Professional Development Programme on Enriching Knowledge of the
Business, Accounting and Financial Studies (BAFS) Curriculum
Course 1 : Contemporary Perspectives on Accounting
Unit 2 : Financial Statements Preparation 1
Technology Education Section, Curriculum Development Institute
Education Bureau, HKSARG
August 2008
1
Learning Objectives
On completion of this unit, you should be able to:
- Describe the elements and components of financial statements.
- Explain the structures and contents of income statement and
balance sheet.
- Explain the overall considerations in relation to presentation of
financial statements, including consistency of presentation,
aggregation and offsetting.
- Prepare properly presented income statement and balance sheet
for a sole proprietor.
- Prepare properly presented income statement and balance sheet
for a partnership.
2
2
Organisation of Unit 2
Financial Statements Preparation 1
The Accounting Cycle
−journalise the transactions;
Learning Resources Corner
−post the journal entries to ledger accounts;
Basic Book-keeping Skills
for Learners
−prepare trial balance;
- Case Study 1: Service
Business
−journalise balancing day adjustments,
−post them to ledger accounts and prepare adjusted trial balance; and
−prepare financial statements.
Definitions:
- asset
- liability
- equity
- revenue
- expense
3
Financial statements
structures:
- Income statement
(internal & external)
- balance sheet
- Case Study 2: Trading
Business
Overall considerations:
- going concern
- accrual basis of accounting
- consistency of presentation
- materiality and aggregation
- offsetting
- true and fair view
Exercise – Sole Trader
Financial Statements:
Sole Trader vs Partnership
The Accounting Cycle
3
Exercise – Partnership
(1)
This Unit focuses on the preparation of financial statements based
on an adjusted trial balance. First, we will recapitulate the
accounting cycle. Then we will take a look on some basic
techniques in the preparation of financial statements.
4
4
The Accounting Cycle (2)
Learning Resources Corner
For details on basic book-keeping skills, please click the button and go to the
Learning Resources Corner.
5
5
The Accounting Cycle (3)
Okay, let’s take a brief look on the accounting cycle first.
`
6
6
The Accounting Cycle (4)
The Accounting Cycle
GENERAL JOURNAL
Date
Account Titles and Narrative
Dr $
2007
Jan 1 Cash
50,000
Capital
To record the capital invested by the owner.
Cr $
50,000
After the occurrence of business transactions, a book-keeper is required to:
1. journalise the transactions
7
7
The Accounting Cycle (5)
GENERAL JOURNAL
Date
Account Titles and Narrative
Debit $
Credit $
2007
Jan 1 Cash
50,000
Capital
50,000
To record the capital invested by the owner.
ASSET
Debit
(+)
Credit
(-)
LIABILITY
Debit
Credit
(-)
(+)
REVENUE
Debit
Credit
(-)
(+)
OWNERS' EQUITY
Debit
Credit
(-)
(+)
EXPENSE
Debit
Credit
(+)
(-)
After the occurrence of business transactions, a book-keeper is required to:
1. journalise the transactions;
2. post the journal entries to ledger accounts;
8
8
The Accounting Cycle (6)
GENERAL JOURNAL
Date
Account Titles and Narrative
Debit $
Credit $
2007
Jan 1 Cash
50,000
Capital
50,000
To record the capital invested by the owner.
LIABILITY
Debit
Credit
(-)
(+)
ASSET
Debit
(+)
Credit
(-)
REVENUE
Debit
Credit
(-)
(+)
OWNERS' EQUITY
Debit
Credit
(-)
(+)
EXPENSE
Debit
Credit
(+)
(-)
After the occurrence of business transactions, a book-keeper is required to:
1. journalise the transactions;
2. post the journal entries to ledger accounts;
9
Please note that the entries to ledger accounts follow the Accounting Equation, ie9
Asset = Liability + Equity
The Accounting Cycle (7)
GENERAL JOURNAL
Date
Account Titles and Narrative
Debit $
Credit $
2007
Jan 1 Cash
50,000
Capital
50,000
To record the capital invested by the owner.
ASSET
Debit
(+)
Credit
(-)
INCOME
Debit
Credit
(-)
(+)
LIABILITY
Debit
Credit
(-)
(+)
CAPITAL
Debit
Credit
(-)
(+)
EXPENSE
Debit
Credit
(+)
(-)
Trial Balance as at 31 December 2007
Dr $
Cr $
Cash
500
Accounts payable
1,000
Fixed assets
50,000
Capital
50,000
Revenue
2,000
Administrative expenses
500
Total
52,000
52,000
10
After the occurrence of business transactions, a book-keeper is required to:
1. journalise the transactions;
2. post the journal entries to ledger accounts;
3. prepare trial balance;
10
The Accounting Cycle (8)
GENERAL JOURNAL
Date
2007
Jan 1
Account Titles and Narrative
ASSET
Debit
(+)
De bit $
Credit $
Cash
1,000
Capital
To re cord the capital invested by the owner.
