CIMA CO2 Official Learning System - Fundamentals of Financial Accounting
Подождите немного. Документ загружается.
STUDY MATERIAL C2
20
THE FRAMEWORK OF FINANCIAL STATEMENTS
Solution
To begin with, the only asset of the business is $100 in the business bank account. Capital invested by Ahmed
also amounts to $100 and the accounting equation looks like this:
Assets
Liabilities
Capital
Bank $100 0 Capital $100
The business then acquires matches worth $20 with a corresponding liability to the supplier. The accounting
equation now looks like this:
Assets Liabilities Capital
Bank $100 Payables $20 Capital $100
Inventories $20
$120
$20
$100
When Ahmed sells 150 boxes, he makes a profi t of (150 7¢) $10.50. His inventory falls to 250 boxes at
5¢ each ($12.50). He also acquires a further asset in the process: cash in hand of $18. The accounting equa-
tion now looks like this:
Assets Liabilities Capital
Bank $100 Payables $20 Original capital $100
Cash in hand $18 Profi t $10.50
Inventories $12.50
$130.50
$20
$110.50
Then Ahmed withdraws $5 from the business for his private use. This amount (referred to as drawings) reduces
the sum owed to him by the business. The accounting equation now looks like this:
Assets Liabilities Capital
Bank $100 Payables $20 Original capital $100
Cash in hand $13 Profi t earned $10.50
Inventories $12.50 Less : drawings ($5)
$125.50
$20
$105.50
Finally, Ahmed makes a payment to his supplier, reducing the funds in the business bank account, and also
reducing the amount of his liability. The accounting equation now looks like this:
Assets Liabilities Capital
Bank $95 Payables $15 Original capital $100
Cash in hand $13 Profi t earned $10.50
Inventories $12.50 Less : drawings ($5)
$120.50
$15
$105.50
Exercise 2.1
J Jones commenced business on 31 January 20X1, transferring $5,000 from her personal
bank account into a business bank account.
21
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FRAMEWORK OF FINANCIAL STATEMENTS
During the fi rst week of February 20X1 the following transactions occurred:
1 Feb. Bought motor van costing $800 paying by cheque
2 Feb. Bought goods on credit:
P Smith $400
E Holmes $250
3 Feb. Sold goods for cash $600 (cost $400)
4 Feb. Banked cash $600
Paid P Smith $400 by cheque
5 Feb. Bought goods on credit:
P Smith $200
A Turner $300
You are required to show the accounting equation at the end of each day’s transactions.
Solution
Assets Liabilities Capital
31 Jan.
Bank 5,000 Nil 5,000
1 F e b .
Bank 4,200
Van 800
5,000 Nil 5,000
2 F e b .
Bank 4,200 P Smith 400
Van 800 E Holmes 250
Inventories 650
5,650 650 5,000
3 F e b .
Bank 4,200 P Smith 400 Original capital 5,000
Van 800 E Holmes 250 Profi t earned 200
Inventories 250
Cash 600
5,850 650 5,200
4 F e b .
Bank 4,400 Original capital 5,000
Van 800 Profi t earned 200
Inventories 250 E Holmes 250
5,450 250 5,200
5 F e b .
Bank 4,400 E Holmes 250 Original capital 5,000
Van 800 P Smith 200 Profi t earned 200
Inventories 750 A Turner 300
5,950 750 5,200
STUDY MATERIAL C2
22
THE FRAMEWORK OF FINANCIAL STATEMENTS
2.4 The accounting equation and the
statement of financial position
The statement of fi nancial position is simply a statement of the assets, liabilities and capi-
tal of a business at a particular time. It is thus nothing more than a detailed representation
of the accounting equation.
2.4.1 The contents of a statement of financial position
In its simplest form the statement of fi nancial position is presented horizontally with assets
being shown on the left and liabilities and capital being shown on the right. As a result the
total of each side of the statement of fi nancial position will be the same – hence the state-
ment of fi nancial position balances . When we prepare statements of fi nancial position, assets
are divided into two categories: non-current assets and current assets.
Non-current assets. Any asset acquired for retention by an entity for the purpose of pro-
viding a service to the business, and not held for resale in the normal course of trading.
In other words, a non-current asset is a resource acquired by an organisation with the
intention of using it to earn income for a long period of time. Examples of non-current
assets include land, buildings, motor vehicles, machinery and equipment.
Current assets. Cash or other assets – for example inventories, receivables and short-term
investments – held for conversion into cash in the normal course of trading.
