Semester 1 Financial Accounting Chapter 7: The Accounting Equation and it's Components . A Statement of Financial position (SFP) shows the net worth of the business · An Income Statement (IS) tells us how much profit or loss a business has made in a given period. Accounting entity may be seen as a set of assets and liabilities. A statement of finance position as an equation: Proprietors' ownership interest in the business = Net resources of the business Ownership interest/claims are called owners' equity/capital Net resources are analysed into assets + liabilities owners' equity/capital = assets and liabilities Asset: tangible/intangible resource that is owned or controlled by an accounting entity as a result of its past events Liability: a legal obligation to transfer an economic resource, e.g. asset/service, to another entity that arises from some past transactions/event. Liabilities represent claims made by outsiders Accounting Equation (based on duality/dual aspect concept): Asset - Liabilities = Owners' capital Assets = Owners' capital + liabilities Concept reasons that: - Every transaction had two aspects: one represented by an asset and the other a liability - Or two changes in either the assets or the liabilities Capital maintenance approach: Profit = increased capital for the business A definition of profit = the maximum amount that could be withdrawn in a period from the business while leaving the capital intact. E.g. capital at £20,000 at start of the year. Profit = the £12,000 increase in capital (assuming no capital is withdrawn or introduced by the owner). Accounting period/periodicity/time interval/time period concept: way of dividing up the life of an accounting entity into discrete periods for the purpose of reporting performance for a period of time, showing its financial position at that time (accounting/financial year, reporting period) - in profit or loss statement. - Accounting year might not coincide with calendar year - AY usually ends on anniversary of formation - For convenience sometimes AY is taken at end of calendar month or end of year or end of particular month for tax purposes. - Can be less than a year, some firms report on their financial position half yearly/quarterly.
Semester 1 Matching concept: Helps determine in which period to classify an item in the profit or loss Sales for that period = revenue for that period Period expenditure = revenue expenditure (RE) . Items that appear in the P&L · Operational costs needed to produce sales · Costs are used up in the period . Matched against the sales to which they relate . Matched against the period to which they relate · repair costs to keep an asset operational (not improvement costs) · RE reduces profitability SFP expenditure = capital expenditure (CE) . Items that appear in the SFP, e.g. Owners' capital, with a portion of the expenditure being allocated to the statement of P&L in line w/ the use of the asset and the reduction in the useful economic life of the asset · Purchase of non-current assets that will generate revenue for