LIABILITY
Debit
Credit
(-)
(+)
Credit
(-)
INCOME
Debit
Credit
(-)
(+)
1,000
OWNERS' EQUITY
Debit
Credit
(-)
(+)
EXPENSE
Debit
Credit
(+)
(-)
Trial Balance as at 31 December 2007
Dr $
Cr $
500
1,000
50,000
50,000
2,000
500
52,000
52,000
Cash
Accounts payable
Fixed assets
Capital
Revenue
Administrative expenses
Total
Final adjustments, like depreciation,
accrual, prepayment, allowance for
doubtful accounts
After the occurrence of business transactions, a book-keeper is required to:
1. journalise the transactions;
2. post the journal entries to ledger accounts;
3. prepare trial balance;
4. journalise balancing day adjustments (final adjustments), post them to
ledger accounts and prepare adjusted trial balance;
11
11
The Accounting Cycle (9)
GENERAL JOURNAL
Date
2007
Jan 1
ASSET
Debit
Credit
(for increase) (for decrease)
Account Titles and Narrative
De bit $
Credit $
Cash
1,000
Capital
To re cord the capital invested by the owner.
LIABILITY
Debit
Credit
(for decrease) (for increase)
1,000
CAPITAL
Debit
Credit
(for decrease) (for increase)
Adjusted Trial Balance as at 31 December 2007
Dr $
Cr $
Cash
500
Accounts payable
1,000
Fixed assets
50,000
Capital
50,000
Revenue
2,000
Administrative expenses
500
Total
52,000
52,000
INCOME
Debit
Credit
(for decrease) (for increase)
EXPENSE
Debit
Credit
(for increase) (for decrease)
Final adjustments, like depreciation,
accrual, prepayment and provision
doubtful debts
After the occurrence of business transactions, a book-keeper is required to:
1. journalise the transactions;
2. post the journal entries to ledger accounts;
3. prepare trial balance;
4. journalise balancing day adjustments (final adjustments), post them to
ledger accounts and prepare adjusted trial balance;
12
12
The Accounting Cycle (10)
GENERAL JOURNAL
Date
2007
Jan 1
Account Titles and Narrative
ASSET
Debit
Credit
(for increase) (for decrease)
LIABILITY
Debit
Credit
(for decrease) (for increase)
INCOME
Debit
Credit
(for decrease) (for increase)
Income Statement
For the year ended 31 Dec 2007
Sales
Cost of sales
Gross profit
Distributive costs
Administration expenses
Finance costs
Profit before tax
Tax
Profit for the year
13
$
10,000
(5,000)
5,000
(1,000)
(1,000)
(500)
2,500
(375)
2,125
De bit $
Cash
1,000
Capital
To re cord the capital invested by the owner.
Credit $
1,000
CAPITAL
Debit
Credit
(for decrease) (for increase)
EXPENSE
Debit
Credit
(for increase) (for decrease)
Adjusted Trial Balance as at 31 December 2007
Dr $
Cr $
Cash
500
Accounts payable
1,000
Fixed assets
50,000
Capital
50,000
Revenue
2,000
Administrative expenses
500
Total
52,000
52,000
Balance Sheet
As at 31 Dec 2007
Assets
Fixed assets
Accounts receivable
Cash and bank
Liabilities
Accounts payable
Equity
Capital
Retained profit
After the occurrence of business transactions, a book-keeper is required to:
1. journalise the transactions;
2. post the journal entries to ledger accounts;
3. prepare trial balance;
4. journalise balancing day adjustments (final adjustments), post them to
ledger accounts and prepare adjusted trial balance; and
5. prepare financial statements (income statement and balance sheet).
$
50,000
5,000
500
55,500
(1,000)
54,500
50,000
4,500
54,500
13
Financial Statements (1)
Financial Statements Preparation
Now, it’s time to take a look on some basic techniques in the preparation of
financial statements.
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14
Financial Statements (2)
With the adjusted trial balance, we will classify those items in the adjusted trial
balance into the following categories:
(1) Balance Sheet – Asset (B/S – Asset),
(2) Balance Sheet – Liability (B/S – Liability),
(3) Balance Sheet – Equity (B/S – Equity),
(4) Income Statement – Revenue (I/S – Revenue), and
(5) Income Statement – Expense (I/S – Expense).
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15
Financial Statements (3)
Adjusted Trial Balance
As at 31 December 2007
Bank
Accounts receivable
Plant & equipment, at cost
Accumulated depreciation
Inventories
Retained profit, at 1 Jan 2007
Accounts payable
Capital
Sales
Cost of sales
Carriage outwards
Office expenses
Interest expenses
Tax
Depreciation
Total
Dr $
500
1,200
50,000
Cr $
15,000
6,000
16,800
2,000
20,000
35,000
15,000
2,000
8,000
500
600
5,000
88,800
88,800
This is an adjusted trial balance. Before extracting the data to the financial
statements, please perform the aforesaid classification.
