Chapter
1
Chapter# 1
ACCOUNTING IN ACTION
Facilitator: Maqsood Ali Jamali
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
1
Accounting in Action
Learning Objectives
1
2
Identify the activities and users associated with
accounting.
Explain the building blocks of accounting: ethics,
principles, and assumptions.
3
State the accounting equation, and define its components.
4
Analyze the effects of business transactions on the
accounting equation.
Introduction to Business
• Business: Any activity that seeks to provide goods
•
•
•
•
and services to others while operating at a profit.
Entrepreneur: A person who risks time and money
to start and manage a business.
Business Entity: Entity means any organization. A
business entity is a commercial organization that aims
to make a profit from its operations.
Goods: Tangible products such as computers, food,
clothing, cars, and appliances.
Services: Intangible products (i.e., products that can’t
be held in your hand) such as education, health care,
insurance, recreation, and travel and tourism.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Introduction to Business
• Revenue: The total amount of money a business
takes in during a given period by selling goods and
services.
• Profit: The amount of money a business earns above
and beyond what it spends for salaries and other
expenses.
• Loss: When a business’s expenses are more than its revenues.
• Commerce: The exchange of goods on a widespread
level. Trade is a basic economic concept involving
the buying and selling of goods and services.
• Drawings: Withdrawal of cash or other assets from
business for the personal use of the owner(s).
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Characteristics of Business
• Businesses exist to make profits.
• Profit is the reward for accepting risk.
• Businesses make profit by supplying
goods or services to others (customers).
• The profit of a business belongs to its
owners.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Forms of Business
Organizations/Ownership
Sole
Proprietorship
Partnership
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Corporation
Sole Proprietorship
• An unincorporated business owned by one
person is called a sole proprietorship .
• The business of a sole trader is owned and
managed by one person. Any individual, who
sets up in business on his/her own, without
creating a company, is a sole trader.
• There is no legal distinction between the
proprietor and the business.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Partnership
A business partnership is an entity in which
two or more individuals (partners) share the
ownership of a business. Each partner
contributes funds (‘capital’) to set up the
business. Partnerships in Pakistan are subject to
rules set out in The Partnership Act 1932.
The relationship between persons who have
agreed to share the profits of a business carried
on by all or any of them, acting for all.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Company/Corporation
• A company/corporation is a form of business
organization that is recognized under the law
as a separate legal entity, with rights and
responsibilities apart from its owners.
• A company is a special form of business entity.
Nearly all companies in business are limited
liability companies with liability limited by
shares.
• In Pakistan, companies are formed according
to the Company Act, 2017.
Kinds of Business By Operations
• Trading/Merchandising Business: Business
that buys merchandise and sells merchandise
to the customers.
• Manufacturing Business: Business that buys
raw materials and converts into finished goods
by manufacturing.
• Servicing Business: Business that provides
services to the customers like banks, schools,
hospitals, law firms, transport companies etc.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Business Activities
• All businesses are involved in three types of
activity—financing, investing, and operating.
FINANCING ACTIVITIES: It takes money to make
money. The two primary sources of outside funds for
corporations are borrowing money and issuing (selling)
shares of stock in exchange for cash.
INVESTING ACTIVITIES :Once the company has
raised cash through financing activities, it will then use
that cash in investing activities.
OPERATING ACTIVITIES: Once a business has the
assets it needs to get started, it can begin its
operations.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
The Account
• An account is an individual accounting record
of increases and decreases in a specific asset,
liability, stockholders’ equity, revenue, or
expense item.
• All transactions are analyzed into different
types and are then recorded in a series of
individual records called accounts.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Accounting
• Accounting is the recording, classifying, and
summarizing, of financial events and
transactions to provide management and other
interested parties the information they need to
make good decisions.
• Accounting is the art of interpreting, measuring,
and communicating the results of economic
activities.
• The information system that identifies, records,
and communicates the economic events of an
organization to interested users.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Accounting
• Accounting can be defined as ‘the process of
identifying, measuring, and communicating
economic information to permit informed
judgements and decisions by users of
information’.
• Accounting has often been called as the
language of business because it communicates
data that help people make better decisions.
