Chapter 1: Overview of Accounting

1.1. Introduction of Accounting

1.1.1. Definition of accounting
- Accounting is the systematic and comprehensive recording of financial
transactions pertaining to a business
- Accounting is a way of recording, analyzing and summarizing transactions of an
entity.
- Accounting is a way of recording, analysing, and summarising transactions of an
entity (a term we shall use to describe any business organization).
1.1.2. Type of accounting
- Financial accounting is concerned with reporting information to users external to an
entity in order to help them to make sound economic decisions about the entity’s
performance and financial position.
- Management accounting (also referred to as managerial accounting) is that area of
accounting concerned with providing financial and other information to all levels of
management in an organization to enable them to carry out their planning, controlling
and decision‐making responsibilities.
- External Users( Lenders, Consumer Groups, Shareholders, External Auditors,
Governments, Customers) : Financial accounting provides external users with financial
statements.
- Internal Users( Internal Auditors, Controllers, Managers, Sales Staff, Officers/Directors,
Budget Officers): Managerial accounting provides information needs for internal
decision makers.
The purpose of accounting information
- Managers of the company: They need information about the company's financial
situation as it is currently and as it is expected to be in the future. This is to enable them
to manage the business efficiently and to make effective decisions
- Shareholders of the company: They want to know how profitable the company's
operations are and how much profit they can afford to withdraw from the business for
their own use
- Trade contacts: Suppliers want to know about the company's ability to pay its debts;
customers need to know that the company is a secure source of supply and is in no
danger of having to close down
- Financial analysts and advisers need information for their clients or audience. For
example, stockbrokers need information to advise investors. Credit agencies want
information to advise potential suppliers of goods to the company. Journalists need
information for their reading public.
1.1.3. THE NEEDS OF FINANCIAL ACCOUNTING
- The objective of financial statements
+ The ultimate goal of accounting is to provide information that is useful for
decision-making. Financial accounting is used to generate information for stakeholders
outside of an organization, such as owners, stockholders, lenders, and governmental
entities.
+ A business should produce information about its activities because there are
user groups who want or need to know that information in order to make decisions
relating to providing resources to the entity.
1.2 ACCOUNTING ASSUMPTIONS AND PRINCIPLES
1.2.1 Accounting assumptions
- Going concern concept is the underlying assumption for the financial framework. The
entity is reviewed as continuing in operation for the foreseeable future. It is assumed
that the entity has neither the intention nor the necessity of liquidation or ceasing to
trade
The going concern assumption is a basic underlying assumption of accounting. For a
company to be a going concern, it must be able to continue operating long enough to
carry out its commitments, obligations, objectives, and so on. In other words, the
company will not have to liquidate or be forced out of business. If there is uncertainty as
to a company’s ability to meet the going concern assumption, the facts and conditions
must be disclosed in its financial statements.
- The monetary unit assumption requires that companies include in the accounting
records only transaction data that can be expressed in money terms. This assumption
enables accounting to quantify (measure) economic events. The monetary unit
assumption is vital to applying the historical cost principle.
- Economic Entity Assumption
+ The business entity concept: A business is a separate entity from its owner.
that accountants regard a business as a separate entity, distinct from its owners or
managers. The concept applies whether the business is a limited liability company (and
so recognized in law as a separate entity), a sole trader, or a partnership (in which case
the business is not legally recognized as separate from its owners).
+ The accounting period concept states that the life of a business can be divided
into artificial periods and that useful reports covering those periods can be prepared for
the business.
- Accounting concepts and convention
+ Accrual basic
 The effects of transactions and other events are recognized when they occur (and
not as cash or its equivalent is received or paid) and they are recorded in the
accounting records and reported in the FSs of the periods to which they relate.
 Entities  record when revenues or expenses are earned or incurred in the
accounting period, to which they relate, not as the cash is paid or received
 Accrual assumption  profit/revenue earned must be matched against the
expenditure incurred in earning it. This is the matching convention
1.2.2. ACCOUNTING PRINCIPLES
- Materiality and aggregation:
+ Omissions or misstatements of items are material if they could, individually or
collectively, influence the economic decisions of users taken on the basis of the
financial statements.