16
16
Financial Statements (4)
Adjusted Trial Balance
As at 31 December 2007
$
Bank
Accounts receivable
Plant & equipment, at cost
Accumulated depreciation
Inventories
Retained profits, at 1 Jan 2007
Accounts payable
Capital
Sales revenue
Cost of sales
Carriage outwards
Office expenses
Interest expenses
Income tax expenses
Depreciation expense
Total
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Equity
B/S-Liability
B/S-Equity
I/S-Revenue
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
$
500
1,200
50,000
15,000
6,000
16,800
2,000
20,000
35,000
$
15,000
2,000
8,000
500
600
5,000
88,800
$
88,800
17
Check your classification with above answer.
17
Financial Statements (5)
Adjusted Trial Balance
As at 31 December 2007
$
Bank
Accounts receivable
Plant & equipment, at cost
Accumulated depreciation
Inventories
Retained profits, at 1 Jan 2007
Accounts payable
Capital
Sales revenue
Cost of sales
Carriage outwards
Office expenses
Interest expenses
Income tax expenses
Depreciation expense
Total
18
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Equity
B/S-Liability
B/S-Equity
I/S-Revenue
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
$
500
1,200
50,000
15,000
6,000
16,800
2,000
20,000
35,000
$
15,000
2,000
8,000
500
600
5,000
88,800
$
88,800
Now, you may ask how we can know the category of each item. To answer the
question, we have to understand the structure of financial statements as well 18
as definitions of “asset”, “liability”, “equity”, “revenue” and “expense”.
Financial Statements
(6)
Balance Sheet
Asset
Liability
Income Statement
Equity
Revenue
Expense
The elements directly related to the measurement of financial position are
presented in the balance sheet, i.e. asset, liability and equity.
The elements directly related to the measurement of financial performance are19
presented in the income statement, i.e. revenue and expense.
19
Financial Statements
Sorry, please try again.
20
20
Financial Statements
(7)
Balance Sheet
Asset
Liability
Equity
Income Statement
Revenue
Expense
The elements are defined1 as:
(a)
An asset is a resource controlled by the enterprise as a result of past
events and from which future economic benefits are expected to flow to
the enterprise.
Question 1: Is an acquired software an asset ?
1
You may refer to the Framework of the Preparation and Presentation of Financial Statements issued by Hong Kong
Institute of Certified Public Accountants.
Yes
21
No
21
Financial Statements
Balance Sheet
Asset
Liability
Equity
(8)
Income Statement
Revenue
Expense
Correct, an acquired software1 is an asset as:
- it is a resource under an enterprise’s control;
- economic benefits of a software can be received through the use.
1
You may refer to the HKAS 38 Intangible Assets issued by Hong Kong Institute of Certified Public Accountants.
22
22
Financial Statements
Sorry, please try again.
23
23
Financial Statements
(9)
Balance Sheet
Asset
(b)
Liability
Equity
Income Statement
Revenue
Expense
A liability is a present obligation of the enterprise arising from past
events, the settlement of which is expected to result in an outflow from
the enterprise of resources embodying economic benefits.
Question 2: Is a provision for legal claims a liability?
Yes
24
No
24
Financial Statements
(10)
Balance Sheet
Asset
Liability
Equity
Income Statement
Revenue
Expense
Correct, provision1 is a liability as:
- it is a present obligation to an enterprise;
- it is probable that the enterprise needs to settle the legal claims
(accordingly cause an outflow of economic benefits) in future, though
the timing is uncertain.
1 You may refer to the HKAS 37 Provisions, Contingent Liabilities and Contingent Assets issued by Hong Kong Institute
of Certified Public Accountants.
25
25
Financial Statements
Balance Sheet
Asset
(c)
Liability
Equity
(11)
Income Statement
Revenue
Expense
Equity is the residual interest in the assets of the enterprise after
deducting all its liabilities.
Capital and retained profit are classified as equity because they
represent the owners’ interest in an enterprise.
26
26
Financial Statements
Sorry, please try again.
27
27
Financial Statements
(12)
Balance Sheet
Asset
(d)
Liability
Income Statement
Equity
Revenue
Expense
Revenue is an increase in economic benefits during the accounting
period in the form of inflows or enhancements of assets or a decrease
of liabilities that results in an increase in equity, other than those relating
to contributions from equity participants (owners).
Question 3: Is sales a kind of revenue ?
Yes
28
No
28
Financial Statements
Balance Sheet
Asset
Liability
(13)
Income Statement
Equity
Revenue
Expense
Correct, sales is a revenue because economic benefits (in the form of
cash or other assets) are received during the sales activities.
