Balance sheet and business transactions easily understood. Learn about assets, liabilities, revenue, expenses and equity.

1. 1
The Balance Sheet
& Business Transactions

2. 2
The characteristics of
business transactions
 A business transaction is recorded when there
has been an exchange of resources between one
business and another person or business in
monetary terms
 The exchange must be at arm’s length.
 Entity concept must be kept intact – i.e. business
records must be kept separate from the owner’s
personal records
 Personal expenditure from the entity’s funds are
known as drawings.
 Transactions can be either in cash or credit.
 Source documents provide evidence of the
business transactions.

3. 3
Examples of Source Documents

4. 4
Business transaction versus a
business event
 Personal transactions are ones that do not
involve an exchange between the business entity
and another entity.
 Negotiations between the entity and outsiders
will not be recorded as a business transaction
until an exchange of resources actually takes
place.
 Negotiations are considered as simply a business
event:
• These must not be included in the entity’s records until a
source document evidences an exchange
of resource/s

5. 5
The accounting equation –
process of double entry
 The accounting equation is known as the
relationship between assets (whether
owned or controlled by the entity)
liabilities and equity
Assets = Liabilities + Equity
 Liabilities and equity represent the claims
against the entity’s assets.
 Business transactions are analysed by
examining the dual effect of each business
transaction and the impact on the
accounting equation

6. 6
The accounting equation –
process of double entry
 The concept of duality simply means that every
business transaction will affect the accounting
equation – the result of which leaves the
equation in balance!
Assets = Liabilities + Equity
 The Equity section of the accounting
equation can be expanded to analyse
the effects of income and expenses –
determines net profit/loss for the period.
 Net profit/loss is then added to the
entity’s opening equity in the equity
section of the Balance Sheet.

7. 7
Worksheet
 The accounting worksheet / trial
balance summarises the duality of
business transactions
 The worksheet (like the Balance
Sheet) is based overall on the
accounting equation (A = L + E)

8. 8
Example of a Worksheet

9. 9
Income Statement
 Used to calculate net profit (or loss)
 It is the difference between
income/revenue and expense
transactions
 Net profit (or loss) is then
transferred to the Balance Sheet

10. 10
Example of an Income
Statement

11. 11
Balance Sheet
 It is a statement of the entity’s
assets and liabilities
 The accounting equation holds true
within the Balance Sheet (i.e. A = L + E)

12. 12
Example of a Balance Sheet
Source: Accounting: Business Reporting for Decision Making, Birt, Chalmers, Byrne, Brooks &
Oliver, 2010.

13. 13
Journals and Ledger
 Journal
• a book used to record similar business transactions in
chronological order. Each entry will have:
 the date of transaction
 name of accounts affected and
 the corresponding debit and credit amount.
 Ledger
• An alternative to journals – can also be used to
summarise journals.
• Each ledger account will have a
 debit (left side) and
 a credit (right side)

14. 14
Debits and Credits
 to increase an asset (e.g. cash) or
an expense account (e.g. wages)
we debit it.
 to increase a liability account
(e.g. creditor) or revenue account
(e.g. sales) we would credit it.

15. 15
Simple Example

16. Teresa is unhappy in her present job and wants to do
something more fulfilling and challenging. Currently she
is an office administrator for a company that imports and
exports. She loves textiles and feels that there is a
business opportunity in selling imported rugs and
carpets. She knows that you have completed studies in
accounting and asks for your help.
Teresa is willing to invest her savings of $20000 into the
business but she also knows that she will need to borrow
money to get started. Her aunty is willing to lend her
$50000 at commercial rates. According to the terms of
the loan the interest is based on a 6% variable rate tied
to the commercial bank rates. The loan is to be paid off
at the rate of $5000 per year for the next 10 years. So
on the 1 April she creates a business account with her
bank, transfers her $20000 across and banks her
aunty’s cheque for $50000.
16

17. So in summary:
Teresa injected $20 000 of her own money into the business.
Teresa borrowed $50 000 from her aunt.
Balance Sheet as at 1 April
Assets = Liabilities + Owner’s Equity
17
Assets Liabilities
Cash $70 000 Loan $50 000
Equity
Capital
Contributed
$20 000
$70 000 $70 000

18. Teresa needs a shop in which to sell her rugs. She finds the right shop
in a boutique shopping precinct which contains arts galleries, antique
shops, coffee shops and smaller retail shops. She leases the shop for a
period of 5 years. The cost of the lease has two components. The first
is a lease premium of $10 000. This is payable immediately and gives
Teresa the right to occupy the shop for the next five years. The second
is a yearly rental of $12000 payable in monthly instalments. On 2
March she signs the lease and writes a cheque for $10 000 in favour of
the leasor.
Balance Sheet as at 2 April
Assets Liabilities
Current Non-Current
Cash $60 000 Loan $50 000
Non-current
Lease $10 000 Equity
Capital Contributed $20 000
$70 000 $70 000
18