+ Financial statements result from processing large numbers of transactions or
other events that are then aggregated into classes according to their nature or
function, such as 'revenue', 'purchases', 'trade receivables', and 'trade payables'.
- Consistency of presentation: the presentation and classification of items in the
financial statements should stay the same from one period to the next, unless:
+ There is a significant change in the nature of the operations or a review of the
financial statements indicates a more appropriate presentation.
+ A change in presentation is required by an IAS.
- Historical cost: Transactions are recorded at their cost when they are incurred.
=> A basic principle of accounting is that the monetary amount at which items are
normally measured in financial statements is at historical cost.
Numerous possibilities can be considered, including:
+ the original cost (historical cost) of the machine.
+ half of the historical cost, on the ground that half of its useful life has expired
+ The amount the machine might fetch on the second hand market (realizable value)
+ The amount needed to replace the machine with an identical machine (replacement
cost) the amount needed to replace the machine with a more modern machine
incorporating the technological advances of the previous two years.
+ The machine’s economic value, ie, the amount of the profits it is expected to generate
for the company during its remaining life (present value)
All of these valuations have something to commend them, but the great advantage of
the first two is that they are based on a figure (the machine’s historical cost) which is
objectively verifiable.
1.3 QUALITATIVE CHARACTERISTIC OF FINANCIAL INFORMATION
1.3.1. Fundamental Qualitative characteristic
- Qualitative characteristics are the qualities or attributes that make financial accounting
information useful to the users
- The objective is to ensure that the information is useful to the users in making
economic decisions
- Financial information should be relevant and faithfully represent what it purports to
represent. The usefulness of financial information is enhanced if it is comparable,
verifiable, timely and understandable.
- Relevance – financial information is regarded as relevant if it is capable of influencing
the decisions of users.
- Faithful representation – this means that financial information must be complete,
neutral and free from error.
1.3.2. Enhancing Qualitative characteristic
Comparability – it should be possible to compare an entity over time and with similar
information about other entities.
- Verifiability – if information can be verified (e.g. through an audit) this provides
assurance to the users that it is both credible and reliable.
- Timeliness – information should be provided to users within a timescale suitable for
their decision making purposes.
- Understandability – information should be understandable to those that might want
to review and use it. This can be facilitated through appropriate classification,
characterization and presentation of information.
Chapter 2 Accounting equation
2.1. The basic elements of Accounting Equation
2.1.1. Assets
Assets is 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.
CURRENT ASSETS
- An asset should be classified as a current asset when it is:
· Expected to be realised in, or is held for sale or consumption in, the entity's normal
operating cycle
· Held primarily for the purpose of being traded
· Expected to be realised within 12 months after the reporting date
· Cash or a cash equivalent which is not restricted in its use
All other assets should be classified as non-current assets
NON- CURRENT ASSETS
- Non-current includes tangible, intangible operating, and financial assets of a long-term
nature. Other terms with the same meaning can be used (eg 'fixed', 'long-term').
NOTE:
The term 'operating cycle' is defined by the standard as follows.
The operating cycle of an entity is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents
Examples of assets:Land & buildings, Motor Vehicles, Plant & Machinery, Fixtures &
fitting, Cash, Inventory, Receivables (debtors)
2.1.2. Liabilities
- Liabilities is 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.
CURRENT LIABILITIES
- A liability should be classified as a current liability when it is:
· Expected to be settled in the entity's normal operating cycle
· Due to be settled within 12 months of the reporting date
· Held primarily for the purpose of being traded
All other liabilities should be classified as non-current liabilities
Examples of Liabilities: Bank loan or overdraft, Payables (creditors), taxation
2.1.3. Equity
Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Equity is also the amount invested in a business by the owners.
- Capital reserves usually have to be set up by law, whereas revenue reserves are
appropriations of profit.
- With a sole trader, profit was added to capital. However, in a limited company, share
capital and profit have to be disclosed separately, because profit is distributable as a
dividend but share capital cannot be distributed. Therefore any retained profits are kept
in the retained earnings reserve.