29
29
Financial Statements
Sorry, please try again.
30
30
Financial Statements
(14)
Balance Sheet
Asset
(e)
Liability
Equity
Income Statement
Revenue
Expense
Expense is a decrease in economic benefits during the accounting
period in the form of outflows or depletions of assets or an incurrence of
liabilities that results in a decrease in equity, other than those relating to
distributions to equity participants (owners).
Question 4: Is salary expenditure an expense?
Yes
31
No
31
Financial Statements
Balance Sheet
Asset
Liability
Equity
(15)
Income Statement
Revenue
Expense
Correct, salary expenditure is an expense because economic benefits
(in the form of cash or incurrence of a liability) are paid by an employer.
32
32
Financial Statements
(16)
Adjusted Trial Balance
As at 31 December 2007
Bank
Accounts receivable
Fixed assets, at cost
Accumulated depreciation
Retained profit, at 1 Jan 2007
Accounts payable
Bank loan, repayable after 5 years
Capital
Sales
Cost of sales
Carriage outwards
Office expenses
Interest expenses
Tax
Depreciation
Total
33
Dr $
16,500
1,200
50,000
Cr $
15,000
16,800
2,000
10,000
20,000
35,000
15,000
2,000
8,000
500
600
5,000
98,800
98,800
Let’s look at the adjusted trial balance and classify the above items again
33
basing on the aforesaid definitions (please click the adjusted trial balance).
Financial Statements
(17)
Adjusted Trial Balance
As at 31 December 2007
Bank
B/S-Asset
Accounts receivable
B/S-Asset
Fixed assets, at cost
B/S-Asset
Accumulated depreciation
B/S-Asset
Retained profit, at 1 Jan 2007 B/S-Equity
Accounts payable
B/S-Liability
Bank loan, repayable after 5 yrs B/S-Liability
Capital
B/S-Equity
Sales
I/S-Revenue
Cost of sales
I/S-Expense
Carriage outwards
I/S-Expense
Office expenses
I/S-Expense
Interest expenses
I/S-Expense
Tax
I/S-Expense
Depreciation
I/S-Expense
Total
Dr $
16,500
1,200
50,000
Cr $
15,000
16,800
2,000
10,000
20,000
35,000
15,000
2,000
8,000
500
600
5,000
98,800
98,800
34
34
Please check whether your classification are the same as above.
Financial Statements
(18)
Adjusted Trial Balance
As at 31 December 2007
Bank
Accounts receivable
Fixed assets, at cost
Accumulated depreciation
Retained profit, at 1 Jan 2007
Accounts payable
Bank loan, repayable after 5 yrs
Capital
Sales
Cost of sales
Carriage outwards
Office expenses
Interest expenses
Tax
Depreciation
Total
35
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Equity
B/S-Liability
B/S-Liability
B/S-Equity
I/S-Revenue
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
Dr $
16,500
1,200
50,000
Cr $
15,000
16,800
2,000
10,000
20,000
35,000
15,000
2,000
8,000
500
600
5,000
98,800
98,800
Good. Now, we move forward to the preparation of financial statements.
Revenue and expense items are extracted from the adjusted trial balance and35
stated in the income statement.
Financial Statements
(19)
Income Statement
For the year ended 31 December 2007
Dr $
Sales
I/S-Revenue
Cost of sales
I/S-Expense
15,000
Carriage outwards
I/S-Expense
2,000
Office expenses
I/S-Expense
8,000
Interest expenses
I/S-Expense
500
Tax
I/S-Expense
600
Depreciation expense
I/S-Expense
5,000
Cr $
35,000
Good. Now, we move forward to the preparation of financial statements.
Revenue and expense items are extracted from the adjusted trial balance and
stated in the income statement.
36
36
Financial
Statements
Income Statement (For Internal Use)
(20)
For the year ended 31 December 2007
$
Sales
Cost of sales
Gross profit
Distribution costs
Carriage outwards
Administrative expenses
Office expenses
Depreciation
$
35,000
(15,000)
20,000
(2,000)
(8,000)
(5,000)
Finance costs
Interest expenses
(13,000)
(500)
Profit before tax
Tax
Profit for the year
4,500
(600)
3,900
After the extraction, we will tidy up the items into the format suggested by Hong
Kong Accounting Standard 1 “Presentation of Financial Statements”, as above.
37
Please note that expenses are generally required to be classified into “Cost of
Sales”, “Distribution Costs”, “Administrative Expenses”, “Finance Costs” and 37
“Income Tax Expenses”, basing on the function of the expenses.
Financial Statements
(21)
Income Statement (For External Use)
For the year ended 31 December 2007
Sales
Cost of sales
Gross profit
$
35,000
(15,000)
20,000
Distribution costs
Administrative expenses
Finance costs
Profit before tax
Tax expenses
Profit for the year
(2,000)
(13,000)
(500)
4,500
(600)
3,900
After the extraction, we will tidy up the items into the format suggested by Hong
Kong Accounting Standard 1 “Presentation of Financial Statements”, as above.
