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Hult International Business School - London

International Accounting

Handout 1 Introduction, Transaction


Recognition, Accounts, Financial Statements
Module A - 2015 / 2016

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Introduction to Accounting
Accounting is (generally) made out to be a complex
subject however the essence of accounting is
simple. Accountants job is quite simple to keep
track of:
Assets, and
Equities (i.e. equity in the assets).

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Assets Definition
Something that is needed in order to run a/the
business, provides a benefit to the business (now
and in the future).
Something that is owned by the business.
Business (not necessarily owns 100% of the asset) has
legal title to the asset.
Examples of Assets:
Production equipment;
Office buildings;

Most office building are never purchased in whole by the owner


(there is usually a mortgage on a building).

Supplies and office equipment.


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Equity Definition
Represents ownership in the assets.
In case of a building it would be the down-payment;

Title holder now has an equity interest in the building.

Most likely the rest of the purchase price would be


financed by a lender.

The lender has an interest / claim on asset.

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Contribution of Assets (I)


A business is a collection (a basket) of assets (otherwise it does not
exist.

Assets can be contributed into the business by the owner(s).

Assets

Owner(s)

In order to start the business, the owner may make a contribution to the business of
items like: cash; production equipment; buildings, office equipment, etc.
A contribution needs to be accounted for / recorded as a business transaction.

Image source: PowerPoint image library.

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Contribution of Assets (II)


There is another way for a company to get assets ...
Assets can be also be contributed into the business by a lender /
creditor.
Assets
Lender(s)
Owner(s)

An obvious example is a loan arranged by the company.


The bank provides cash to the business, whereas the owner signs a note
promising to repay the loan (with interest) at some point in the future.
Also, equipment (or a building) may be purchased with a potion of it financed by a bank
loan.

Image source: PowerPoint image library.

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Recording Transaction (I)


Once transactions have been recorded ... a report can be prepared
which will list:

What assets are held by the business.


Who has interest in / claim on the assets.

Assets must be owned by someone: either creditors or owners.

Whatever is the value of the assets ... must be equal to the sum total of the
claims of creditors and owners.

Assets

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Lender(s)

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Owner(s)

Accounting Fundamental Equation


All assets must be owned by either lenders of shareholders.

Assets

Assets

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Lender(s)

Liabilities

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Owner(s)

ShareholderEquity

Recording Transaction (II)


A transaction is an event that makes a change to:

Assets;
Liabilities;
Shareholders Equity

Every transaction must be recorded (how ?)


Lets start with a table below where each asset, liability and equity has a
column (i.e. An account) in which changes are recorded.
Assets
Cash

A/R

Office
Supplies

=
PPE

Computer
Workstation

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Liabilities
A/P

Debt

Shareholder's
Equity

JohnDoe
Capital

Transactions (I)
Transaction impacting Shareholders Equity:
1. Shareholder (Winston Wolfe) starts a consulting business by contributing
$20,000 of cash and $1,000 office supplies to the business;
2. WW contributes his workstation computer (worth $2,000) to the business;
3. WW performs a service job for a Customer A and receives $500 from him.
4. WW performs another service job for a Customer B and is promised to be paid
$700 in the near future (no payment received yet).
Assets
Cash
Transaction1
Transaction2
Transaction3
Transaction4
Balance

A/R

+20,000

Office
Supplies
+1,000

=
PPE

Computer
Workstation

Liabilities
A/P

+
+

Debt

+2,000
+500
20,500

+700
700

1,000

2,000

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Shareholder's
Equity
WinstonWolfe
Capital
+21,000
+2,000
+500
+700
24,200

Revenue Recognition
Under Generally Accepted Accounting Principals (GAAP) and under
International Financial Reporting Standards (IFRS) ... rules of
accrual accounting must be followed.
1. Revenues are to be recognized (recorded) when they have been earned;
2. It does not matter whether cash for services performed or goods delivered has
been received yet or not.
3. Revenues are to be recognized the moment invoice is issued;

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Shareholders Equity in Detail


Shareholders Equity is affected by:
1. Capital investments made into the business (recorded in Common Stock
account);

In case of a small business (sole proprietorship) called Capital account;

2. Capital withdrawals made from the business (recorded in Dividends account);

In case of a small business (sole proprietorship) called Drawing account;

3. Business revenues; recorded in Revenue account(s);


4. Business expenses; recorded in Expense account(s);
Shareholder'sEquity
Dividends

CommonStock

Expense(s)

Revenue(s)

+21,000
+2,000

23,000
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+500
+700
1,200

Transactions (II)
Transaction impacting Shareholders Equity:
5. Shareholder (Winston Wolfe) takes $3,000 out of the business to use for home
improvement work around his house.
6. WW pays the $200 monthly business internet bill.