• Users of accounting information can be divided
broadly into two groups: internal users and
external users.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
LEARNING
OBJECTIVE
1
Identify the activities and users
associated with accounting.
Accounting consists of three basic activities—it

identifies,

records, and

communicates
the economic events of an organization to interested users.
LO 1
Luca Pacioli-1445-1517
An Italian Mathematician Known as
The Father of Accounting and Double
Entry-Book Keeping
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
History of Accounting
• Luca Pacioli (1445-1517), was a mathematician. He
wrote on the topic ‘in order that the subjects of the
most gracious Duke of Urbino [his sponsor or
benefactor] may have complete instructions in the
conduct of business, and to ‘give the trader without
delay information as to his assets and liabilities’.
What Pacioli wrote is contained in a mathematics
textbook (Summa de arithmetica, geometria,
proportioni et proportionalita – Everything about
Arithmetic, Geometry and Proportion) which was
first published in Italy in 1494. It has been translated
into many languages, including English.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Business Transaction
• A business transaction is an interaction between a
business and customer, supplier or any other party
with whom they do business.
• It is an economic event that must be recorded in the
business’s accounting system.
• A business transaction means any activity which
creates some kind of legal relationship such as
purchase of goods, payment of various expenses etc.
• Transactions (business transactions) are a
business’s economic events recorded by accountants.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Classification of transactions
• Cash transactions and Credit transactions.
• Internal transactions and external transactions.
• External transactions involve economic events
between the company and some outside enterprise.
For example, Campus Pizza’s purchase of cooking
equipment from a supplier, payment of monthly rent
to the landlord, and sale of pizzas to customers are
external transactions.
• Internal transactions are economic events that occur
entirely within one company. The use of cooking and
cleaning supplies are internal transactions for Campus
Pizza.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Accounting Information
• The primary objective of accounting is to
provide information that is useful for decision
making purposes.
• The final product of accounting information is
the decision that is enhanced by the use of that
information, whether the decision is made by
owners, management, creditors, governmental
regulatory bodies, labor unions, or the many
other groups that have an interest in the
financial performance of an enterprise.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Users and Uses of Accounting
Information/Financial Information
• The purpose of financial information is to
provide inputs for decision making.
• Accounting is the information system that
identifies, records, and communicates the
economic events of an organization to
interested users.
Users of accounting
information can be divided broadly into two
groups: internal users and external users.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
INTERNAL USERS
• Internal users of accounting information are
managers who plan, organize, and run a
business. These include marketing managers,
production supervisors, finance directors,
and company officers.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
EXTERNAL USERS
• External users of accounting information are
individuals and other enterprises that have a
current or potential financial interest in the
reporting enterprise, but that are not involved
in the day-to-day operations of that enterprise.
• External users of financial information may
include the following:
• Stockholders, Suppliers, Creditors, Customers,
Potential investors, Trade associations,
General public, Governmental agencies etc.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Internal and External Users of Accounting
Information/Financial Information
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
CHARACTERISTICS OF USEFUL
INFORMATION
• Relevance: Accounting information is considered
relevant if it would make a difference in a business
decision. Financial statements provide relevant
information that helps predict future events and
provide feedback about prior expectations for the
financial health of the company. For accounting
information to be relevant it must be timely.
• Reliability: To be reliable, accounting information
must be verifiable—we must be able to prove that it
is free of error. Also, the information must be a
faithful representation of what it purports to be—it
must be factual. Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
CHARACTERISTICS OF USEFUL
INFORMATION
• Comparability: In accounting, comparability
results when different companies use the same
accounting principles. To make comparison across
companies easier, each company must disclose the
accounting methods used.
• Consistency: Consistency means that a company
uses the same accounting principles and methods
from year to year.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Accounting System
• An accounting system consists of the personnel,
procedures, technology, and records used by an
organization (1) to develop accounting information
and (2) to communicate this information to decision
makers.
• Accounting Period: The span of time covered by an
income statement. One year is the accounting period
for much financial reporting, but financial statements
are also prepared by companies for each quarter of
the year and for each month.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
BASIC FUNCTIONS OF AN
ACCOUNTING SYSTEM
• Interpret and record the effects of business
transactions.
• Classify the effects of similar transactions in a
manner that permits determination of the
various totals and subtotals useful to
management and used in accounting reports.
