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Slide 2.1 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 2 A Systematic approach to financial reporting:

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Presentation on theme: "Slide 2.1 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 2 A Systematic approach to financial reporting:"— Presentation transcript:

1 Slide 2.1 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 2 A Systematic approach to financial reporting: the accounting equation

2 Slide 2.2 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Assets and liabilities Assets Resources available to the business. Liabilities Obligations of the business.

3 Slide 2.3 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Assets minus LiabilitiesequalOwnership interest The accounting equation Statement of financial position A – L = OI

4 Slide 2.4 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 The ownership interest is the residual claim after liabilities to third parties have been satisfied. The accounting equation (Continued) A – LOI

5 Slide 2.5 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Alternative ways of expressing the accounting equation AssetsequalOwnership interest plus Liabilities A = OI + L

6 Slide 2.6 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 A = OI + L Alternative ways of expressing the accounting equation (Continued) OI + L A

7 Slide 2.7 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Definition of an asset A resource controlled by the entity, as a result of past events, and from which future economic benefits are expected to flow to the entity.

8 Slide 2.8 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Analysis of definition Controlled by an entity: Can we restrict access to the item? Past events: Has an agreement or event taken place that has resulted in the organisation obtaining control of the item? Future economic benefits: Will cash be generated in the future?

9 Slide 2.9 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Examples of assets Land and buildings owned by a business. Raw materials owned by the business. Workforce employed by the business. Major advertising campaign undertaken by the business.

10 Slide 2.10 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Recognition Recognised as an asset (i.e. reported in the balance sheet)? Only if It is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably.

11 Slide 2.11 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 RecogniseNot recognise Land and buildingsWorkforce Raw materialsAdvertising campaign Why? Relative certainty of future benefit Uncertainty of benefits: lack of evidence that cash will flow to the business in the future. Recognise or not?

12 Slide 2.12 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Definition of a liability a present obligation of the entity. arising from past events. the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

13 Slide 2.13 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Analysis of definition Present obligation: legal or as a result of commercial reality. Past events: normally receiving goods or services or borrowing money. Outflow embodying economic benefits: cash or other resource leaving the business.

14 Slide 2.14 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Recognition of liability Is there sufficient evidence that outflow of benefit (cash or other resources) will occur? Can the obligation be measured reliably?

15 Slide 2.15 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Examples of liability Bank borrowing by the business. Sales tax (VAT) payable by a business based on past sales.

16 Slide 2.16 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Liabilities not recognised An item that fails the recognition test (not reported in the balance sheet) might well be reported in the notes to the accounts as a ‘contingent liability’. Example of the ‘prudent’ nature of financial reporting practice. For example: Potential liability for defective products. (Will a legal action actually be undertaken?)

17 Slide 2.17 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Ownership interest The ownership interest is the residual amount found by deducting all of the entity’s liabilities from all of the entity’s assets. The term net assets is used as a shorter way of saying ‘total assets less total liabilities’. Recognition totally dependent on the recognition of assets and liabilities.

18 Slide 2.18 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Changes in ownership interest Compare the financial position of the business at two points in time. At time t = 0 Assets(t0) – Liabilities(t0) = Ownership interest(t0) At time t = 1 Assets(t1) – Liabilities(t1) = Ownership interest(t1)

19 Slide 2.19 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Change in (Assets – Liabilities) or Change in Net assets =Change in Ownership interest Subtracting

20 Slide 2.20 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Causes of change in OI Normal business transactions: supplying goods and services to customers. Owner contributing resources to the business (Invest cash in the business) or Owner withdrawing resources from the business (withdraw cash from the business).

21 Slide 2.21 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Revenue and expense Revenue: increase in ownership interest (i.e. increase in net assets). Providing a service to a customer for which payment is made. Expense: decrease in ownership interest (i.e. decrease in net assets). Cost of providing a service to a customer.

22 Slide 2.22 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Revenue minus Expenses =Profit Net impact of business transactions

23 Slide 2.23 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Change in ownership interest equalsCapital contributed/ withdrawn by the ownership plus Revenue minus Expenses Equation for change in ownership interest

24 Slide 2.24 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Assets minus Liabilities at the end of the period equalOwnership interest at the start of the period plus Capital contributed/withdrawn in the period plus profits for the period Equation for change in ownership interest (Continued)

25 Slide 2.25 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 2 Bookkeeping Supplement

26 Slide 2.26 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 LEFT-HAND SIDE AssetsIncreaseDecrease RIGHT-HAND SIDE LiabilitiesDecreaseIncrease Ownership interestDecreaseIncrease AssetsequalOwnership interest plus Liabilities Accounting equation

27 Slide 2.27 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Rules 1.Ask yourself: Is this item an asset or a liability or a part of the ownership interest? 2.Choose the line in the table. asset liability ownership interest

28 Slide 2.28 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 ?? AssetIncreaseDecrease LiabilityDecreaseIncrease Ownership interest DecreaseIncrease 3. Ask yourself: Has the item increased or decreased? 4. Choose the box that contains the answer. Rules (Continued)

29 Slide 2.29 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 AssetIncreaseDecrease LiabilityDecreaseIncrease Ownership interestDecreaseIncrease ACTION TO TAKEDEBIT ENTRIES IN A LEDGER ACCOUNT CREDIT ENTRIES IN A LEDGER ACCOUNT 5. Make a debit entry or a credit entry Rules (Continued)

30 Slide 2.30 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Ownership interest The ownership interest may be increased by: Earning revenue New capital contributed by the owner The ownership interest may be decreased by: Incurring expenses Capital withdrawn by the owner

31 Slide 2.31 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 Ownership interest (Continued)


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