This is for the past months internet usage; not any future usage.
It is an expense incurred and not a prepayment for future usage (asset).

7. WW receives a $250 council tax bill for the month just ended and is payable in
two weeks time (no payment made yet).
8. $300 of office supplies are used up (portion of an asset has become an expense).
Assets
Cash
Balance
Transaction5
Transaction6
Transaction7
Transaction8
Balance

20,500
3,000
200

Office
Supplies
700
1,000

A/R

=
PPE

Computer
Workstation
2,000

=
=

Liabilities
A/P

+
+

Debt
0

+250
17,300

700

300
700

2,000

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250

Shareholder's
Equity
WinstonWolfe
Capital
24,200
3,000
200
250
300
20,450

Expense Recognition
Under Generally Accepted Accounting Principals (GAAP) and under
International Financial Reporting Standards (IFRS) ... rules of
accrual accounting must be followed.
1. Expenses are to be recognized (recorded) when they have been incurred;
2. It does not matter whether cash for services received or goods delivered has
been made yet or not.
3. Expenses are to be recognized the moment invoice is received;

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Transactions (III)
Transaction impacting Assets only:
9. WW purchases office supplies for $1,500 of company cash.
10. WW sells $200 worth of office supplies to another party.

These office supplies originally cost $200.

11. WW collects $500 worth of A/R balance from the transaction when services
were performed on account.

Assets
Cash
Balance
Transaction9
Transaction10
Transaction11
Balance

17,300
1,500
+200
+500
16,500

Office
Supplies
700
700
+1,500
200
500
200
2000

A/R

=
PPE

Computer
Workstation
2,000

2,000

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Liabilities

Shareholder's
Equity

250

WinstonWolfe
Capital
20,450

250

20,450

A/P

Debt

Transactions (IV)
Transaction impacting Liabilities:
12. WW purchases another computer workstation for $2,000 and agrees to pay at
a later date (on account).
13. $3,000 is borrowed from a bank.

WW (as a director of the company) signed a promissory note to repay the debt at a later
date.
Interest will be charged on this loan as long as it is outstanding.

14. WW pays off the council tax bill received earlier.

Assets
Cash
Balance
Transaction12
Transaction13
Transaction14
Balance

16,500
+3,000
250
19,250

Office
Supplies
200
2000

A/R

=
PPE

Computer
Workstation
2,000
+2,000

Liabilities

A/P

250
+2,000

WinstonWolfe
Capital
20,450

20,450

Debt
0

Shareholder's
Equity

+3,000
200

2000

4,000

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250
2000

3000

Transactions Summary (I)


Balance of Assets = $25,450;
Balance of Liabilities and shareholders Equity = $25,450;
Assets
Cash
Transaction1
Transaction2
Transaction3
Transaction4
Transaction5
Transaction6
Transaction7
Transaction8
Transaction9
Transaction10
Transaction11
Transaction12
Transaction13
Transaction14
Balance

A/R

+20,000

Office
Supplies
+1,000

=
PPE

Computer
Workstation

Liabilities
A/P

Debt

+2,000
+500
+700
3,000
200
+250
1,500
+200
+500

300
+1,500
200

WinstonWolfe
Capital
+21,000
+2,000
+500
+700
3,000
200
250
300

500
+2,000

+3,000
250
19,250

Shareholder's
Equity

+2,000
+3,000

200

2000

4,000

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250
2000

3000

20,450

Transactions Summary (II)


Sum total of individual balances in each of Shareholders Equity
accounts = $20,450;
Shareholder's
Equity
WinstonWolfe
Capital
+21,000
+2,000
+500
+700
3,000
200
250
300

20,450

Shareholder'sEquity
Dividends
Transaction1
Transaction2
Transaction3
Transaction4
Transaction5
Transaction6
Transaction7
Transaction8
Transaction9
Transaction10
Transaction11
Transaction12
Transaction13
Transaction14
Balance

CommonStock

Expense(s)

Revenue(s)

+21,000
+2,000
+500
+700
3,000
200
250
300

3,000

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23,000

750

1,200

Financial Reporting
At the end of an accounting period, financial information needs to be
reported to interested parties.

