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					       Lesson 2
 Business Transactions
and Accounting Equation

       Task Team of
 FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
                 Outline
Enterprises
Accounting Transactions, Accounting
 Events, and Accounting Circumstances
Economic Activities and Accounting
 Elements
 Accounting Equation




                                        2
           Opening Story
Funding and Spending at College
  Assets of a college student
     →Cash
     →CD player
     →Computer
  Funding these assets
     →Sponsored by parents
     →Sponsored by relatives
     →Borrowed from relatives and acquaintance


                                                 3
 Opening Story (continued)
 We could deal with the above-mentioned financial
  issues from the following perspectives:
  How do we fund our daily expenditures and possessions?
  How do we spend the “funds” which we have sourced?
  What about the relationship between the “funds”which
   we have sourced and our daily expenditures and
   possessions?




                                                            4
             Enterprises

Concept of Enterprise
  Definition of “enterprise”
  Functions of an enterprise
  Characteristics of an enterprise




                                      5
     Forms of Enterprise
There are three major forms of enterprise:
  Sole-proprietorship
  Partnership
  Corporations




                                              6
     Sole proprietorships
Single person owns the business
Not separate from its owner in terms of
 responsibility and liability
The business is the owner and the owner is
 the business




                                              7
            Partnership
Owned by two or more people
Similar to a sole proprietorship
Not separate from the owners in terms of
 responsibility and liability




                                            8
           Corporations
Legally separate and financially separate
 from the owners
Ownership in a corporation is divided into
 units called shares of capital stock
Owners are called shareholders or
 stockholders
Corporations are separate legal entities


                                              9
Characteristics of Enterprise

Characteristics     Proprietorship Partnership Corporation
Business entity          yes           yes         yes
Legal entity              no           no          yes
Limited liability         no           no          yes
Unlimited life            no           no          yes
Business taxed            no           no          yes
One owner allowed        yes           no          yes


                                                             10
 Four Types of Enterprise
 Service organization – provides services (does
  something for you) rather than selling something
 Merchandising business – buys goods, adds value
  to them, then sells them to customers
 Manufacturer – makes the products it sells
 Financial services company – doesn’t make
  tangible products and doesn’t sell products made
  by other companies; deals in services related to
  money


                                                     11
 Resources in an Enterprise

 Major resources:
  Human resources
  Properties,plant and equipment,supplies, raw
   materials, finished products or inventories
  Financing
    →In cash or bank deposits
    →In material forms



                                                  12
  Movements of Material
Resources in an Enterprise
An example-Beauty Photo Store




                                 13
  Movements of Material
Resources in an Enterprise
 Movements in a manufacturing
  enterprise
   →cash/bank deposit→raw materials →work-in-
    process→finished products→fin→cash/bank
    deposit
 Movements in a merchandising
  enterprise
   →cash/bank deposit→inventory→ cash/bank
    deposit




                                                14
  Activities of Enterprise
Three major phases of business
 activities:
  Inception
  Operating
  Liquidation



                                  15
  Inception of Enterprise
Inception and investment of funds
   →External funding
        State, legal persons, privates or foreign investors;
        Financing from banking institutions, other legal
         persons or privates
   →Owners’equity and liabilities



Investment        Financing of         Total funds of a firm
 of owners          creditors



                                                               16
Inception of Enterprise
Forms of Investment
  →Monetary(cash/bank deposits)
  →Property, plants and equipment
  →Raw materials and goods,etc.
Sources and changes of funds
  →Increase of owners’equity or liabilities
  →Increase of assets


                                              17
     Operating Activities
 Operating activities and changes of asset
  Changes of assets in Beauty Photo Store

               2 cameras
                  lens
    cash      +producing    photos           cash
               equipment
                   +
                supplies

  Connections between Beauty Photo Store and
   Suppliers, clients, etc.