• Summarize and communicate the information
contained in the system to decision makers.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Custody of Accounting Records
• All the accounting records, including but
not limited to ledgers, statements,
accounts, vouchers, invoices, banking
records, record of procurement and sales,
etc. should be in the custody of the
accounting personnel.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Book Keeping
• Book keeping is a part of Accounting which means to
record the business transactions in book of general
journal.
• Bookkeeping usually involves only the recording of
economic events/transactions. It is therefore just one
part of the accounting process. In total, accounting
involves the entire process of recording, classifying,
and summarizing economic events/transactions.
• The clerical dimension of accounting that includes
recording the routine transactions and day-to-day
record keeping of an enterprise.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Book Keeping
• Business entities operate a system to record
business transactions in accounting records.
This system is called a book-keeping system.
• Double entry bookkeeping is used to record
transactions in systems designed to allow the
management of the business to monitor its
progress and produce periodic financial
statements and performance reports.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Double Entry Book-Keeping
• The rules for debits and credits are designed so
that every transaction is recorded by equal
dollar amounts of debits and credits.
• The phrase double-entry refers to the need for
both debit entries and credit entries, equal in
dollar amount, to record every transaction.
• Every transaction must be recorded (entered)
in two places. The process of doing this is
called double entry book-keeping.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
The Role of Accounting Records
Establishes accountability for
assets and transactions.
Keeps track of routine business
activities.
Obtains detailed information
about a particular transaction.
Evaluates efficiency and
performance within company.
Maintains evidence of company’s
business activities.
The
accounting
process
Economic
activities
Actions
(decisions)
Accounting
“links” decision
makers with
economic
activities  and
with the results of
their decisions.
Decision
makers
Ac
counting
in
formation
Types of Accounting Information
Accounting can be broadly divided into three
categories.
Financial
Cost
Managerial
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Financial Accounting
• The field of accounting that provides economic
and financial information for investors,
creditors, and other external users.
• Financial Accounting is a systematic process
of
identifying,
analysing,
recording,
classifying
and
summarising
business
transactions in terms of money in order to
prepare a summary at the end of the year to
find out the results of the concerned
accounting year in terms of profit or loss and
assets, liabilities and equities.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Financial Accounting
• Financial Accounting aims at finding the
results of an accounting year in terms of profits
or losses and assets, liabilities & stockholders’
equity. In order to do this, it is essential to
record various transactions in a systematic
manner.
• Providing information about the financial
resources, obligations, and activities of an
economic entity that is intended for use
primarily by external decision makers—
investors and creditors.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
The Purpose of Financial Accounting
• Financial accounting is a term that describes:
maintaining a system of accounting records for
business transactions and other items of a
financial nature; and reporting the financial
position and the financial performance of an
entity in a set of financial statements.
• Financial accounting focuses on the needs of
external users, and managerial accounting
focuses on the needs of internal users.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Cost Accounting
• The accounting concepts and practices for
measuring the cost of performing different
business activities and of manufacturing
various products.
• Cost accounting systems are the methods and
techniques used by enterprises to track
resources consumed in creating and delivering
products and services to customers.
• An area of accounting that involves measuring,
recording, and reporting product and service
costs.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Managerial Accounting
• Managerial accounting (or management accounting)
involves the preparation and use of accounting
information designed to assist managers in planning
and controlling the operation of the business and in
decision making
• Managers uses information of financial accounting
and cost accounting in order to make managerial
decisions.
• Managerial (or management) accounting involves the
development and interpretation of accounting
information
intended specifically to assist
management in operating the business.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Tax Accounting
• The preparation of income tax returns is a
specialized field within accounting. To a great
extent, tax returns are based on financial
accounting
information.
However,
the
information often is adjusted or reorganized to
conform with income tax reporting
requirements.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Audit
• An investigation of financial statements
designed to determine their fairness in
relation to generally accepted accounting
principles.
• An audit is an investigation of a company’s
financial statements, designed to determine the
fairness of these statements.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Ethics—A Key Concept
• For information to be useful, it must be trusted.
This demands ethics in accounting. Ethics are
beliefs that separate right from wrong. They
are accepted standards of good and bad
behavior.