2.2. The use of Accounting Equation
2.2.1. The basic accounting equation
Definition: The accounting equation is considered to be the foundation of the double-
entry accounting system.
The accounting equation shows on a company's balance sheet whereby the total of all
the company's assets equals the sum of the company's liabilities and shareholders'
equity.
The accounting Equation : Asset = Liabilities + Equity
Equity + Liabilities = Total assets
Equity/ Capital = Capital introduced + Retained profits
Equity/ Capital = Capital introduced + (Earned profit – Drawings)
Profit/Loss = Revenue - Expenditure
Drawings are amounts of money taken out of a business by its owners

2.2. The use of Accounting Equation

2.2.2 Transaction analysis in accounting equation

Chapter 3
3.1. Sources of documents
- Source documents: are the documents which are produced by or input into a
business's accounting system as the starting point to recording the transactions of a
business for accounting purposes
The documents may be hard copy or electronic
- The purpose of source document
3.1.2.TYPES OF SOURCES OF DOCUMENTS
- Sale system: customer order, dispatch goods, invoice, receive payment

+ Sales order: A document of the company that details an order placed by a

customer for goods or services. The customer may have sent a purchase order to the
company from which the company will then generate a sales order. Sales orders are
usually sequentially numbered so that the company can keep track of orders placed by
customers
+ Invoice: An invoice may relate to a sales or purchase order. Invoices are source
documents for credit transactions.
+ Credit note: A document issued to a customer relating to returned goods, or
refunds when a customer has been overcharged for whatever reason. It can be
regarded as a negative invoice.
+ Goods despatched note: A document of the company that lists the goods that
the company has sent out to a customer. The Company will keep a record of goods
despatched notes in case of any queries by customers about the goods sent. The
customer will compare the goods despatched a note to what they receive to make sure
all the items listed have been delivered and are the right specification.
- Purchase system: Purchase order, Receive goods, invoice, paymen

+ Invoice: An invoice may relate to a sales or purchase order. Invoices are source
documents for credit transactions.
+ Debit notes: A debit note might be issued to a supplier as a means of formally
requesting a credit note from that supplier. A debit note is not a source document.
+ Goods received note: A document of the company that lists the goods that a
business has received from a supplier. A goods received note is usually prepared by the
business's own warehouse or goods receiving area.
- Bank transaction: receipt, remittance advice, ….
SOURCES DOCUMENTS FOR BANK TRANSACTION:
 Bank statement. This contains a number of adjustments to a company's book
balance of cash on hand that the company should reference to bring its records
into alignment with those of the bank.
 Cash register tape. This can be used as evidence of cash sales, which supports the
recordation of a sale transaction.
 Remittance advice. A document sent to a supplier with a payment, detailing
which invoices are being paid and which credit notes offset. A remittance advice
allows the supplier to update the customer's records to show which invoices have
been paid and which are still outstanding. It also confirms the amount being paid,
so that any discrepancies can be easily identified and investigated.
 Receipt. A document confirming confirmation that a payment has been received.
This is usually in respect of cash sales, eg a till receipt from a cash register.
3.2.1. The purpose of books of prime entry
- Books of prime entry (books of original entry) records of source documents – of
transactions – so that it knows what is going on.
- Books of prime entry are books in which we first record transactions.
- The details on these source documents need to be summarised, as otherwise the
business might forget to ask for some money, or forget to pay some, or even
accidentally pay something twice.
The books of prime entry serve to ‘capture’ transactions as soon as possible so
that they are not subsequently lost or forgotten about.
3.2.2. Types of books of prime entry
- Cash book:
+ The cash book is used to record money received and paid out by the business
through the business bank account.
+ Some cash, in notes and coins, is usually kept on the business premises in order
to make occasional payments for odd items of expense.
+ Accounted for separately in a petty cash book.
- Petty cash book: The book of original entry for small payments and receipts of
cash.
+ Most common, petty cash use the imprest system  reimburse/ refund the
total amount paid out in a period (i.e. if on 1 Dec petty cash paid out $100  under
imprest system, on 2 Dec accountant will draw $100 to top-up the amount paid in
yesterday).