In other words, a current asset is one that is either already cash, or will be converted
into cash within a short period of time. Liabilities are similarly divided into two categories,
refl ecting the time between the statement of fi nancial position date and the date by which
the liability should be settled. These categories are referred to as current liabilities and non-
current liabilities.
Current liabilities. Liabilities that fall due for payment within 1 year. They include that
part of non-current loans due for repayment within 1 year.
Non-current liabilities. Liabilities that are due for repayment more than 1 year after the
statement of fi nancial position date.
Example 2.B
Nadim had the following assets and liabilities on 1 January:
$
Land 200,000
Buildings 60,000
Inventories 10,000
Receivables 15,000
Cash in hand 5,000
Bank balance 32,000
322,000
Payables 17,000
Bank loan 240,000
257,000
We can calculate the value of Nadim’s capital using the accounting equation.
23
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FRAMEWORK OF FINANCIAL STATEMENTS
The total value of Nadim’s assets on 1 January is $322,000; his liabilities totalled $257,000. Therefore his
capital must be $65,000, that is:
Assets Liabilities Capital
322
000
257 000 65 000,,,
We can now prepare Nadim’s statement of fi nancial position.
Statement of fi nancial position of Nadim as at 1 January
Assets $’000 $’000 Liabilites $’000
Non-current asset Capital 65
Land 200
Buildings 60 Non-current liabilities
260 Bank loan 240
Current assets
Inventories 10 Current liabilities
Receivables 15 Payables 17
Bank balance 32
Cash in hand 5
62
322 322
We can see from the above that the statement of fi nancial position could be used to calculate the value of capi-
tal. If this method were used the capital value is the fi gure to make the statement of fi nancial position balance.
You should also note the order in which the current assets are listed. This is referred to as the order of liquidity.
Liquidity is the measure of closeness of assets to being cash, and it is usual for current assets to be listed from the
least liquid to the most liquid (as above). Returning to our example, let us assume that Nadim had the following
transactions during the fi rst week of January:
1. Bought offi ce equipment costing $7,000, paying $2,000 deposit by cheque, the balance to be paid at the
end of March.
2. Returned some offi ce equipment to his supplier because it was faulty. Nadim had originally been charged
$3,000 for it.
3. Received $8,000 from his receivables. They all paid him by cheque.
We can now see how these transactions affected his accounting equation.
1. Assets (offi ce equipment) increase by $7,000
Assets (bank balance) decrease by $2,000
Liabilities (payables) increase by $5,000
Nadim’s accounting equation is amended to:
Assets Liabilities Capital
327
000
262 000 65 000,,,
2. Assets (offi ce equipment) decrease by $3,000
Liabilities (payables) decrease by $3,000
Nadim’s accounting equation becomes:
Assets Liabilities Capital
324 000
259 000 65 000,,,
3. Assets (receivables) decrease by $8,000
Assets (bank balance) increase by $8,000
This has no effect on Nadim’s accounting equation.
STUDY MATERIAL C2
24
THE FRAMEWORK OF FINANCIAL STATEMENTS
Nadim’s statement of fi nancial position after these three transactions looks as follows:
Statement of fi nancial position
Assets $’000 $’000 Liabilities $’000
Non-current assets Capital 65
Land 200
Buildings 60 Non-current liabilities
Offi ce equipment 4 Bank loan 240
264
Current assets Current liabilities
Inventories 10 Payables 19
Receivables 7
Bank balance 38
Cash in hand 5
60
324 324
2.4.2 Vertical presentation of a statement of financial
position
The statement of fi nancial position presentation used so far is known as the horizontal for-
mat. It may be thought of as representing a set of scales, whereby the amount on each side
of the centre is equal. In this way it can be said to balance. In practice, a vertical presenta-
tion is used and an example is given below.
Statement of fi nancial position: vertical format
Assets $’000 $’000
Non-current assets
Land 200
Buildings 60
Offi ce equipment 4
264
Current assets
Inventories 10
Receivables 7
Bank balance 38
Cash in hand 5 60
324
Capital and liabilities
Capital 65
Non-current liabilities
Bank loan 240
Current liabilities
Payables 19
324
The difference between the current assets and the current liabilities is known as the net cur-
rent assets, if positive, or net current liabilities, if negative; it is also known as the working
capital of the business. In later studies you will learn that this is an important measure of the
25
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FRAMEWORK OF FINANCIAL STATEMENTS
short-term liquidity of an organisation. In Nadim’s statement of fi nancial position above, the
net current assets (working capital) is $41 (60−19).