• There is an old saying: Good ethics are good
business.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Five Main Elements of
Accounting/Five Main Accounts
Following are five main accounts:
• Assets
• Liabilities
• Owner’s Equity/Stockholders’Equity
• Revenue
• Expenses
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Assets
• Assets are the resources of the business which
have potential to generate profit.
• Assets are resources a business owns.
• Assets are the economic resources that are
owned by a business and are expected to
benefit future operations. In most cases, the
benefit to future operations comes in the form
of positive future cash flows.
• Assets= Liabilities + Owner’s Equity
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Types of Assets
There are two main a types of asset:
1. Real Assets (Real Estate and Commodities)
2. Financial Assets ( Currency, Stocks and
Bonds).
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Types of Assets
• Real assets are those assets which have
intrinsic or real value.
• Financial assets are financial claims.
These are financial instruments or
financial securities. Financial assets do
not have any intrinsic or real value.
• If financial asset is your asset than it is
liability of anyone else.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Categories of Assets
• Assets are presented in the balance sheet under
two main categories: Current assets and Noncurrent assets
• Current assets: assets that are expected to
provide economic benefit in the short term
(within one year from the balance sheet date).
• Non-current assets: assets that have a long
useful life and are expected to provide future
economic benefits for the entity over a period
of several years.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Categories of Assets
• Example: Current assets: Cash, Marketable
securities, trade receivables:(money owed by
customers who have purchased goods or services on
credit include: Bills receivables, Notes receivables,
Accounts receivables), Merchandise Inventory,
Supplies, Prepaid expenses.
• Example: Non-current assets: Long term
investments, Land, Building/Property , Plant and
equipment (Machinery), Automobile, Furniture and
Fixture and Intangible assets/other assets (Good will,
Copy right, Patent, Trade marks etc.)
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Basis for Asset Valuation
The Cost Principle: Assets such as land,
buildings, merchandise, and equipment are
typical of the many economic resources that are
required in producing revenue for the business.
The prevailing accounting view is that such
assets should be presented at their cost. When we
say that an asset is shown in the balance sheet at
its historical cost, we mean the original amount
the business entity paid to acquire the asset.
• The cost principle dictates that assets be
recorded at their cost.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Liabilities
• A liability is an amount that the entity owes to
another party.
• Liabilities are claims against assets—that is,
existing debts and obligations.
• Liabilities means what we owe.
• Liabilities are presented in the statement of
financial position/balance sheet under two
main categories: current liabilities and noncurrent liabilities.
• Liabilities= Assets - Owner’s Equity
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Liabilities
Current liabilities: Amounts payable by the
company within 12 months from the balance
sheet date such as: Bills payable, Notes payable,
Accounts payable, Unearned revenue, Accrued
expenses, Short term loan, Current portion of
Long term debt etc.
Non-current liabilities: Amounts payable
beyond 12 months from the balance sheet date
such as: Mortgage payable, Bonds payable, Long
term loan etc.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Owner’s Equity
• Equity is the residual interest in the business
that belongs to its owner or owners after the
liabilities have been deducted from the assets.
Equity is sometimes referred to as the ‘net
assets’ of the business. (Net assets means total
assets minus total liabilities).
• The ownership claim on total assets is
owner’s equity. It is equal to total assets
minus total liabilities.
• Owner’s Equity= Assets - Liabilities
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Revenue
• The term ‘revenue’ means income earned in
the course of normal business operations.
• Earning revenue causes owners’ equity to
increase. When a business renders services or
sells merchandise to its customers, it usually
receives cash or acquires an account receivable
from the customer.
• Revenue is the gross increase in owners’
equity resulting from operation of the business.
• Sales revenue, commission revenue, interest
revenue etc.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Revenue and Capital Receipts
• Revenue receipts arise from the normal
operations of a business from its operations.
They are generally of a short term nature such
as sales revenue, interest revenue, commission
revenue, rent revenue, serviced revenue etc.
• Capital receipts are receipts of ‘long term’
income, such as money from a bank loan, or
new money invested by the business owners
(which is called ‘capital’).
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
EXPENSES
• Expenses are the costs of the goods and services used
up in the process of earning revenue.