 + Under what is called the imprest system, the amount of money in petty cash is
kept at an agreed sum or 'float' , so that each toping is equal to the amount paid out
in the period.
+ Although the amounts are small, petty cash transactions still need to be recorded
to prevent fraudulent or misuse of funds (i.e. IOU).
+ There are usually more payments than receipts in petty cash.
- Jourrnal:
+ The final book of original entry is the journal. This is the record of transactions
which do not appear in any of the other books of original entry. Non-current asset
purchases are usually recorded via the journal.
+ Journal is also ONE of the books of original entry.
+ Journal keeps a record of unusual movement between accounts
Record any double entry made but  do not arise from other books of original entry
(i.e. Journal entries are made when corrected errors or adjustments like prepayment…)
- Computerised books of prime entry: Books of prime entry still exist within the
workings of a computerized system.
+ Most companies now use a computerised system to manage their accounting
transactions and to prepare their financial statements, rather than manual books.
+ Most systems still use the concepts of the books of prime entry for recording
sales and purchases, cash receipts and payments
+ Entries are usually made by entering a sale or a purchase which is then
recorded in a book of prime entry within the working of the accounting system.
Computerised books of prime entry: Function & Benefit
Most accounting information is numerical and, of course, computers excel at dealing
with that type of data. Computerised accounting systems should offer the following
advantages over manual systems:
 faster provision of information
 provision of information that would not be easily available without a
computerised accounting system
 once the system is set up, cheaper information
 more accurate information because arithmetic and certain other errors will be
eliminated.
Chapter 5
5.1. The ledger account
5.1.1. Classification of ledger accounts
- Asset: A resource controlled by an entity as a result of past events and from which
future economic benefits are expected to flow to the entity: Inventories, Machinery,
Trading securities, Receivable, Cash in bank, Cash on hand, Factory buildings, Motor
vehicles, Furniture.
- Liability: A present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow of resources embodying economic
benefits: Payable, loan
- Equity: The residual interest in the assets of an entity after deducting its liabilities:
Capital, Net profit (Undistributed profit after tax)
- Revenue: arises in the course of the ordinary activities of an entity-and is referred
to by a variety of different name including sales, fees, interest, dividends, royalties
and rent
- Expense: decreases in economic benefits during the accounting period in the form
of outflows or depletions of assets or incurrences of liabilities that result in
decreases in equity, other than those relating to distributions to equity participants:
Salaries, rent paid, bank interest paid, insurance expenses, advertising expenses
Every account classification has:
- Balance brought down (opening balance)
- Balance carried down (closing balance)
- Increase
- Decrease
- Closing balance (CB) = Opening balance (OB) + Increasing - Decreasing
- Opening balance of Year N+1 = Closing balance of Year N
5.2.1. Purchasing transactions
- Introduction: When purchasing on cash
1. Increase assets (inventories, fixed assets, tools, raw material…)
2. Decrease cash
• DR PURCHASING
• CR CASH
- Introduction: When purchasing on credit
1. Increase assets (inventories, fixed assets, tools, raw material…)
2. Increase Trade accounts payable
• DR PURCHASING
• CR ACCOUNT PAYABLE
- Introduction: When sale on cash:
1. Increase cash
2. Increase Sales revenue
• DR Cash
• CR Sales revenue
- Introduction: When sale on credit:
1. Increase Trade accounts receivable
2. Increase Sales revenue
• DR Accounts receivable
• CR Sales revenue
5.2.3. Journal entries
- The journal is the record of prime entry for transactions which are not recorded in
any of the other books of prime entry, for example: capital, depreciation, loan and
correction of errors transactions. These transactions are excluding purchasing, sales,
cash and payroll one
- Remember that one of the books of prime entry is the journal.
Chapter 6 THE TRIAL BALANCE
6.1. CORRECTION OF ERRORS
6.1.1 TYPES OF ERRORS
There are six main types of error. Some can be corrected by journal entry; some
require the use of a suspense account
(1) Errors of transposition
- An error of transposition is when two digits in a figure are accidentally
recorded the wrong way round.
