Chapter 2: Analysing transactions and

preparing year-end financial statements.

Overview:
1. The basic financial reports
2. Classification of transactions
3. Review of balance sheet and income statement

© Chris Guilding 1
1. The basic financial reports

As part of financial reporting (i.e., external reporting),

companies prepare:
• a balance sheet,
• an income statement,
• a statement of owner’s equity,
• a statement of cash flows.

The main statements we will be reviewing are the balance

sheet and the income statement.

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1. The basic financial reports (cont’d)
The main sections of a balance sheet:

Assets are “things” that are owned (most usually purchased) by

the organisation. To qualify as an asset, the organisation should
be able to derive some future value from ownership. Typical
assets include: cash, accounts receivable, china, silver, glass,
linen, stock, cars, equipment, land and buildings.

Liabilities may be seen as the opposite of assets. They reflect

financial obligations of the organisation. Typical liabilities
include: wages & salaries payable, trade creditors and bank loan.

Owner’s equity reflects the financial interest of the owner(s) in

the organisation. It includes original investment plus all profits
not paid outGuilding
© Chris to the owner(s) (retained profits). 3
1. The basic financial reports (cont’d)

Fundamental balance sheet equation:

Assets - Liabilities = Owner’s Equity (A - L = OE)

i.e., the owner’s equity (interest) in the company equals the
surplus assets that would be left over after the company’s
liabilities have been paid off.

Alternatively, the balance sheet equation can be stated as:

Assets = Liabilities + Owner’s Equity (A = L + OE)

i.e., money is raised and goes towards buying assets.
Money raised but not “ploughed” into assets is held as cash
(which is also an asset).
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 2. Classification of transactions
Following the recording of business transactions, the balance
sheet equation (A = L + OE) must be maintained.

The “double impact” that transactions have on the balance sheet

equation will be shown using the following 10 transactions made
by the Kenit hotel.

Transaction 1)
Geoff Kenit contributes $30,000 cash to commence his own hotel
business.

ASSETS = LIABILITIES + OWNER’S

EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
+30,000 © Chris Guilding
+ 30,000 5
 2. Classification of transactions (cont’d)
Transaction 2)
Billed clients $19,000 for use of conference facilities.

ASSETS = LIABILITIES + OWNER’S

EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
+19,000 +19,000

Transaction 3)
Purchased stock on credit for $800.

ASSETS = LIABILITIES + OWNER’S

EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
© Chris Guilding
+ 800 + 800 6
 2. Classification of transactions (cont’d)
Transaction 4)
Received $6,000 from customers billed in transaction (2) above.

ASSETS = LIABILITIES + OWNER’S

EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
+6,000 -6,000

Transaction 5)
Purchased a van for $12,000, paying $3,000 in cash and obtaining a
loan for the balance.
ASSETS = LIABILITIES + OWNER’S
EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
- 3,000 © Chris Guilding +12,000 + 9,000 7
 2. Classification of transactions (cont’d)
Transaction 6)
Paid $500 to trade creditors to reduce amount owing for stock
purchased.
ASSETS = LIABILITIES + OWNER’S
EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
- 500 - 500

Transaction 7)
Owner withdrew $1,500 from the business.

ASSETS = LIABILITIES + OWNER’S

EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
- 1,500 © Chris Guilding - 1,500 8
 2. Classification of transactions (cont’d)
Transaction 8)
The accountant has determined that $600 of stock has been used.

ASSETS = LIABILITIES + OWNER’S

EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
- 600 - 600

Transaction 9)
Paid $250 for miscellaneous expenses (telephone, electricity, etc.).

ASSETS = LIABILITIES + OWNER’S

EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
- 250 © Chris Guilding
- 250 9
 2. Classification of transactions (cont’d)
Transaction 10)
Repaid $5,000 of the loan taken out for the van.

ASSETS = LIABILITIES + OWNER’S

EQUITY
Cash Acc. Acc. Loan Profit
at bank Rec’ble Stock Van Payable Payable Capital & Loss
- 5,000 - 5,000

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The net effect of these 10 transactions can be summarised as follows. Note how
columns are added, then the column totals are added to give the value for the 3
main areas of the balance sheet (i.e., assets, liabilities and owners equity).

ASSETS = LIABILITIES + OWNERS EQUITY

Cash at Acc. Acc. Loan Profit &
bank Rec’ble Stock Van P’ble P’ble Capital Loss
1 + 30,000 + 30,000
2 + 19,000 + 19,000
3 + 800 + 800
4 + 6,000 - 6,000
5 - 3,000 + 12,000 + 9,000
6 - 500 - 500
7 - 1,500 - 1,500
8 - 600 - 600
9 - 250 - 250
10 - 5,000 - 5,000
25,750 13,000 200 12,000 300 4,000 28,500 18,150

© Chris Guilding
$50,950 = $4,300 + $46,650 11
 Geoff Kenit Hotel: Income statement for the
first 10 days of May

$ $
Sales 19,000
less Expenses
Stock used 600
Miscellaneous 250
850
Income (Profit) 18,150

Geoff Kenit Hotel: Statement of Owner’s Equity for the 10 days

ending May 10th
$
Owner’s equity contribution 30,000
plus net profit 18,150
48,150
less Drawings 1,500
Owner’s equity end of month 46,650
© Chris Guilding 12
Geoff Kenit Hotel: Statement of Owner’s equity for the 10 days
ending May 10th

$
Owner’s equity contribution 30,000
plus net profit 18,150
48,150
less Drawings 1,500
Owner’s equity end of month 46,650

Geoff Kenit Hotel: Balance Sheet as at 10 May

Assets $ Liabilities $ $
Cash 25,750 Accounts payable 300
A/R 13,000 Loan payable 4,000
Stock 200 4,300
Van 12,000 Owner’s equity
Capital 46,650
$50,950 $50,950
© Chris Guilding 13
3. Review of balance sheet and income statement

a) The Balance Sheet

• Shows the assets, liabilities and owner’s equity at one point in

time.
• Assets are “things” that are owned (most usually purchased) by
the organisation.
• Liabilities can be seen as the opposite of assets. They reflect
financial obligations of the organisation.
• Owner’s equity is a representation of the owners’ financial
investment in the organisation.

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3. Review of balance sheet and income statement

b) Income statement

• Shows the deduction of expenses for the year from revenues

during the year to give profit (or loss) for the year.
• Revenues represent inflows of economic benefits during the
reporting period.
• Expenses represent the consumption of economic benefits
during the reporting period.

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