FAC1502 STUDY NOTEs

Study unit 2
The financial position

We already know that the primary purpose for financial information is that it
provides important information an entities finances, it tells us the financial
position and performance of an entity, and this allows the users of this
information to make informed decisions.

Accounting Entity

If the business maintains its own financial records, it is considered an

accounting entity. Whoever keeps the financial records is the accounting
entity, they are responsible for all the financial reports (financial statements)
made. It’s important to keep the business as separate from its owners, this
means that. This means that an entity’s financial activities and transactions
must be separated from the personal finances of the owner.

The financial Position

The statement of financial position captures all the transactions that took
place on the exact last day of the financial year, let’s say that the financial
period was from 1 October to 30th September, in the statement of financial
position it will only capture the last days events in the statement (30 th day of
September) and not necessarily the whole year.

The financial position

The financial position is described in terms of assets, equity and liabilities at

a given time.

The Elements of the Financial Statement (Assets, Equity, Liabilities,

Income and Expenses)

1.) Assets

Non-Current and Current Assets: Assets are basically the resources a

business owns.

a.) Current Assets- These are assets a business may use up or convert into
cash within one year for example, stock (trading inventories),
consumable stores on hand (What the business uses during its
operations, e.g. office supplies (pen, paper, book, etc.), Cleaning
materials, office tools, etc.) Debtors accrued income (money the
 business has earned but has not yet received), prepaid expenses, bank
(favorable balance), cash float (amount of money the business keeps
on hand for everyday operations), petty cash.

b.) Non-current Assets: Assets that are not used up or converted into cash
within a year for example, land, buildings, vehicles, furniture, etc. They
use these assets to make money and there is no intention of selling it
or using it up within a year.

Liabilities

We have current liabilities and non-currents liabilities; current liabilities refer

to any outstanding payments that the business must settle within one year
for example creditors/trade payables, bank overdraft, accrued expenses, etc.
Non-current liabilities refer to any outstanding that the business must make
after one year, they are long-term liabilities, for example long term loans,
mortgage, debt issued to raise capital)

Equity (value of the assets in the business)

The difference between the assets a business owns, and the liabilities
incurred for example: Assets-liabilities=net assets value When the assets
exceed the liability it is called equity.

Basic accounting equations

Assets= Owner’s equity+ Liabilities

Remember that not all assets are owned by the entity, for example if a
business buys a vehicle on credit, they do not own this vehicle until they
completely pay it off.

Equity(wealth)= all valuables(assets) in the business – all the claims

against those assets (liabilities).

The double entry system

An account consists of a left-hand side and a right-hand side. It is

represented in a “T” format. The LHS is the debit side and the RHS is the
credit side. The total of the debit side must always be the same total on the
credit side. Every transaction has a dual effect on the elements of the
BAE (basic accounting equation) and after every transaction the BAE
must be in balance.
All “T” accounts are called the general ledger.

What are Sources of Financing?

Ways in which a business can basically raise money/capital to fund their

business activities, investments or operations. For example, bank loans,
Leasing (when a business rents their property or equipment instead of selling
it completely), Owner can provide more capital from his pockets to the
business, creditors/trade payables, etc.

Exercises on this topic are done on paper!!

Study Unit 3

The financial performance

The financial result of an entity is measured in terms of profit/loss

that the entity has made over a financial period (12 months). An entity
makes a profit when the income that is earned is more than the expenditure
it has incurred in generating that income. The difference between income
and expenses is known as the profit/loss. Profit is the business owner’s
reward for the capital he/she has invested. Profit increases the equity of the
business.

The statement of profit/loss and other comprehensive income of a business

provides information about the results of the operating activities of the
business, it basically shows the performance of the business in a specified
period.

INCOME-EXPENSES= PROFIT/LOSS FOR THE YEAR

Income

Profit/income refers to increases in assets and decreases in liabilities that

result in an increase in equity.