In order to prepare the above statement you should recognise that individual assets, cap-
ital and liabilities are grouped under fi ve main headings as:
1. non-current assets
2. current assets
3. capital
4. non-current liabilities
5. current liabilities.
2.5 The income statement
In the course of his business, Nadim will attempt to earn money by selling his goods to
customers. The money earned in this way is referred to as the sales revenue (or simply the
sales ) of the business. To sell goods, he fi rst has to buy them (or manufacture them – but
we shall assume that Nadim is a retailer rather than a manufacturer). Obviously, there is a
cost involved in the buying of the goods. The difference between the cost of the goods he
sells and the sales revenue earned from customers is called the gross profi t of the business.
Apart from having to purchase goods, Nadim incurs other costs in running his business.
He must buy fuel for his delivery van. He probably pays rent for the warehouse or shop
premises in which he stores his goods. If he employs anyone to help him he will have to
pay wages. All of these costs have to be paid for from the gross profi t earned by selling
goods. The amount remaining after all of these expenses have been paid is called the net
profi t of the business.
What happens to this net profi t once it has been earned?
●
As a private individual, Nadim has living expenses like everyone else. He will need to
withdraw some of the net profi t from the business to pay for these; such a withdrawal is
referred to as drawings .
●
Any profi t that Nadim does not need to withdraw simply remains in the business,
increasing his capital.
In Example 2.A, you saw that Ahmed, trading as Ahmed’s Matches, made a profi t of
$10.50, and withdrew $5 for himself, leaving the other $5.50 in the business to increase
his capital.
Example 2.C
In the following month, Nadim sells goods on credit to his customers for $6,000. He already had some inven-
tories, costing $10,000, so he used $1,000 worth of that existing inventory, and bought in another $3,000
worth of inventories that was all used to fulfi l the order. He has not yet paid for this extra inventory. His rent
bill for the month is $500 and his van running costs are $300. He withdraws $200 from the business for his
private use.
Present an income statement for Nadim for this month, and a statement of fi nancial position at the end of the
month.
STUDY MATERIAL C2
26
THE FRAMEWORK OF FINANCIAL STATEMENTS
Solution
Income statement for the month
$’000 $’000
Sales 6
Less : cost of goods sold (4)
Gross profi t 2
Less : Rent 0.5
Van running costs 0.3
0.8
Net profi t earned 1.2
Notes :
1. The cost of goods sold fi gure can be calculated as $1,000 from existing inventory, plus $3,000 bought
specially. See Section 2.5.1 for another way to calculate the cost of goods sold.
2. Nadim’s drawings are not business expenses, but are deducted from his capital on the statement of fi nancial
position below.
The part of the income statement which calculates gross profi t is known as the trading account. This comprises
sales less cost of goods sold equals gross profi t. The trading account is thus a sub-section of the income state-
ment although its name does not appear within the income statement. Nevertheless, it is a very important part of
the income statement.
Statement of fi nancial position at the end of the month
Assets $’000 $’000
Non-current assets
As before 264
Current assets
Inventories (10–1) 9
Receivables (7 6) 13
Bank balance 38
Cashinhand (5−0.5−0.3−0.2) 4
64
328
Capital and liabilities
Capital 66
Long-term liabilities
Bank loan 240
Current liabilities
Payables (19 3) 22
328
Notice that the capital of the business has increased by $1,000 – the amount of net profi t retained in the busi-
ness. It is possible to prepare a statement of changes in capital, showing exactly how the fi gure of $65,000 has
risen to $66,000.
27
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FRAMEWORK OF FINANCIAL STATEMENTS
Statement of changes in capital
$’000 $’000
Capital at start of the month 65.0
Net profi t earned in period 1.2
Net profi t withdrawn by Nadim (0.2)
Net profi t retained in the business 1.0
Capital at end of month 66.0
You should see clearly from this statement how the income statement links up with the
statement of fi nancial position: the net profi t earned, shown in the income statement,
becomes an addition to capital in the statement of fi nancial position, and Nadim’s draw-
ings are deducted from this.
In Chapter 13 we will learn more about the income statement and how it may be part of
a statement of comprehensive income. However, until Chapter 13, we will just refer to the
income statement.
2.5.1 The cost of goods sold
We shall be looking at the income statement in more detail later on, but at this stage it is
worth noting one general point, which will be illustrated by the particular example of the
cost of goods sold.
In computing the profi t earned in a period the accountant’s task is:
●
fi rst, to establish the sales revenue earned in the period;
●
second, to establish the costs incurred by the business in earning this revenue.
