Chapter 1 The Accounting Equation and the Balance Sheet

Accounting involves the recording of transactions to explain the financial position of the business. The actual record of accounting is called Book-Keeping which records and classifies transactions so as to find whether the business is making a profit or a loss in its trading operations. Accounting involves: The recording of business transactions in financial terms. Reporting and presenting financial information to the owner of the business and other interested parties. Advising the owner and other parties how to use the financial reports to assess the business past performance. To help the owner and accountant for decision making. Possible users of Accounting can be: Owner of a business; Prospective buyer; Commercial Banks; Tax Departments Inland Revenue Department; Prospective partners; Shareholders; Managers. Assets: These are the possessions of the business, namely: 1) Fixed Assets are those Assets that will provide service to the business for a longer period than one year. These are: Land and Buildings or Premises Plant and Machinery or Equipment Fixtures and Fittings or Furniture Motor Vehicles or Motor Vans. 2) Current Assets are those Assets which can easily be changed into money. Stock of goods Debtors (people who owe money to the business). Cash at Bank Cash in Hand. Liabilities: These are all the obligations of the business, namely: 1) Long Term Liabilities are obligations that are generally paid by the business in more than one year. Bank and Private Loans
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2) Current Liabilities are those obligations that are generally paid by the business within one year. Creditors (people to whom the business owes money). Bank Overdraft (this is when the business is allowed to write cheques in excess of the balance at bank). 3) Capital is the money owed by the business to the owner. Capital is what the owner invests in money and moneys worth. A Balance Sheet is a statement showing the assets owned and the liabilities owed by the business as at a certain date. The totals of this statement must agree. Example: M.Zammit has the following Assets and Liabilities as at 31 December 2000: Land and Buildings Lm40,500, Plant and Machinery Lm15,000, Fixtures and Fittings Lm5,500, Bank Loan Lm10,000, Creditors Lm2,900, Motor Vehicles Lm20,000, Stock of goods Lm5,000, Debtors Lm8,500, Cash at Bank Lm6,300, Loan from A.Callus Lm5,000, Cash in Hand Lm2,100 and Capital Lm85,000. Balance Sheet as at 31 December 2000 Lm Liabilities Assets Land and Buildings 40,500 Capital Plant and Machinery 15,000 Bank Loan Fixtures and Fittings 5,500 Loan - A.Callus Motor Vehicles 20,000 Creditors Stock of goods 5,000 Debtors 8,500 Cash at Bank 6,300 Cash in Hand 2,100 102,900

Lm 85,000 10,000 5,000 2,900

102,900

Balance Sheet Equations 1) Capital = Assets - Liabilities 85,000 = 102,900 - 17,900

2)

Assets = Capital + Liabilities 102,900 = 17,900 + 85,000

3)

Liabilities = Assets - Capital 17,900 = 102,900 - 85,000

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The effect of business transactions on the Balance Sheet Started business with Lm50,000 in the bank. Cash at bank + Lm50,000 Capital + Lm 50,000

Bought a motor van by cheque Lm6,000. Motor Van + Lm6,000 Cash at Bank - Lm6,000

Bought stock of goods on credit from our suppliers Lm2,000. Stock of goods + Lm2,000 Creditors + Lm2,000

Sold stock of goods on credit to our customers Lm600. Stock of goods - Lm600 Debtors + Lm600

Received a loan from A.Smith Lm10,000 by cheque. Cash at Bank + Lm10,000 A debtor paid us by cash Lm200. Cash in hand + Lm200 Debtors - Lm200 Loan (A.Smith) + Lm10,000

The proprietor introduced another Lm2,000 in the business bank account. Cash at Bank + Lm2,000 Capital + Lm2,000

The owner takes out Lm500 cash for his personal use. Cash in Hand - Lm500 Capital - Lm200

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Exercises: Q.1 You are to complete the gaps in the following table: Liabilities Capital Assets Lm Lm Lm (a) 12,000 4,000 ? (b) 15,000 6,000 ? (c) 30,000 ? 8,000 (d) 45,000 ? 20,000 (e) ? 5,000 15,000 (f) ? 10,000 30,000 Distinguish from the following list the items that are Liabilities from those that are Assets. (a) Loan from C.Borg (b) Motor Vehicles (c) Office Furniture (d) Bank Overdraft (e) Debtors (f) Creditors (g) Cash in Hand (h) Cash at Bank (i) Premises (j) Equipment Mario Borg sets up a new business. Before he actually sells anything, he has bought motor vehicle Lm2,500; premises Lm5,000 and stock of goods Lm1,500. He has Lm150 cash in hand and Lm850 in the bank. He had borrowed Lm2,000 from S.Galea and creditors totalled Lm3,000. Calculate Mario Borgs Capital ? Distinguish between the following: (i) Fixed Assets and Current Assets; (ii) Long Term Liabilities and Current Liabilities Q.5 Draw up M Zammits Balance Sheet as at 31 December 1999 (Show clearly the necessary Headings) : Bank overdraft Lm600; Debtors Lm550, Delivery Van Lm2,700; Stock Lm7,250; Furniture and Fittings Lm3,850; Creditors Lm1,340; Premises Lm 48,000; Loan Lm42,000; Cash in hand Lm150; Capital? Q.6 Draw up G Galeas Balance Sheet as at 31 December 1999 (Show clearly the necessary Headings) : Motor Vehicles Lm7,830; Furniture and Fittings Lm5,585; Debtors Lm1,980; Stock Lm12,240; Cash in hand Lm240; Cash at Bank Lm4,670; Creditors Lm2,605; Loan from M Spiteri Lm20,000; Premises Lm68,250; Mortgage on premises Lm35,800; Capital?

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Q.3

Q.4

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Q.7

Show the effects of the following transactions upon Assets, Liabilities and Capital. Ex. We pay a creditor Lm100 in cash. Assets Cash - Lm100 (a) (b) (c) (d) (e) (f) Liabilities Creditors - Lm100 Capital No effect

Started business with Lm50,000 in cash. Bought stock of goods on credit Lm3,000. Bought fixtures Lm1,000 paying by cheque. Mario Gatt lends the business Lm500 in cash. Owner puts further money by cash in the business Lm2,500. Bought premises paying Lm1,500 by cheque.

Q.8)

Show the effects of the following transactions upon Assets, Liabilities and Capital : i. Started business with Lm5000 cash. ii. We pay a creditor Lm70 cash. iii. Bought goods on credit Lm275. iv. J Vella lends the firm Lm200 in Cash. v. Bought fixtures paying by cheque Lm300 vi. A debtor pays us Lm50 by cheque. vii. The owner puts a further Lm2000 cash into the business. viii. A debtor returns to us Lm80 goods. ix. We return goods Lm60 to a supplier. x. The owner takes out Lm100 cash for his personal use. Lino Callus has the following Assets and Liabilities as at 31 March 1999: Buildings Lm6,000; Creditors Lm1,600; Motor Vehicles Lm4,000; Stock Lm2,000; Loan from L Mallia Lm2,000; Debtors Lm2,800; Cash at Bank Lm3,200; Capital? During the first week of April, Lino Callus: i. Paid a cheque of Lm500 to a creditor; ii. Bought some goods on credit for Lm900; iii. Bought fixtures Lm800 by cheque; iv. Received Lm300 by cheque from one of the Debtors. v. Repaid part of the loan by cheque Lm1,000.

Q.9)

You are required to : a) Calculate the amount of Capital as at 31 March 1999. b) Show the effect of the transactions which occurred during the first week of April ; c) Draw up a Balance Sheet as at 7 April 1999.

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