Revenue: is income earned through an entity’s normal daily operating

activities, for example:

 Fees earned
 Sales
 Interest income
 Rental income
 Commission income
  Credit losses recovered

Profit/gains: Increases in economic benefits that do not come from the daily
operations of an entity, for example:

 Profit on sale of non-current assets

Expenses

Losses/expenses are decreases in assets or increases in liabilities that

decrease equity and the profit of the year.

Expenses: Incurred in the normal course of an entity’s activities, they arise

when generating an income for example:

 Cost of sales (purchases of trading stock)

 Wages and salaries
 Interest expense
 Rental expenses
 Advertising
 Credit losses
 Insurance, etc.

Losses: Decreases in economic benefits that do not arise from normal

activities of an entity, for example:

 A loss in sales of non-current assets

Influence of profit/loss on equity

Equity refers to the wealth of the owner of an entity. For instance, if the
owner of the business decides to close down and sell all the assets in the
entity and pays all the liabilities, the amount left would be the equity.

Income increases equity and expenses decrease equity.

Equity can be calculated as follows:

a.) Equity= Assets-Liabilities

b.) Capital (Opening balance) + additional capital + total
comprehensive income for the year – Drawings = Capital
(Owner’s equity)

Exercise done on paper!!

Statement of changes in equity

Th purpose of the statement of changes in equity is to reconcile the equity
at the beginning of the period with the equity at the end of the financial
period. The balance of the equity at the end of the financial period is then
shown in the statement of financial position.

Study Unit 4
The double-entry system

 Think about what effect the transaction is going to have on the BAE.
 Identify the accounts involved
 Determine which accounts will be debited and which accounts will be
credited.
 Debit side must equal the credit side

Transactions that affect only assets and interest

 Capital Contributions, increases our assets and equity “capital”

 Acquisition of Loans, increases our assets and increases our liabilities
 Purchase of assets for cash, bank decreases and assets (trading stock
increases)
 Buying assets on credit, asset increases and liabilities increase
 Payments to creditors, bank decreases and liabilities decreases
 Drawings of cash, bank decreases and equity decrease

Accrual principle- Record transactions when money is earned and

not actually received

The general ledger

An account is opened on a general ledger for every asset, equity and liability
item. Every account appears on its own on a page in the ledger and each
account is given a number, which is known as a folio number.

Balancing an Account

The closing balance of the previous period becomes the opening balance of
the next period.

 c/d = Carried down, which indicates the amount to be carried down

to the following month.
 b/d = brought down, which indicates that the amount has been
brought down from the previous month
Golden Rule: For each transaction you must make a debit entry as
well as a credit entry for the debit side to be equal to the credit
side.

THE CONTRA LEGDER ACCOUNT

 An item that is in the ledger account is simply the name of the other
ledger account involved in the transaction. This other ledger is known
as the Contra ledger account.

*Drawings are not expenses resulted in business operations

THE TRIAL BALANCE

A trial balance is a list of all the balances b/d or the closing amounts of
the accounts in the general ledger on a specific date. The debits must be
equal to the credits – this is a possible indication of the correctness of the
recording of transactions in the general ledger. Represents a summary of
the balances in the general ledger to see if all the debits are equal
to the credits.

*Golden Rule: The balance brought down must be used to

prepare the general ledger
 Assets and expenses have debit balances brought down and
entered on the debit side of the trial balance.
 Equity(capital), liabilities and income accounts have credit
balances brought down and must be entered on the credit side
of the trial balance.

The income and expenditure accounts are called nominal

accounts
*Revenue – expenses = Profit/loss

*Golden rule- The balance of the statement of changes in equity

must be the same as the “capital” reflected in the statement of
financial position

STUDY 5
The accounting Cycle
Transactions that took place- Completion of Source Documents- Recording of
Transactions in Journals- Posting to ledgers- Reporting in financial
statements- Analysis and Interpretation of financial statements- Decision
making by management

*Then the decision made by management goes all the way back to
the transactions that took place, and the cycle continues to
continue.