Please note that expenses are generally required to be classified into “Cost of
Sales”, “Distribution Costs”, “Administrative Expenses”, “Finance Costs” and
38
“Income Tax Expenses”, basing on the function of the expenses.
38
Financial Statements
(22)
Adjusted Trial Balance
As at 31 December 2007
Bank
Accounts receivable
Fixed assets, at cost
Accumulated depreciation
Retained profit, at 1 Jan 2007
Accounts payable
Bank loan, repayable after 5 yrs
Capital
Sales
Cost of sales
Carriage outwards
Office expenses
Interest expenses
Tax
Depreciation
Total
Dr $
16,500
1,200
50,000
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Asset
B/S-Equity
B/S-Liability
B/S-Liability
B/S-Equity
I/S-Revenue
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
I/S-Expense
Cr $
15,000
16,800
2,000
10,000
20,000
35,000
15,000
2,000
8,000
500
600
5,000
98,800
98,800
Then, asset, liability and equity items are extracted from the adjusted trial
balance and stated in the balance sheet.
39
39
Financial Statements
(23)
Adjusted Trial Balance
As at 31 December 2007
Bank
B/S-Asset
Accounts receivable
B/S-Asset
Fixed assets, at cost
B/S-Asset
Accumulated depreciation
B/S-Asset
Retained profit, at 1 Jan 2007 B/S-Equity
Accounts payable
B/S-Liability
Bank loan, repayable after 5 yrs B/S-Liability
Capital
B/S-Equity
Dr $
16,500
1,200
50,000
Cr $
15,000
16,800
2,000
10,000
20,000
Then, asset, liability and equity items are extracted from the adjusted trial
balance and stated in the balance sheet.
40
40
Financial Statements
(24)
Balance Sheet
As at 31 December 2007
ASSETS
Non-current assets
Plant & equipment, at cost
Accumulated depreciation
$
$
50,000
(15,000)
35,000
Current assets
Accounts receivable
Bank
41
1,200
16,500
Total assets
17,700
52,700
EQUITY AND LIABILITIES
Capital
Retained profit (at 31 Dec 2007)
Total equity
20,000
20,700
40,700
Non-current liabilities
Bank loan (repayable after 5 years)
10,000
Current liabilities
Accounts payable
Total liabilities
Total equity and liabilities
2,000
12,000
52,700
Again, we will tidy up the items into the format suggested by Hong Kong
41
Accounting Standard, HKAS 1 “Presentation of Financial Statements”, as above.
Financial Statements
(25)
Balance Sheet
As at 31 December 2007
ASSETS
Non-current assets
Plant & equipment, at cost
Accumulated depreciation
$
$
50,000
(15,000)
35,000
Current assets
Accounts receivable
Bank
42
1,200
16,500
Total assets
17,700
52,700
EQUITY AND LIABILITIES
Capital
Retained profit (at 31 Dec 2007)
Total equity
20,000
20,700
40,700
Non-current liabilities
Bank loan (repayable after 5 years)
10,000
Current liabilities
Accounts payable
Total liabilities
Total equity and liabilities
2,000
12,000
52,700
Please note that the retained profit ($20,700) in the balance sheet represent
the retained profit at the end of an accounting year, while retained profit stated
on adjusted trial balance ($16,800) represent the balance at the beginning of 42
an accounting year.
Financial Statements
(26)
Balance Sheet
As at 31 December 2007
ASSETS
Non-current assets
Plant & equipment, at cost
Accumulated depreciation
$
$
50,000
(15,000)
35,000
Current assets
Accounts receivable
Bank
43
1,200
16,500
Total assets
17,700
52,700
EQUITY AND LIABILITIES
Capital
Retained profit (at 31 Dec 2007)
Total equity
20,000
20,700
40,700
Non-current liabilities
Bank loan (repayable after 5 years)
10,000
Current liabilities
Accounts payable
Total liabilities
Total equity and liabilities
2,000
12,000
52,700
We need to use the following formula to compute the retained profits stated in
the balance sheet, rather than extracting directly from the adjusted trial balance:
Closing retained profit = Opening retained profit ($16,800) + Profit for the43
year ($3,900) – Drawings for the year ($0) = $20,700.
Financial Statements
(27)
Balance Sheet
As at 31 December 2007
ASSETS
Non-current assets
Plant & equipment, at cost
Accumulated depreciation
$
$
50,000
(15,000)
35,000
Current assets
Accounts receivable
Bank
44
1,200
16,500
Total assets
17,700
52,700
EQUITY AND LIABILITIES
Capital
Retained profit (at 31 Dec 2007)
Total equity
20,000
20,700
40,700
Non-current liabilities
Bank loan (repayable after 5 years)
10,000
Current liabilities
Accounts payable
Total liabilities
Total equity and liabilities
2,000
12,000
52,700
What’s more, HKAS 1 requires assets and liabilities to be further classified as
“current” and “non-current” assets.