(2) Errors of omission
- An error of omission means failing to record a transaction at all, or making a
debit or credit entry, but not the corresponding double entry.
(3) Errors of principle
- An error of principle involves making a double entry in the belief that the
transaction is being entered in the correct accounts, but subsequently finding out
that the accounting entry breaks the 'rules' of an accounting principle or concept
(4) Errors of commission
Errors of commission are where the bookkeeper makes a mistake in carrying out
their task of recording transactions in the accounts.
Here are two common types of errors of commission:
(i) Putting a debit entry or a credit entry in the wrong account and
(ii) Errors of casting (adding up).
(5) Error of original entry
An incorrect figure is entered in the records and then posted to the correct account
This error means that a wrong amount has been initially recorded in the book of
original entry and subsequently posted to the ledger accounts. This error is just as
simple as the name implies.
(6) Compensating errors
Compensating errors are errors which are, coincidentally, equal and opposite to one
another.
Once an error has been detected, it needs to be put right.
• (a) If the correction involves a double entry in the ledger accounts, then it is done
by using a journal entry.
• (b) When the error breaks the rule of double entry, then it is corrected by the use
of a suspense account as well as a journal entry
6.1. CORRECTION OF ERRORS
6.1.2. SUSPENSE ACCOUNTS
- A suspense account is an account showing a balance equal to the difference in a
trial balance
- Suspense accounts, as well as being used to correct some errors, are also opened
when it is not known immediately where to post an amount. When the mystery is
solved, the suspense account is closed and the amount correctly posted using a
journal entry
A suspense account is a temporary account which can be opened for a number of
reasons. The most common reasons are as follows.
(a) A trial balance is drawn up which does not balance (ie total debits do not equal
total credits).
(b) The bookkeeper of a business knows where to post the credit side of a
transaction, but does not know where to post the debit (or vice versa).
For example, a cash payment might be made and must obviously be credited to cash.
But the bookkeeper may not know what the payment is for, and so will not know
which account to debit.
Use of suspense account:
(1) When the trial balance does not balance
When an error has occurred which results in an imbalance between total debits and
total credits in the ledger accounts, the first step is to open a suspense account.
(2) Not knowing where to post a transaction
Another use of suspense accounts occurs when a bookkeeper does not know
where to post one side of a transaction. Until the mystery is sorted out, the entry
can be recorded in a suspense account.
(3) Summary:
(4) There are five main types of error. Some can be corrected by journal entry; some
require the use of a suspense account.
- Errors that leave total debits and credits in the ledger accounts in balance can
be corrected by using journal entries. Otherwise, a suspense account has to be
opened first, and later cleared by a journal entry.
- Suspense accounts, as well as being used to correct some errors, are also
opened when it is not known immediately where to post an amount. When the
mystery is solved, the suspense account is closed and the amount is correctly
posted using a journal entry.
- Suspense accounts are only temporary. None should exist when it comes to
drawing up the financial statements at the end of the accounting period
6.2. CONTROL ACCOUNT AND RECONCILIATION
6.2.1 Control account
- A control account keeps a total record of a number of individual items. It is an
impersonal account which is part of the double entry system.
- Control accounts are used chiefly for trade receivables and payables.
(a) A receivables control account is an account in which records are kept of
transactions involving all receivables in total. The balance on the receivables control
account at any time will be the total amount due to the business at that time from
its receivables.
(b) A payables control account is an account in which records are kept of
transactions involving all payables in total. The balance on this account at any time
will be the total amount owed by the business at that time to its payables
- Although control accounts are used mainly in accounting for receivables and
payables, they can also be kept for other items, such as inventories, wages and
salaries, and cash. The first important idea to remember, however, is that a control
account is an account which keeps a total record for a collective
item (eg receivables), which in reality consists of many individual items (eg individual
trade receivables)
- Before looking at control accounts for accounts receivable and payable, we need to
consider the accounting treatment for discounts.Discounts can be defined as follows.
– A trade discount is a reduction in the list price of an article, given by a wholesaler
or manufacturer to a retailer. It is often given in return for bulk purchase orders.