                                                    18
 Liquidation of Enterprise
Liquidation of enterprise and payoff of
 funds
  Payment of taxes
  Distribution of profits
  Declaration of dividends
  Payoff of borrowings
Withdrawals and changes of funds
  Decrease of assets
  Decrease of liabilities or owners’equity

                                              19
 Accounting Transactions
A business transaction is an event that
 affects the financial position of a business
 and may be reliably recorded




                                                20
    Economic Activities and
     Accounting Elements
Accounting element:
 Uses of funds and assets
    →cash
    →equipment,etc.
  Resources of funds and equity
    →Borrowings and equity of creditors-
     liabilities
    →Investments and owners’equity

                                           21
         Uses of Funds
Uses and changes of funds
  Beauty Photo Store
    →From cash to equipment
    →Using equipment to produce photos
    →From photos to cash




                                         22
     Circulation of Funds
Circulation of funds:
  Uses of funds
     →Beauty Photo Store
       Cost of equipment
       Cost of supplies
       Human costs?
  Uses and payoff of funds
     →What are the operating purposes for Beauty
      Photo Store?

                                                   23
      Payoff of Funds
Payoff of Funds and Revenues
  →Cash receptions and revenues by Beauty
   Photo Store
 increase of funds and profit
 Net
  →Difference between uses and payoff of cash?
  →Nature of profit?




                                                 24
 Accounting Transactions
Accounting transactions-Economic
 exchange between two different accounting
 entities
  Mutual exchange
    →A purchases an asset,paying cash or bearing the
     responsibility of paying cash in future
    →B sells the asset, earning the rights of receiving or
     collecting cash
  One-way transaction
    →Investments or donations to another accounting
     entity
                                                             25
      Accounting Events
Accounting events-internal transferring of
 resources among departments of a same
 entity
  allotments of raw materials for plants
  Damages caused by earthquakes
External versus internal events
  Between different entities
  Within a same entity


                                              26
 Accounting Circumstances
 Accounting circumstances-usually an outcome of
  collaboration of multiple events
   Circumstances and their impacts
       →Changes in prices,exchange rates
 How to determine these changes?
   E.g. uncollectability of receivables due to the
     liquidation of the debtor
   Unpredictability


                                                      27
   Accounting Elements
Assets
Liabilities
Owners’equity
Revenues
Expenses
Profits



                         28
               Assets
Assets are economic resources owned
 by a business that are expected to be of
 benefit in the future.




                                            29
Further Thoughts on Assets

Human resources as an asset?
  Value and labor of Manager of Beauty Photo
    Store?
  Cameramen and shop
   assistants?
Natural resources as an asset?




                                                30
             Liabilities
Liabilities are creditor’s claims to the
 assets. Liabilities are obligations to
 outsiders




                                            31
        Owners’Equity
Owner’s Equity is the owner’s claim to
 the assets. It is the amount of assets
 that remains after subtracting the
 liabilities.




                                          32
Changes in Owners’Equity
Investments by owners and revenues,
 amounts earned by delivering goods or
 services to customers, increase owner’s
 equity.
Withdrawals of assets from the business by
 owners and expenses decrease owner’s
 equity. Expenses occur when assets are
 used or liabilities increase as a result of
 earning revenues.
                                               33
               Revenue
Revenues (sales) are increases in owners'
 equity arising from increases in assets
 received in exchange for the delivery of
 goods or services to customers.
Revenues are increases in economic
 resources, either through increases to assets
 or reductions to liabilities



                                                 34
     Revenue Recognition
 Revenue should be recognized in the financial
  statement when:
  the performance has been achieved
  there is reasonable assurance regarding the
   measurement and collectability of the
   consideration




                                                  35
                 Expense
 Expenses are decreases in owners' equity that
  arise because goods or services are delivered to
  customers.
 Expenses are decreases in economic resources,
  either through outflows or the using-up of assets
  or incurrence of liabilities from delivering or
  producing goods, rendering services, or carrying
  out other activities that constitute the entity’s
  normal business



                                                      36
    Expense Recognition
Cost, expenditure, and expense
General recognition criteria
Approaches to expense recognition




                                     37
Cost, Expenditure, and Expense

 When we agree to pay out cash (or other assets)
  for goods or services received, we have incurred a
  cost

 When we actually pay the cash, we have an
  expenditure

 When the benefits of the cost have been used and
  we put that cost (or a portion thereof) on the
  income statement, we have recognized an expense