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Do you have any idea on how to distinguish an asset from current to noncurrent?
Financial Statements
(28)
Balance Sheet
As at 31 December 2007
$
ASSETS
Non-current assets
Plant & equipment, at cost
Accumulated depreciation
$
50,000
(15,000)
35,000
Current assets
Accounts receivable
Bank
1,200
16,500
Total assets
17,700
52,700
EQUITY AND LIABILITIES
Capital
Retained profit (at 31 Dec 2007)
Total equity
20,000
20,700
40,700
Non-current liabilities
Bank loan (repayable after 5 years)
10,000
Current liabilities
Accounts payable
Total liabilities
Total equity and liabilities
2,000
12,000
52,700
Generally, we will classify an asset as current if it is expected to be realised or
sold or consumed within twelve months after the balance sheet date.
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All other assets should be classified as non-current.
Financial Statements
(29)
Balance Sheet
As at 31 December 2007
ASSETS
Non-current assets
Plant & equipment, at cost
Accumulated depreciation
$
$
50,000
(15,000)
35,000
Current assets
Accounts receivable
Bank
1,200
16,500
Total assets
17,700
52,700
EQUITY AND LIABILITIES
Capital
Retained profit (at 31 Dec 2007)
Total equity
20,000
20,700
40,700
Non-current liabilities
Bank loan (repayable after 5 years)
10,000
Current liabilities
Accounts payable
Total liabilities
Total equity and liabilities
2,000
12,000
52,700
Similarly, we will classify a liability as current if it is expected to be settled
within twelve months after the balance sheet date.
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All other liabilities should be classified as non-current.
46
Overall Considerations (1)
I am sure that you are now equipped with the basic technique in the
preparation of financial statements. But this is not enough. I would like to tell
you more on the considerations required by HKAS 1 “Presentation of Financial
Statements” in preparing financial statements.
First of all, the management of an entity shall make an assessment of an
entity’s ability to continue as a going concern when preparing financial
statements.
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Overall Considerations (2)
Financial statements shall be prepared on a going concern basis unless the
entity is going to liquidate or cease trading.
When the management has significant doubt on the entity’s ability to continue
as a going concern, those uncertainties shall be disclosed in the financial
statements.
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Overall Considerations (3)
Secondly, an entity (whatever a sole trader, a partnership or a company) is
required to prepare its income statement and balance sheet using the accrual
basis of accounting (in opposite of the cash basis of accounting).
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49
Overall Considerations (4)
Accordingly, assets, liabilities, equity, revenue and expenses are recorded in
accounting records and presented in financial statements when they satisfy the
definitions and:
- associated future economic benefit is probable to flow to or from the entity;
and
- the cost (or value) can be measured with reliability.
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Overall Considerations (5)
For example: a sales transaction is recorded as revenue when goods are
delivered to the customers (accrual basis of accounting), rather than when the
sales consideration is received (cash basis of accounting).
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Overall Considerations (6)
Thirdly, the presentation and classification of items in the financial statements
are required to be retained from one period to the next (known as Consistency
of Presentation), unless in rare circumstance.
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Overall Considerations (7)
Fourthly, material class of similar items is required to be presented separately
in the financial statements. Items of a dissimilar nature or function should be
presented separately, unless they are immaterial (Materiality and
Aggregation).
For example, accounts receivable and other receivables should be presented
in the balance sheet separately in regard of the dissimilar nature. However, if
they both are immaterial, we can group them together as “receivables” and
present it as a single item in the balance sheet.
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53
Overall Considerations
Sorry, please try again.
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Overall Considerations (8)
Fifthly, unless in rare situation, assets and liabilities should not be offset
(offsetting).
Question 5: If a bank’s balance of an entity is $1,000 (asset) while another
bank’s balance is an overdraft of $600 (liability), should we offset the
bank balance against the bank overdraft?
Yes
No
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Overall Considerations (9)
Correct, we should not offset the bank balance against the bank overdraft and
present the net bank balance of $400 in the balance sheet as an asset. Instead,
we should present bank balance of $1,000 as an asset and bank overdraft of
$600 as a liability, separately, in the balance sheet.
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56
Overall Considerations
Sorry, please try again.
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57
Overall Considerations (10)
Similarly, revenue and expenses should not be offset.
Question 6: An entity sells goods of $1,000 (revenue) to Peter on 1.1.2007.
The entire amount is due on 31.3.2007. Peter does not pay on time and he
goes into bankrupt on 30.12.2007 and, therefore, the amount due
becomes a bad debt (expense). Should we offset the sales revenue
against the bad debt expense?