 – A cash (or settlement) discount is a reduction in the amount payable in return for
payment in cash, or within an agreed period.
- Receivables control account
+ At any time the balance on the receivables control account should be equal to
the sum of the individual personal account balances on the receivables ledger.
+ Most customers have a debit balance
+ Some customer may have a credit balance, perhaps because it has overpaid the
business, or paid for goods and then returned some.
Contra: When a person or business is both a customer and a supplier, amounts owed
by and owed to the person may be 'netted off' by means of a contra
- A payables control account
A payables control account is an account in which records are kept of transactions
involving all payables in total. The balance on this account at any time will be the total
amount owed by the business at that time to its payables.
• At any time the balance on the payables control account should be equal to the
sum of the individual personal account balances on the payables ledger.
• Most supplier have a credit balance
• Some supplier may have a debit balance, perhaps because it has
an overpayment of account to a supplier; Return made to creditors not yet
refunded; Deposit made to suppliers
• Contra: When a person or business is both a customer and a supplier, amounts
owed by and owed to the person may be 'netted off' by means of a contra
6.2.2 reconciliation
BANK RECONCILIATION
- A bank reconciliation is a comparison of a bank statement (sent monthly, weekly or
even daily by the bank) with the cash book. Differences between the balance on the
bank statement and the balance in the cash book will be errors or timing differences,
and they should be identified and satisfactorily explained.
- The cash at bank account, the cash book and the bank statement
• The cash at bank account in the nominal ledger is the control account for the
cash book, although often they are one and the same.
• The cash at bank account, the cash book and the bank statement all reflect
transactions through the business's bank account.
• Cash is an asset (a debit balance) in the business's ledger accounts. As far as the
bank is concerned it owes the business money. Thus every item recorded as a
debit in the business's books – a positive bank balance, and any receipts of cash
– will be shown as a credit on the bank statement.
• When cash is a liability (a credit balance) in the business's books, as far as the
bank is concerned it is owed money. Thus every credit entry in the business's
books – a negative bank balance, and any payments of cash – will be shown as a
debit on the bank statement.
- Disagreement with the cash book
+ There are five common explanations for differences between cash book and
bank statement.
• Error
• Unrecorded bank charges or bank interest.
• Automated payments and receipts.
• Dishonoured cheques
• Timing differences
+ A comparison of a bank statement (sent monthly, weekly or even daily by the
bank) with the cash book.
• Differences between the balance on the bank statement and the balance in the
cash book should be identified and satisfactorily reconciled
• When doing a bank reconciliation, have to look for the following items on the
bank statement and in the cash book:
• Errors in the cash book
• Corrections and adjustments to the cash book
• Errors in the bank statement
 • Items reconciling the correct cash book balance to the bank statement
(timing differences)
+ Corrections and adjustments to the bank statements (timing differences):
• Unpresented cheques (outstanding cheque): Cheques drawn (ie paid) by the
business and credited in the cash book, which have not yet been presented to
the bank, or 'cleared', and so do not yet appear on the bank statement
• Uncleared lodgements: Cheques received by the business, paid into the bank and
debited in the cash book, but which have not yet been cleared and entered in the
account by the bank, and so do not yet appear on the bank statement
+ The corrected cash book balance is then equal to the corrected bank balance
+ Corrections and adjustments to the cash book
(i) Payments made into the bank account or from the bank account by way of standing
order or direct debit, which have not yet been entered in the cash book
(ii) Dividends received (on investments held by the business), paid direct into the bank
account but not yet entered in the cash book
(iii) Bank interest and bank charges, not yet entered in the cash book
(iv) Errors in the cash book that need to be corrected
The corrected cash book balance is then shown in the statement of financial position.
6.3. Preparing a trial balance
6.3.1 The purpose of a trial balance
• A trial balance is a list of ledger balances shown in debit and credit columns
• A trial balance can be used to test the accuracy of the double entry accounting
records. It works by listing the balances on ledger accounts, some of which are
debits and some credits. Total debits should equal total credits.
Extract ledger balance to trial balance includes steps:
The first step: Collection of ledger accounts.
- Before you draw up a list of account balances, you must have a collection of ledger
accounts.

