide 3.28 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 11 Sept:Invoices are sent to some clients showing fees due for work done in preparing contracts for them. The total of the invoiced amounts is £8,820. Clients are allowed up to 30 days to pay. Transaction number: 6 DEBITCREDIT AssetTRADE RECEIVABLES (DEBTORS) £8,820 Ownership interest (revenue) FEES FOR WORK DONE £8,820

29. Slide 3.29 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 19 Sept:Cheques received from clients in payment of invoices amount to £7,620. Transaction number: 7 DEBITCREDIT AssetBANK £7,620TRADE RECEIVABLES (DEBTORS) £7,620

30. Slide 3.30 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 26 Sept:Payment is made to Stylecraft for the amount due for office furniture, £30,000 Transaction number: 8 DEBITCREDIT AssetBANK £30,000 LiabilityTRADE PAYABLE: (STYLE-CRAFT) £30,000

31. Slide 3.31 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 28 Sept:Bills are received as follows: for computer rental and on-line searches, £1,500; gas, £100; electricity, £200 and telephone/fax £1,000 (Total £2,800) Transaction number: 9 DEBITCREDIT LiabilityTRADE PAYABLES £2,800 Ownership interestEXPENSES £2,800

32. Slide 3.32 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 30 Sept :Legal assistant is paid salary of £1,800 for period to end of month Transaction number: 10 DEBITCREDIT AssetBANK £1,800 Ownership interestEXPENSE £1,800 Analysis of transaction (Continued)

33. Slide 3.33 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 TRIAL BALANCEDebitCredit ££ ASSETS Land and buildings250,000 Office furniture30,000 Traders receivables debtors1,200 Prepayment540 Cash at bank15,280 LIABILITIES Trade payables2,800 Long-term loan150,000 TRIAL BALANCE Table 3.11 Summary of debit and credit entries for each category of asset, liability and ownership interest

34. Slide 3.34 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 OWNERSHIP INTEREST Revenue8,820 Expenses4,600 Capital contributed140,000 Totals301,620 TRIAL BALANCE (Continued) Table 3.11 Summary of debit and credit entries for each category of asset, liability and ownership interest (Continued)