Yes
No
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Overall Considerations (11)
Correct, we should not offset the sales revenue against the bad debt expense
and present the net amount of $0 in the income statement. Instead, we should
present sales revenue of $1,000 as revenue and bad debt expense of $1,000
as an expense, separately, in the income statement.
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Overall Considerations (12)
Last but not least, financial statements shall give a true and fair view of the
financial position, financial performance and cash flows of an entity.
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Overall Considerations (13)
True and fair view requires the faithful representation of the effects of
transactions, other events and conditions in accordance with the definitions
and recognition criteria for assets, liabilities, income and expenses set out in
the Framework1.
Presumably, the application of Hong Kong Financial Reporting Standards will
result in financial statements that give a true and fair view.
1
You may refer to HKAS 1 “Presentation of Financial Statements” issued by Hong Kong Institute of Certified
Public Accountants.
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Sole Trader vs Partnership (1)
We will prepare financial statements for sole traders, partnerships or
companies (which we will look into details in Unit 3). The major difference
among those types of financial statements is attributable to the variation in their
legal structures, which affect the composition of the equity.
In the financial statements of a sole trader, sole trader’s capital account is the
only component of the equity. The sole trader’s capital at the end of an
accounting year is calculated as followings:
Closing Capital = Opening Capital + Profit for the year - Drawings
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Sole Trader vs Partnership (2)
As there are more than one owner in a partnership, the equity will be
comprised of partners’ capital accounts and current accounts in the financial
statements of a partnership.
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Sole Trader vs Partnership (3)
Partners’ capital accounts are used in recording capital invested and withdrawn
by the partners.
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Sole Trader vs Partnership (4)
Partners’ current accounts are used in recording usual affairs between the
partners and partnership firm, e.g.:
(a)
salaries to the partners;
(b)
interest to the partners for their contributed capital;
(c)
share of profit or loss in accordance with agreed profit-sharing ratio;
(d)
drawings of partners from their share of profit; and
(e)
the charge of interest on drawings from partners.
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Sole Trader vs Partnership (5)
A & B Partnership
Appropriation Account for the year ended 31 December 2007
$
$
Profit for the year
Add: Interest on partners’ drawings:
-A
-B
Less: Interest for partners' capital:
-A
-B
Less: Salaries to partners:
-A
-B
P
IA
IB
I
X
iA
iB
i
Y
SA
SB
Balance of profit
S
Z
Balance of profit divided in accordance with the agreed ratio:
-A
ZA
-B
ZB
Z
Besides, we will prepare an appropriation account (as presented above) in
order to show how profit for the year is divided among partners in accordance
with partnership agreement, e.g. partners’ salaries, share of profit or loss.
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Your Show Time
Now, it is time to do exercises. Please attempt the following two exercises:
1.Prepare the financial statements for a sole trader; and
2.Prepare the financial statements for a partnership.
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Exercise: Sole Trader
Tommy T
Adjusted Trial Balance as at 31 December 2007
Dr $
Accounts payable
Accounts receivable
Carriage outwards
Bank
Bank loan, repayable after five years
Cost of sales
Electricity expense
Motor vans, at cost
Motor vans – Accumulated depreciation at 31 December 2007
Rent and rate expenses
Other operating expenses (including depreciation)
Sales
Capital, at 1 Jan 2007
Drawings ( made during the year)
Cr $
5,000
8,000
700
3,000
10,000
20,000
1,300
40,000
8,000
7,000
13,000
50,000
40,000
20,000
113,000
113,000
Tommy Tam carries a retailing business, called Tommy T. The adjusted trial balance on
the business’ books as at 31 December 2007 is as above. Please prepare the financial
statements for Tommy T in accordance with the HKAS 1 “Presentation of Financial
Statements”.
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Answer: Sole Trader (1)
Tommy T
Income Statement for the year ended 31 December 2007
$
Sales
50,000
Cost of sales
(20,000)
Gross profit
30,000
Distribution costs
(700)
Administrative expenses (13,000 + 1,300 + 7,000)
(21,300)
Profit for the year
8,000
Please compare your answer with above suggested answer for the income
statement.
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Answer: Sole Trader (2)
Tommy T
Balance Sheet as at 31 December 2007
ASSETS
Non-current assets
Motor vans, at cost
Motor vans – Accumulated depreciation
$
$
40,000
(8,000)
32,000
Current assets
Accounts receivable
Bank
8,000
3,000
11,000
43,000
Total assets
EQUITY AND LIABILITIES
Capital, at 1 Jan 2007
Profit for the year (extracted from the income statement)
Drawings (made during the year)
Capital, at 31 Dec 2007
Non-current liabilities
Bank loan (repayable after 5 years)
Current liabilities
Accounts payable
Total liabilities
Total equity and liabilities
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Please compare your answer with above
suggested answer for the balance sheet.