Books of First Entry

Transactions of the same type are grouped together and analyzed in

subsidiary journals or books of first entry before they are recorded in a
summarized form in a ledger.

*A journal is a link between source documents and the ledger, No

transactions can be recorded in the ledger unless it has been
recorded in the journal and no transaction may be recorded in a
journal without the necessary source document as proof that a
transaction actually took place.

Types of Journals

 The cash receipts journal and the cash payments journal – all
cash transactions are recorded. NB: When someone makes a cash
payment to settle the accounts that they owe it will not be
recorded under the bank column in the CRJ, as it was a cash
payment!!
 The purchases journal and the purchases returns journal – All
credit purchases and returns of credit purchases are recorded.
 The sales journal and the sales returns journal – all credit sales and
returns of credit sales are recorded.
 The general journal- this is where transactions that were not
recorded in one of the other journals are recorded here. E.g. bad debts
recovered, correction of errors, etc.

Purchases Journal and Purchases Returns Journal

Only merchandise bought on credit is recorded in the purchases journal.

Any other credit sale is recorded in the General Journal.

If there is a trade discount the trade discount is never recorded in

the accounting records of the purchaser.
Thes source documents for the PJ are original invoices, the source
documents for the PRJ are original credit notes.
Sales Journal and Sales Returns Journal
Only for merchandise sold on credit is recorded in the Sales Journal, any
other credit sale is recorded in the General Journal,

The source documents for the SJ are duplicates of sales invoices

The source documents for entries in the sales journal returns are
duplicate of credit notes issued.
The Trial Balance
For the Folio column the B’s represent all the accounts that all the accounts
that will appear in the Statement of Financial Position and the N’s represent
all the nominal accounts that will appear and closed off to the statement of
profit/loss and other comprehensive income.

General Journal

All the other transactions that did not appear in the previous journals will be
recorded here like purchases and sales of goods done credit,
other than Merchandise will be recorded here.
Settlement Discount

Settlement discount granted- Offering discounts to our debtors to

encourage them to pay amounts that they owe to us.

Settlement Discount received- A discount is often received from creditors

to encourage quick settlement on the amounts that we owe.

VAT-VALUE ADDED TAX

If the entity is registered as a VAT vendor, the amounts/transactions

automatically include VAT at 15%

Output VAT- this is tax the business charges on their goods and services
rendered to customers

Input VAT- This is the tax that a business must pay for when purchasing
goods and services.
Output VAT – Input VAT= Amounts payable/refundable, this is the amounts
payable to SARS or the amounts that can be claimed from SARS.

*For instance, if the input VAT (the VAT the business pays) is more than the
output VAT (the VAT that the business charges) this means that the business
has paid more VAT than received VAT, thus they can claim the balance from
SARS, and this is seen as an ASSET (Input VAT-ASSET)

*Whereas if the Output VAT is greater than the Input VAT the business
(happens more often in businesses) must pay the outstanding balance to
SARS, as they have received more VAT than having paid more VAT, this is
seen as a liability. (Output VAT- LIABILITY)

Tax Period

Every business (or entity) that is registered for VAT is assigned a specific tax
period by the tax authorities. This means the business must submit its VAT
return for that period.

 Some businesses need to submit their VAT returns every two months.
This means they report on the VAT they collected and paid for the last
two months.

 Other businesses may have different periods, where they submit

returns for "unequal months- every 3rd month” (like January, March,
May, etc.) or "equal months" (like February, April, June, etc.).

So, the key idea is that businesses are assigned specific periods in which
they report their VAT, and these periods can vary based on how the tax
authorities organize them.

Accounting Basis

There are two ways to calculate VAT liability (the amount of VAT a business
owes to the tax authorities):

 Invoice basis: VAT is recorded when the invoice is sent or the

payment is received, whichever comes first.
 Payment’s basis: VAT is recorded only when the actual payment is
made or received.

Vat Inclusive amounts- These amounts include 15% VAT

VAT exclusive amounts- These amounts exclude 15% VAT