• Expenses arising in the ordinary course of activities,
including the cost of sales, selling and administrative
expenses such as salaries and wages expenses,
advertising expenses, utilities expenses, depreciation
expenses, interest expenses, taxes etc. and losses
arising from disasters such as fire and flood, and also
losses from disposing of noncurrent assets for less
than their carrying value.
• Expenses are often called the “costs of doing
business,” that is, the cost of the various activities
necessary to carry on a business.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
EXPENSES
• An expense always causes a decrease in
owners’equity.
• Expenditure: Expenditure takes place when
an asset or service is acquired. Expenditure
will include both payment of a sum
immediately and a promise to pay it at a future
date.
• Expense: An expenditure whose benefit is
finished or enjoyed immediately such as
salaries, rent, etc.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Capital and Revenue Expenditure
• Capital expenditure is expenditure made to
acquire or improve long term assets that are
used by the business for a number of years
such as improvements and additions t existing
non-current assets (for example, building
extensions, installation of air-conditioning etc.)
• Revenue expenditure is expenditure on dayto-day operating expenses such as purchase of
goods meant for resale, selling and
administrative expenses etc.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Generally Accepted Accounting Principles
• Financial reporting is regulated and controlled
for every company who are required to file it.
Regulations help to ensure that information
reported in financial statements has the
required qualities and content.
• The concepts, principles, conventions, laws,
rules and regulations that are used to prepare
and present financial statements are known as
Generally Accepted Accounting Principles or
GAAP.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Generally Accepted Accounting Principles
• The accounting profession has developed standards
that are generally accepted and universally practiced.
This common set of standards is called generally
accepted accounting principles (GAAP). These
standards indicate how to report economic events.
• The primary accounting standard-setting body in the
United States is the Financial Accounting
Standards Board (FASB). Many countries outside
of the United States have adopted the accounting
standards issued by the International Accounting
Standards Board (IASB). These standards are called
International Financial Reporting Standards (IFRS).
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Accounting Principles
There are four general principles:
1. Measurement principle.
2. Revenue recognition principle.
3. Expense recognition principle (matching
principle).
4. Full disclosure principle.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Measurement Principles
• GAAP generally uses one of two measurement
principles, the cost principle or the fair value
principle.
• COST PRINCIPLE: The cost principle (or
historical cost principle) dictates that companies
record assets at their cost.
• FAIR VALUE PRINCIPLE: The fair value
principle states that assets and liabilities should be
reported at fair value (the price received to sell an
asset or settle a liability). Fair value information may
be more useful than historical cost for certain types of
assets such as financial assets/securities.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Revenue recognition principle
• Revenue is recognized (1) when goods or
services are provided to customers and (2) at
the amount expected to be received from the
customer. Revenue (sales) is the amount
received from selling products and services.
The amount received is usually in cash, but it
also can be a customer’s promise to pay at a
future date, called credit sales.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Expense recognition principle
(matching principle)
• A company records the expenses it
incurred to generate the revenue reported.
An example is rent costs of office space.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Full disclosure principle
• A company reports the details behind
financial statements that would impact
users’ decisions. Those disclosures are
often in footnotes to the statements.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Accounting Assumptions
There are four accounting assumptions.
1. Going-concern assumption.
2. Monetary unit assumption.
3. Time period assumption.
4. Economic/ Business entity assumption.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Accounting Assumptions
• Assumptions provide a foundation for the accounting
process. Two main assumptions are the monetary
unit assumption and the economic entity
assumption.
• MONETARY
UNIT
ASSUMPTION:
The
monetary unit assumption requires that companies
include in the accounting records only transaction
data that can be expressed in money terms.
• BUSINESS
ENTITY
ASSUMPTION:
An
economic entity can be any organization or unit in
society. The economic entity assumption requires
that the activities of the entity be kept separate and
distinct from the activities of its owners.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Accounting Assumptions
• Going-concern assumption: Accounting
information presumes that the business will
continue operating instead of being closed or
sold. This means, for example, that property is
reported at cost instead of liquidation value.
• Time period assumption: The life of a
company can be divided into time periods,
such as months and years, and useful reports
can be prepared for those periods.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
ACCRUAL VERSUS CASH BASIS
OF ACCOUNTING
• The policy of recognizing revenue in the
accounting records when it is earned and
recognizing expenses when the related goods
or services are used is called the accrual basis
of accounting.
