Finance

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Chapter 2: Analysing transactions and preparing year-end financial statements.
Overview: 1. The basic financial reports 2. Classification of transactions 3. Review of balance sheet and profit and loss statement

© Chris Guilding

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1. The basic financial reports
As part of financial reporting (i.e., external reporting), companies prepare: • a balance sheet, • a profit and loss statement,• a statement of owner’s equity, • a statement of cash flows. The main statements we will be reviewing are the balance sheet and the profit and loss statement.

© Chris Guilding

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1. The basic financial reports (cont’d)
The main sections of a balance sheet: Assets are “things” that are owned (most usually purchased) by the organisation. To qualify as an asset, the organisation should beable to derive some future value from ownership. Typical assets include: cash, accounts receivable, china, silver, glass, linen, stock, cars, equipment, land and buildings. Liabilities may be seen as the opposite of assets. They reflect financial obligations of the organisation. Typical liabilities include: wages & salaries payable, trade creditors and bank loan. Owner’s equity reflects thefinancial interest of the owner(s) in the organisation. It includes original investment plus all profits © out to the not paidChris Guilding owner(s) (retained profits).

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© Chris Guilding

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1. The basic financial reports (cont’d)
Fundamental balance sheet equation: Assets - Liabilities = Owner’s Equity (A - L = OE) i.e., the owner’s equity (interest) in the company equals the surplusassets that would be left over after the company’s liabilities have been paid off. Alternatively, the balance sheet equation can be stated as: Assets = Liabilities + Owner’s Equity (A = L + OE) i.e., money is raised and goes towards buying assets. Money raised but not “ploughed” into assets is held as cash (which is also an asset). © Chris Guilding

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2. Classification of transactions
Followingthe recording of business transactions, the balance sheet equation (A = L + OE) must be maintained. The “double impact” that transactions have on the balance sheet equation will be shown using the following 10 transactions made by the Kenit hotel.
Transaction 1) Geoff Kenit contributes $30,000 cash to commence his own hotel business.
ASSETS Cash Acc. at bank Rec’ble Stock © Chris Guilding+30,000 = LIABILITIES Acc. Loan Payable Payable + OWNER’S EQUITY Profit Capital & Loss + 30,000

Van

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2. Classification of transactions (cont’d)
Transaction 2) Billed clients $19,000 for use of conference facilities.
ASSETS Cash Acc. at bank Rec’ble +19,000 = LIABILITIES Acc. Loan Payable Payable + OWNER’S EQUITY Profit Capital & Loss +19,000

Stock

Van

Transaction 3) Purchased stockon credit for $800.
ASSETS Cash Acc. at bank Rec’ble = LIABILITIES Acc. Loan Payable Payable + 800 + OWNER’S EQUITY Profit Capital & Loss
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© Chris Guilding

Stock + 800

Van

© Chris Guilding

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2. Classification of transactions (cont’d)
Transaction 4) Received $6,000 from customers billed in transaction (2) above.
ASSETS Cash Acc. at bank Rec’ble +6,000 -6,000 = LIABILITIESAcc. Loan Payable Payable + OWNER’S EQUITY Profit Capital & Loss

Stock

Van

Transaction 5) Purchased a van for $12,000, paying $3,000 in cash and obtaining a loan for the balance.
ASSETS Cash Acc. at bank Rec’ble Stock © Chris Guilding - 3,000 = LIABILITIES Acc. Loan Payable Payable + 9,000 + OWNER’S EQUITY Profit Capital & Loss
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Van +12,000

2. Classification of transactions(cont’d)
Transaction 6) Paid $500 to trade creditors to reduce amount owing for stock purchased.
ASSETS Cash Acc. at bank Rec’ble - 500 = LIABILITIES Acc. Loan Payable Payable - 500 + OWNER’S EQUITY Profit Capital & Loss

Stock

Van

Transaction 7) Owner withdrew $1,500 from the business.
ASSETS Cash Acc. at bank Rec’ble Stock © Chris Guilding - 1,500 = LIABILITIES Acc. Loan Payable Payable +...
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