40,000
8,000
(20,000)
28,000
10,000
5,000
15,000
43,000
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Exercise: Partnership
Dr $
Accounts payable
Accounts receivable
Carriage outwards
Bank
Bank loan, repayable after five years
Cost of sales
Electricity expense
Motor vans, at cost
Motor vans – Accumulated depreciation at 31 December 2007
Rent and rate expenses
Other operating expenses (including depreciation)
Sales
Capital account - Bruce, at 1 Jan 2007
Capital account - Robin, at 1 Jan 2007
Current account - Bruce, at 31 Dec 2007
Current account - Robin, at 31 Dec 2007
Drawings - Bruce (made during the year)
Cr $
5,000
8,000
700
3,000
10,000
20,000
1,300
40,000
8,000
7,000
13,000
50,000
15,000
15,000
15,000
5,000
20,000
118,000
118,000
Additional information: (1) Bruce entitles to receive a salary of $3,000 per annum.
(2) Profit and loss sharing ratio between Bruce and Robin is 1:1
Bruce and Robin operated a business in partnership, namely R&B Company.
The adjusted trial balance of the partnership as at 31 December 2007 is as
above. Please prepare the financial statements for R&B Company in
accordance with HKAS 1 “Presentation of Financial Statements”.
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Answer: Partnership (1)
R&B Company
Income Statement for the year ended 31 December 2007
$
Sales
50,000
Cost of sales
(20,000)
Gross profit
30,000
Distribution costs
(700)
Administrative expenses (13,000 + 1,300 + 7,000)
(21,300)
Profit for the year
8,000
Please compare your answer with above suggested answer for the income
statement.
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Exercise: Partnership (2)
R&B Company
Appropriation Account for the year ended 31 December 2007
$
Profit for the year
8,000
Less: Salary to parnters:
- Bruce
Balance of profit
(3,000)
5,000
Balance of profit divided in accordance with the agreed ratio:
- Bruce (1/2)
- Robin (1/2)
2,500
2,500
5,000
Please compare your answer with above suggested answer for the
appropriation account.
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Answer: Partnership (3)
R&B Company
Balance Sheet as at 31 December 2007
$
ASSETS
Non-current assets
Motor vans, at cost
Motor vans – Accumulated depreciation
40,000
(8,000)
Current assets
Accounts receivable
Cash
Total assets
8,000
3,000
$
32,000
11,000
43,000
EQUITY AND LIABILITIES
Capital accounts, at 1 Jan 2007
Profit for the year (extracted from the appropriate account)
Drawings (made during the year)
Capital accounts, at 31 Dec 2007
Bruce
15,000
2,500
(20,000)
(2,500)
Robin
15,000
2,500
17,500
Total
30,000
5,000
(20,000)
15,000
Current accounts, at 1 Jan 2007
Salary to partners
Current accounts, at 31 Dec 2007
Total equity
15,000
3,000
18,000
15,500
(5,000)
(5,000)
12,500
10,000
3,000
13,000
28,000
Non-current liabilities
Bank loan (repayable after 5 years)
Current liabilities
Accounts payable
Total liabilities
Total equity and liabilities
Please compare your answer with above suggested
answer for the balance sheet.
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$
10,000
5,000
15,000
43,000
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Recapitulation (1)
Now, you have come to the end of the unit.
Let us recapitulate the essential points of the following in
the next two slides:
•
Structures and contents of financial statements
•
Overall considerations for presentation of financial
statements
•
Preparation of income and balance sheet for a sole
trader and a partnership
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Recapitulation (2)
Structures and contents of financial statements
- Financial statements are comprised of income statement and
balance sheet.
- Asset, liability and equity are elements that presented in the
balance sheet.
- Revenue and expense are elements that presented in the income
statement.
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Recapitulation (3)
Overall considerations for presentation of financial statements:
- going concern;
- accrual basis of accounting;
- consistency of presentation;
- materiality and aggregation;
- offsetting; and
- true and fair view.
Preparation of income statement and balance sheet for:
- a sole proprietor; and
- a partnership.
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Further Readings
•
Yau, L. and Yau, R. (2001), Book-Keeping
and Accounts, Hong Kong Institute of
Accredited Accounting Technicians Limited,
2nd Edition.
•
Li, T. M. and Ng, P. H. (2005), Financial
Accounting, Hong Kong Institute of
Accredited Accounting Technicians Limited.
‧ 邱韞華及邱在光 (2001), 簿記與會計, 香港財務
會計協會有限公司, 第二版.
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End of the Unit
End-of-unit Assessment
This is the end of Unit 2.
Please go to the Unit
Assessment before
attempting the next unit.
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Learning Resources Corner
If you would like to
(a) learn Basic Book-keeping Skills for Learners, and
(b) do Case Studies,
please go to the Learning Resources Corner.
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