                                                       38
General Recognition Criteria

Recognized items must:
  meet the definition of a financial statement
   element
  have a valid measurement basis and amount


Financial statement elements are based on
 future economic benefits or sacrifices; these
 must be probable for recognition to be
 appropriate
                                                  39
General Recognition Criteria (cont)

Expenses are decreases in economic
 resources, either by way of outflows or
 reductions of assets or incurrences of
 liabilities, resulting from an entity’s
 ordinary revenue generating or service
 delivery activities [CICA 1000.38]
Asset or expense? if the asset recognition
 criteria are met, an asset is recorded. If not,
 an expense is recorded
                                                   40
          Approaches to
       Expense Recognition
Definitional approach: expenses are created
 either through the reduction of an asset or
 the increase in a liability
Matching approach: once revenues are
 determined in conformity with the revenue
 principle for any reporting period, the
 expenses incurred in generating the revenue
 should be recognized in that period

                                               41
            Profit / Loss
Income (profit or earnings) is the excess of
 revenues over expenses




                                                42
     Accounting Equation
 Assets – Liabilities = Owners Equity
 Net Assets = Owners’ Equity
 Every accounting transaction has an equal affect
  on both sides of the equation.
 Purchase a $20,000 car for cash.
   Increase asset car and decrease asset cash by
    $20,000. No net change to assets.
 Purchase a $20,000 car on credit.
   Increase asset car and increase liabilities by
    $20,000.

                                                     43
         Dual Aspect of
       Accounting Equation
 Assets = Liabilities + Owners’ equity.
   LHS = RHS.
   First view:
     →Resources = Obligations to creditors or claims on
       resources + Residual claim.
   Second view:
     →Amounts invested in resources = how these amounts
       were financed.
     →Resources = financed by creditors + financed by
       owners.


                                                          44
        Beauty Photo Store
         -- An Illustration
Changes to the accounting equation of
 Beauty Photo Store:

      Asset:130000   +   Liability:30000    =    Equity:100000



     Revenue:15000   +   Expense:9000       =   Profit:6000


      Assets
                     +                      =   Owners’ equity
                         Liabilities30000
130000+15000-9000                               100000+6000




                                                                 45
                 Summary
 Economic resources in the enterprise-
  human,financial and material resources
 Economic transactions derive from the operating
  activities of an enterprise
 Accounting elements are basic components of
  economic transactions
 Accounting elements comprise of assets,liabilities,
  owners’equity, revenues, expenses and profit
 Economic transactions are viewed in the forms of
  increase or decrease in accounting elements
 Accounting equation:A=L+OE

                                                        46
      Case for Discussion
                      Marks and Spencer
 In 1882, a Russian refugee named Michael Marks came to
  the North East of England. Needing work, he put a tray
  round his neck and started selling haberdashery in the
  villages around Leeds. Two years later he borrowed £5
  from his friend Isaac Dewhirst to buy stock, and was able
  to open a stall in Leeds market.
 Within ten years Marks’s success as a trader had enabled
  him to establish a chain of stalls in markets throughout
  North East England. In 1894, Marks realized that his
  business was getting too large for him to manage
  effectively on his own. He decided
  to form a partnership with
  Tom Spencer – and Marks
  & Spencer was born.

                                                              47
Case for Discussion (cont)
 The business continued to thrive and grow, so in 1903 Marks
  and Spencer registered their partnership as a private limited
  company. This allowed more people to become involved with
  managing the growing company and increase its finances by
  buying shares in the company. One shareholder was Israel Sieff,
  who became chairman of the company in 1917. Sieff can be
  credited with shaping the future of Marks & Spencer. By 1926,
  Marks & Spencer had opened 125 stores. In order to continue
  its successful development the company finally registered as a
  public limited company (plc) in order to obtain as much capital
  as possible to finance its continued growth.

 And the rest, as they say,
  is history.



                                                                    48
     Suggested Questions
 How many people started the original business
  that eventually became Marks & Spencer?
 Who owned the original business?
 Who owns Marks & Spencer plc?
 Why do you think Marks & Spencer became a
  public limited company?
 Do you think the business would have developed
  in the way it has if it was still owned by one person?




                                                           49
The End of Lesson 2

				
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