19. Teresa needs to fit out the shop in order to display the
wares she has for sale. On 3 April she contracts with a
builder to do the fit out for $20 000. The next day she
finishes the fit out and Teresa writes a cheque for $20 000
in favour for the builder.
Balance Sheet as at 4 April
Assets Liabilities
Current Non-Current
Cash $40 000 Loan $50 000
Non-current
Lease $10 000 Equity
Shop Fixtures $20 000 Capital Contributes $20 000
$70 000 $70 00019

20. Teresa needs to purchase her inventory of rugs and
carpets. She approaches several companies and decides
to buy her first stock from Carpetable Pty Ltd. On 5 April
she selects a range of small, medium and large rugs and
carpets of varying textures, colours and fabrics from
Carpetable Pty Ltd at a cost of $35 000. This is payable in
28 days.
Balance Sheet as at 5 April
Assets Liabilities
Current Current
Cash $40 000 Accounts Payable $35 000
Inventory $35 000 Non-current
Non-current Loan $50 000
Lease $10 000 Equity
Shop Fixtures $20 000 Capital Contributed $20 000
$105 000 $105 00020

21. During April Teresa sold $20 000 worth of inventory for
$40000. Interest expense was $250 for the month and
depreciation on fixtures was $334. The monthly rent was
$1000. Ignore the lease for simplicity.
Profit/(Loss) = $40000-$20000-$250-$334-$1000
= $18416.
Balance Sheet as at 30 April
Assets Liabilities
Current Current
Cash $78 750 Accounts Payable $35 000
Investory $15 000 Non-current
Non-current Loan $50 000
Equity
Shop Fixtures $20000
Less Accum Dep $334 $19 666
Capital Cont.$20000
+Retain Prof$18416 $38 416
$123 416 $123 416
21

22. Note that we have worked out the profit and loss in one line
above. Given the first month of trading it was simple
enough to do and we can remember what amounts
represent what expense. However, as time moves on and
as we incur more and varied expenses it is best to list the
profit and loss as a schedule as below:
Sales $40 000
Less: COGS $20 000
GROSS Profit $20 000
Less other expenses
Depreciation 334
Lease Rent payments 1 000
Interest Expense 250 $ 1 584
NET Profit $18 416
This is the income statement. It also gives us more
information.
22

23. We have ignored the prepaid lease payment of $10000 for 5 years.
This is an asset as it gives Teresa the right to use the shop over the
next five years. According to the matching principle we should account
for the proportion of the lease cost that is used each period. Therefore
the cost of the lease each month is $167. ($10000/5yrs/12mths). The
new balance sheet is as follows:
Balance Sheet as at 30 April
Assets Liabilities
Current Current
Cash $78 750 Accounts Payable $35 000
Inventory $15 000 Non-current
Non-current Loan $50 000
Lease Prepaid $10000
Less amortisation $ 167 $ 9 833
Equity
Shop Fixtures $20000
Less accum deprec$ 334 $19 666
Capital Contrib $20 000
+Retain Profit $18 249 $38 249
$123 249 $123 249
23
Assets Liabilities
Current Current
Cash $78 750 Accounts Payable $35 000
Inventory $15 000 Non-current
Non-current Loan $50 000
Lease Prepaid $10000
Less amortisation $ 167 $ 9 833
Equity
Shop Fixtures $20000
Less accum deprec$ 334 $19 666
Capital Contrib $20 000
+Retain Profit $18 249 $38 249
$123 249 $123 249

24. 24
The Balance Sheet
 The financial position of an entity at
a particular point in time
 Lists
• Assets
 What the business owns or controls
• Liabilities
 External claims on the entity’s assets
• Owner’s equity
 Internal claims on the entity’s assets

25. 25
Accounting Equation
Assets = Liabilities + Owner’s Equity

26. 26
Assets
 ‘A resource controlled by the entity
as a result of past transactions or
other past events and from which
future economic benefits are
expected to flow to the entity.’
 Future economic benefit
 Controlled by the entity
 Result of past transaction or event

27. 27
Asset
Recognition
 ‘It is probable that any future
economic benefits associated with
the asset will flow to the entity and
the asset has a cost or other value
that can be measured reliably.’

28. 28
Assets
 Examples
• cash
• receivables (debtors)
• prepayments
• inventories
• property
• tangible vs intangible

29. 29
Liabilities
‘A present obligation of the entity arising
from past events, the settlement of
which is expected to result in an outflow
from the entity of resources embodying
economic benefits.’
 A future sacrifice of economic benefits
 A present obligation to another entity
 A result of a past transaction or other
past events

30. 30
Liabilities
Recognition
 ‘It is probable that the outflow of
resources embodying economic
benefits will result and can be
measured reliably.’