• The purpose of accrual accounting is to
measure the profitability of the economic
activities conducted during the accounting
period.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
ACCRUAL VERSUS CASH BASIS
OF ACCOUNTING
• Using the accrual basis means that companies
recognize revenues when earned (the revenue
recognition principle), even if cash was not
received. Likewise, under the accrual basis,
companies recognize expenses when incurred
(the matching principle), even if cash was not
paid.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
ACCRUAL VERSUS CASH BASIS
OF ACCOUNTING
• An alternative to the accrual basis is the cash
basis.
Under
cash-basis
accounting,
companies record revenue only when cash is
received. They record expense only when cash
is paid. The cash basis of accounting is
prohibited
under
generally
accepted
accounting principles(GAAP).
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION
• A fundamental characteristic of every
statement of financial position/balance sheet is
that the total for assets always equals the total
of liabilities plus owners’equity.
• Everything that a business owns has been
supplied to it either by creditors or by the
owners.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION
• The equality of the assets on the one hand and
the claims of the creditors and the owners on
the other hand is expressed in the following
Accounting Equation :
Assets = Liabilities + Owners’Equity
•The basic accounting equation is:
Assets = Liabilities + Owner’s Equity.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION
• Ray Neal started a smartphone app
development company named Softbyte. On
September 1, 2019, he invested $15,000 cash
in the business.
• Softbyte purchased computer equipment for
$7,000 cash.
• Softbyte purchased headsets (and other
computer accessories) for $1,600 from Mobile
Solutions. Mobile Solutions agrees to allow
Softbyte to pay this bill in October.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION (Continue)
• Softbyte received $1,200 cash from customers
for app development services it ha performed.
• Softbyte received a bill for $250 from the
Daily News for advertising on its online
website but postpones payment until a later
date.
• Softbyte
performed
$3,500
of
app
development services for customers. The
company receives cash of $1,500 from
customers, and it bills the balance of $2,000 on
account.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION(Continue)
• Softbyte paid the following expenses in cash
for September: office rent $600, salaries and
wages of employees $900, and utilities $200.
• Softbyte paid its $250 Daily News bill in cash.
• Softbyte received $600 in cash from customers
who had been billed for services.
• Ray Neal withdrew $1,300 in cash from the
business for his personal use.
Required: Prepare an Accounting Equation.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION
• From the following transactions, prepare
accounting equation of Overnight Auto
Service:
• Jan. 20 Michael McBryan started the business
by investing $80,000 in cash.
• Jan. 21 Purchased land for $52,000, paying
cash.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION-Continue
• Jan. 22 Purchased a building for $36,000,
paying $6,000 in cash and issuing a note
payable for the remaining $30,000.
• Jan. 23 Purchased tools and equipment on
account, $13,800.
• Jan. 24 Sold some of the tools at a price equal
to their cost, $1,800, collectible within 45
days.
• Jan. 26 Received $600 in partial collection of
the account receivable from the sale of tools.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION-Continue
• Jan. 27 Paid $6,800 in partial payment of an
account payable.
• Jan. 31 Received $2,200 of sales revenue in
cash.
• Jan. 31 Paid $1,400 of operating expenses in
cash—$200 for utilities and $1,200 for wages.
• Required: Prepare an Accounting Equation.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION
Robinson opened his own law office on July 1,
2019. During the first month of operations, the
following transactions occurred.
• 1. Robinson invested $11,000 in cash in the
law practice.
• 2. Paid $800 for July rent on office space.
• 3. Purchased equipment on account $3,000.
• 4. Performed legal services for clients for cash
$1,500.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
THE ACCOUNTING EQUATION-Continue
• 5. Borrowed $700 cash from a bank on a note
payable.
• 6. Performed legal services for client on
account $2,000.
• 7. Paid monthly expenses: salaries and wages
$500, utilities $300, and advertising $100.
• 8. Robinson withdrew $1,000 cash for personal
use.
• Required: Prepare an Accounting Equation.
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]
End of Chapter 1
Maqsood Ali Jamali [BBA(Hons),
MBA(Finance)]