This second point is not as simple as it might sound. For example, it would not be true to
say that the costs incurred in an accounting period are equal to the sums of money expended
in the period. This could be illustrated by many examples, some of which you will encoun-
ter later in the text. For now, we focus on one particular cost: The cost of goods sold .
A trader may be continually buying goods and selling them on to customers. At the
moment he draws up his fi nancial statements it is likely that he has inventories that have
been purchased in the period but not yet sold. It would be wrong to include the cost of
this closing inventory as part of the cost of goods sold, for the simple reason that these
goods have not yet been sold.
Looking back to the beginning of the accounting period, it is likely that opening inven-
tories were on hand. These have presumably been sold in this period and their cost must
form part of the cost of goods sold, even though they were purchased in an earlier period.
What all this illustrates is that the cost of goods sold in an accounting period is not
the same as the cost of goods purchased in the period. In fact, to calculate the cost of
goods sold we need to do the following calculation (presented here using the fi gures from
Nadim’s business above):
$
Cost of opening inventories at the start of the period 10,000
Cost of purchases during the period 3,000
13,000
Less: cost of closing inventories at the end of the
period 9,000
Cost of goods sold 4,000
STUDY MATERIAL C2
28
THE FRAMEWORK OF FINANCIAL STATEMENTS
It is this fi gure of $4,000 – not the purchases of $3,000 – that is matched with the sales
revenue for the period in order to derive the fi gure of gross profi t.
Exercise 2.2
Explain briefl y what is meant by the following terms:
●
assets;
●
liabilities;
●
capital;
●
revenue;
●
expense.
Solution
●
Assets. Items possessed by an organisation, which may be used to provide income in the
future. Includes non-current assets (land, buildings, machinery, etc.) and current assets
(inventories, receivables, cash, etc.).
●
Liabilities. Financial obligations or amounts owed by an organisation. Includes loans,
overdrafts and payables.
●
Capital. The amount of investment made by the owner(s) in the organisation, and not
yet withdrawn. The amount includes initial and subsequent amounts introduced by the
owner(s), plus any profi ts earned that have been retained in the organisation.
●
Revenue. Amounts earned by the activities of the organisation, which eventually result in
receiving money. Includes sales revenue, interest received and so on. Revenue increases profi t.
●
Expense. Costs used up in the activities of the organisation. Includes heat, light, local
business tax, inventories consumed, wages and so on. Expenses reduce profi t.
Exercise 2.3
On 1 June 20X1, J Brown started business as a jobbing gardener with a capital of $2,000
in cash. A list of fi gures extracted from his records on 31 May 20X2 shows the following:
$
Purchases of seeds, plants, etc. 700
New motor van 1,100
Mowing machine 70
Cultivator 250
Motor van expenses 300
Rent of garage 200
Paid to wife for clerical work 500
Insurance 200
Private expenses paid from bank 1,500
Cash in hand and bank 180
Cash received from customers 3,000
Capital at the start of the year 2,000
Inventories of seeds, plants, etc. at the end of the year 100
29
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FRAMEWORK OF FINANCIAL STATEMENTS
You are required to prepare:
(A) an account to show J Brown’s profi t or loss for the year ended 31 May 20X2,
(B) a statement of fi nancial position as at 31 May 20X2.
Solution
Income statement of J Brown for the year ended 31 May 20X2
$ $
Sales 3,000
Purchases of seeds, plants 700
Less : closing inventories of seeds, plants (100)
Cost of goods sold 600
Gross profi t 2,400
Less : Motor van expenses 300
Rent of garage 200
Wife’s wages 500
Insurance 200
1,200
Net profi t 1,200
Statement of fi nancial position of J Brown as at 31 May 20X2
Assets $ $
Non-current assets
Motor van 1,100
Mowing machine 70
Cultivator 250
1,420
Currents assets
Inventories of seeds and plants 100
Cash in hand and at bank 180
280
1,700
Capital
Capital introduced 2,000
Add : net profi t for the year 1,200
3,200
Less : drawings (1,500)
Captital at the end of the period 1,700
2.6 Profit and cash
Note that in Example 2.C, Nadim’s business made a profi t of $1,200. But his bank balance
remained unchanged and his cash holdings actually fell. This was because some of his transac-
tions that affected profi t did not affect cash at the same time. For example, his customers did
not pay Nadim, nor did Nadim pay his suppliers, until after the end of the month. Also, there
was a transaction that affected cash, but not profi t – Nadim took $200 cash in drawings, which