31. 31
Liabilities
 Examples
• payables (creditors)
• tax liabilities
• mortgages
• loans

32. 32
Equity
 ‘The residual interest in the assets of the
entity after deduction of its liabilities.’
 Equity = Assets – Liabilities
 Categories of Owner’s equity
• Owner’s equity contributed
• Owner’s equity retained
• Reserves
 Equity cannot be defined independently

33. 33
Equity
 Categories
• contributed equity
• Reserves
 Asset Revaluation reserve
 General Reserve
 Foreign currency translation reserve
• retained profits
• outside interests in controlled entities

34. 34
Summary of asset and liability
definition and recognition criteria

35. 35
Simple Example
Revisited

36. On 2 May Teresa bought another $50000 worth
of inventory on credit and paid the account owing
from her previous inventory purchases. She
decided to spend some money on advertising to
try to boost her name in the area. This marketing
cost $5000. Teresa paid for this in cash.
Throughout May Teresa sold $55000 worth of
rugs for $100 000 ($80000 for cash and $20 000
on credit).
36

37. Income Statement for May
Sales $100 000
Less COGS
Beginning Inventory $15 000
+Purchases $50 000
$65 000
-End Inventory $10 000 $55 000
Gross Profit $45 000
Other Expenses
Depreciation $ 334
Interest $ 250
Marketing $ 5 000
Lease Prepaid $ 167
Lease Rent Payment $ 1 000 $ 6 751
Net Profit $38 249
37

38. Balance Sheet as at 31 May
*Cash $78750 - $35000 + $80000 - $1000 - $250 - $5000 38
Assets Liabilities
Current Current
Cash* $117 500 Accounts Payable $50 000
Accounts Receivable $ 20 000 Non-current
Inventory $ 10 000 Loan $50 000
Non-current
Lease Prepaid $10000
Less amortisation$ 334 $ 9 666
Equity
Shop Fixtures $20000
Less Accum Deprec $ 668
$19 332
Capital Cont. $20 000
Beg Retained
Profit $18 249
+ Net Profit $38 249
$56 498 $76 498
$176 498 $176 498

39. 39
Balance Sheet Format
 ‘T’ Format/Horizontal
 Narrative Format/Vertical
 Remember:
• Balance Sheet balances
• i.e. Assets = Liabilities + Equity
 Generally presented in order of liquidity
 Comparative Information (2 years)
 Parent entity and consolidated entity

40. 40
Classification of Items
 Current and Non-current
• Current Assets – expected to be consumed or
converted to cash in next 12 months eg. cash,
inventory, debtors
• Non-Current Assets – normally held on a
continuing basis to generate wealth eg. Land
and buildings
• Current Liabilities – due and payable within 12
months eg. Trade creditors
• Non-current Liabilities – payable beyond 12
months eg. Long term loan

41. 41
Conventions
 Business entity convention
 Money measurement
 Valuation
 Going Concern (continuity)
 Dual aspect
 Conservatism
 Stable Monetary Unit
 Objectivity/reliability

42. 42
Valuation
The dollar value assigned to assets and
liabilities is called their carrying or
book value
The carrying value can either be:
 Historical cost – i.e. original cost
• Current cost
 Market value
• Present value
So which one do we choose?

43. 43
Valuation
 The one that ensures the information is
relevant and reliable
For example
• Debtors: net realisable value
 i.e. expected collection value
• Inventory: lower of cost or net realisable value
 NRV = expected selling price minus any costs involved in the sale
• Non-Current Assets: lower of cost or recoverable amount
(selling price or value in use - i.e. amount expected to be
recovered through use and/or sale)
 Benefits consumed each period are recorded as an expense of the
business for that period
• Depreciation – for tangible non-current assets
• Amortisation – for intangible non-current assets
• Goodwill - purchased goodwill only

44. 44
Balance Sheet Analysis
 liquidity: ability to meet current obligations from
liquid assets. Related to the probability of
business failure.
 mix of assets held: current vs non current.
Given their long term nature, an over-investment
in non current assets can cause cash shortages.
 financial structure: reliance on external vs
internal sources of finance. Important because
external finance involves legal obligations

45. 45
Limitations of the Balance Sheet
1. Asset, Liability and Entity values are at a particular point
in time only (these values will change over time)
2. The entity’s value is not really reflected in balance sheet
due to
• Items that generate future benefits or involve future
sacrifices not satisfying definition/recognition criteria
• The historical nature (or combinations of cost and fair
values) of the Balance Sheet
3. Preparing a Balance Sheet involves –
• management choices
• judgements and
• estimations