Three standard financial reports are constructed:


1. The Balance Sheet (Statement of Financial Position) reports balances of
Assets, Liabilities and Shareholders Equity accounts.
2. Income Statement presents a summary of revenues and expenses recorded in
the Shareholders Equity Account in order to determine the profit earned by the
business.
3. Statement of changes in Shareholders Equity summarizes the evolution of all
Shareholders Equity accounts.
Image source: http://www.transtutors.com/homework-help/accounting/accounting-basicsrelationship-between-economic-events/

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Balance Sheet
At the end of an accounting period, financial information needs to be
reported to interested parties.
WinstonWolfeServicesInc.
BalanceSheet($s)
December31,20X5
Assets
Cash
A/R
OfficeSupplies
PPE
ComputerWorkstation
TotalAssets

Liabilities
A/P
Debt
TotalLiabilities

19,250
200
200
0
4,000
25,450

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2000
3000
5,000

Shareholder'sEquity
WinstonWolfeCapital

20,450

TotalLiabilities
&Shareholder's
Equity

25,450

Income Statement
At the end of an accounting period, financial information needs to be
reported to interested parties.
WinstonWolfeServicesInc.
IncomeStatement($s)
FortheyearendedDecember31,20X5
Revenue(s)
ConsultingServiceRevenues
Expense(s)
InternetExpense
200
CouncilTaxExpense 250
SuppliesExpense 300
TotalExpenses
NetIncome

1,200

750
450

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Statement of Shareholders Equity (I)


At the end of an accounting period, financial information needs to be
reported to interested parties.
WinstonWolfeServicesInc.
StatementofChangesinShareholder'sEquity($s)
FortheyearendedDecember31,20X5

WinstonWolfeCapital,December31,20X4
Add:StockIssuance
23,000
Add:NetIncome
450
Total
23,450
3,000
Subtract:PaymentofDividends
IncreaseinShareholder'sEquity

20,450

WinstonWolfeCapital,December31,20X5

20,450

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Retained Earnings (I)


Retained earnings is the portion of corporations Net Income that is
kept / retained by the corporation as opposed to distributed to
shareholders in the form of dividends.

If a corporation produces a net loss for the period, then this loss decreases the
corporation's retained earnings balance.
If the balance of the retained earnings account is negative it may be called
retained losses, accumulated losses or accumulated deficit.
Retained earnings and losses accumulate from one year to the next.
Retained earnings are reported as part of the shareholders equity section of
the corporation's balance sheet.
Net accumulated losses may lead to negative shareholders' equity, also known
as shareholders' deficit.

Image source: http://www.wyzant.com/resources/lessons/accounting/financial-statements

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Statement of Shareholders Equity (II)


Since
Net Income Dividends = Retained Earnings
It is more common to see the following.
WinstonWolfeServicesInc.
StatementofChangesinShareholder'sEquity($s)
FortheyearendedDecember31,20X5

WinstonWolfeCapital,December31,20X4
Add:StockIssuance
23,000
Add:RetainedEarnings
2,550
Total
20,450
WinstonWolfeCapital,December31,20X5

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20,450

The Accounts (I)


Using a table (below) is not practical, nor is it even feasible for large
businesses that have to record thousands of transactions in
thousands of accounts every day.
Assets
Cash

A/R

Office
Supplies

=
PPE

Computer
Workstation

New concepts will help:

Instead of using one sheet of paper for all


the accounts, a single sheet of paper will
be used for each account;

A stack of these papers (accounts) is called


a General Ledger.

Image source: PowerPoint image library.

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Liabilities
A/P

Debt

Shareholder's
Equity

JohnDoe
Capital

The Accounts (II)


Once accounts have been separated, they are further subdivided into
two sides.
Increases in each account are recorded on one side, whereas the
decreases are recorded on the other side.
Each side can now be added up, sub-totalled separately;
Increases and decreases can then be netted out in order to determine
the balance in each account.
Example of a T account for Cash:

$33.8K subtotal on the Left hand side;


$7.5K subtotal on the Right hand side;
$26.3K balance on the Left hand side;

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