The second step: Balancing ledger accounts

 At the end of an accounting period, a balance is struck on each account in turn. This
means that all the debits on the account are totalled and so are all the credits. If the
total debits exceed the total credits there is said to be a debit balance on the
account; if the credits exceed the debits then the account has a credit balance.
The third step: Collecting the balances
If the basic principle of double entry has been correctly applied throughout the
period it will be found that the credit balances equal the debit balances in total.
A trial balance can be used to test the accuracy of the double entry accounting
records. It works by listing the balances on ledger accounts, some of which are
debits and some credits. Total debits should equal total credits.
An adjusted trial balance is a listing of all the balances on ledger accounts that will
appear on the financial statements after year-end adjusting journal entries have
been made.
Chapter 7 The basic financial statements
7.1.1 Definition of financial statements
- Financial statements are reports prepared by a company’s management to present
the financial performance and position at a point in time.
- A general-purpose set of financial statements usually includes a Statement Of
Financial Position, Statement Of Comprehensive Income, Statement Of Changes in
Equity, and statement of cash flows.
- These statements are prepared to give users outside of the company, like investors
and creditors, more information about the company’s financial positions.
7.1.2. Types of financial statements
1. Statement Of Financial Position - SOFP (Balance Sheet)
2. Statement Of Comprehensive Income - SOCI –
(Income statement)
3. Statement Of Cash Flows – SOCF
4. Statement Of Changes in Equity – SOCE
Statement of Financial position
 • A list of all the assets controlled and all the liabilities owed by a business as at a
particular date: it is snapshot of the financial position of the business at a
particular moment. Monetary amounts are attributed to assets and liabilities. It
also quantifies the amount of the owners’ interest in the company: equity.
ELEMENTS OF STATEMENT OF FINANCIAL POSITION
- Asset: is 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.
- A liability: is 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.
- Equity: is the residual interest in the assets of the entity after deducting all its
liabilities. Equity is also the amount invested in a business by the owners
7.3.1 Overview of Statements of Comprehensive Income
The main financial statements
- Statement of total comprehensive income/ Profit or Loss
+ A statement displaying items of income and expense in a reporting period as
components of profit or loss for the period.
+ The statement shows whether the business has had more income than expense (a
profit for the period) or vice versa (a loss for the period)
The link between the statement of financial position and the statement of profit or loss
is provided by the statement of cash flows and the statement of changes in equity
- Information about the business's financial is needed by users.
+ To understand the return that the entity has produced on its economic resources
+ To assess how well management has discharged its responsibilities to make efficient
and effective use of the reporting entity’s resources
+ To help predict the business's future returns on its economic resources
7.3.2. From trial balance to Statements of comprehensive income
 Revenue
There are important rules on revenue recognition and these are the subject of
IFRS 15. We will look at this in detail in later in this chapter.
  Cost of sales
This represents the summary of the detailed workings we have used in a sole
trader's financial statements.
 Expenses
Notice that expenses are gathered under a number of headings. Any detail
needed will be given in the notes to the financial statements.
 Finance cost
This is interest payable during the period. Remember (from the previous chapter)
that this may include accruals for interest payable on loan stock.
 Income tax expense
This represents taxation as detailed in Section 3.7 below. Once again, this will
include accruals for the tax due on the current year's profits. However, it may also
include adjustments for any over- or underprovision for prior periods
- An income statement will contain the following basic elements:
1. Revenues
2. Expenses
• Cost of goods sold, Interest expenses, SGA (selling, general and
administrative) expense, depreciation expense, Income tax expense
3. Profits
• Gross profit, net operating income (also known as EBIT), earnings
before taxes (EBT), and net income
• Sales - Cost of Goods Sold = Gross Profit
• Sales - Operating Expenses /Selling expenses/ General and Administrative
expenses/ Depreciation and Amortization Expense= Operating income (EBIT)
• Sales - Interest Expense = Earnings before taxes (EBT)
• Sales - Income taxes = Net income (EAT)
1. EBIT = Earnings before interest and taxes;
2. EBT = Earnings before taxes; EAT = Earnings after taxes