Chapter 1: Introduction

1) Accounting: The Language of Business

Accounting helps businesses record, analyze, and report financial transactions.

It provides essential information about profit, loss, and financial position.

2) Sections of Accounting

Accounting is divided into two key sections:

1. Book-keeping (Recording Transactions)

Definition: The process of systematically recording all financial transactions.

Importance:

• Ensures that every transaction is recorded.

• Prevents errors, omissions, and fraud.

• Uses double-entry book-keeping (every transaction affects two accounts).

Example: A business buys furniture for $500. The transaction is recorded as:

• Debit (Dr) Furniture Account $500 (Increase in asset)

• Credit (Cr) Cash/Bank Account $500 (Decrease in asset)

2. Accounting (Preparing Financial Statements)

Definition: Uses book-keeping records to prepare financial reports.

Purpose:

• Helps business owners monitor progress.

• Shows if the business is profitable or at a loss.

Key Financial Statements:
Income Statement – Shows profit or loss over a period.
Statement of Financial Position (Balance Sheet) – Shows assets & liabilities at a given time.

Example: If a business earns $10,000 in sales and incurs $7,000 in expenses, the profit is:
Profit = Sales – Expenses
$10,000 – $7,000 = $3,000 (Net Profit)

Book-keeping records transactions, and Accounting interprets them.

Double-entry system ensures accuracy.
Income Statement = Profit or Loss.
Statement of Financial Position = Assets & Liabilities.
Financial statements help in business growth & decision-making.

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3. Assets, Liabilities, and Capital
Accounting records focus only on the business – the owner and the business are separate entities.

1. Capital (Owner’s Contribution)

• Definition: The resources (money, buildings, vehicles, etc.) provided by the owner to start or run
the business.

• It represents what the business owes to the owner.

• Example: If the owner invests $10,000, the business owes this amount to the owner as capital.

2. Assets (What the Business Owns)

• Definition: Anything owned by or owed to the business that has financial value.

• Example of Assets:
Cash → Money in hand or in the bank.
Inventory (Stock) → Goods available for sale.
Machinery, Buildings, Vehicles → Fixed assets used in operations.
Accounts Receivable (Debtors) → Money owed by customers.

3. Liabilities (What the Business Owes to Others)

• Definition: Amounts owed by the business to external parties (other than the owner).

• Example of Liabilities:
Bank Loans – Money borrowed from a bank.
Creditors (Accounts Payable) – Suppliers who have not yet been paid.
Overdrafts – A negative bank balance due to withdrawals exceeding deposits.

4. The Accounting Equation

The fundamental rule of accounting:

Assets = Capital + Liabilities

Alternative Form:

Assets=Owner’s Equity + Liabilities

This equation must always balance – the total value of what a business owns (assets) is always equal
to the total amount invested by the owner (capital) plus what is borrowed (liabilities).

Example of the Accounting Equation:

Scenario:

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 • The owner invests $15,000 (Capital).

• The business takes a $5,000 loan (Liability).

• The business buys equipment worth $12,000 and has $8,000 in cash (Assets).

Applying the accounting equation:

Assets = Capital + Liabilities

Equipment $ 12000 + Cash $ 8000 = Capital $ 15000+ Loan $ 5000
$20000 = $20000

The equation balances!

Capital = Money or resources provided by the owner.

Assets = Resources owned or owed to the business.
Liabilities = Debts owed by the business to others.
Accounting Equation:
Assets = Capital + Liabilities (Always Balanced!).
If two elements of the equation are known, the third can be calculated.

Understanding the Accounting Equation

Assets = Capital → At the start, all business assets are funded by the owner’s capital.
When a new asset is bought using cash or bank funds, total assets remain the same, but one asset
(cash/bank) decreases while another (e.g., machinery, equipment) increases.

Example:

• A business has $10,000 in the bank (Asset).

• It buys a machine for $4,000.

• New Assets: Machine = $4,000, Bank = $6,000.

• Total assets = Capital ($10,000) → Equation balances!

2) Purchasing on Credit (Trade Payables / Creditors)

When goods are bought on credit, the business receives inventory but does not pay immediately.
The supplier becomes a creditor (trade payable) because the business owes money.
New Rule: Assets = Capital + Liabilities

Example:

• Business buys $3,000 worth of inventory on credit.

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 • Assets increase (Inventory +$3,000).

• Liabilities increase (Creditors +$3,000).

• Total Assets = Capital + Liabilities → Equation still balances!

3) Selling on Credit (Trade Receivables / Debtors)

When goods are sold on credit, the business does not receive cash immediately.
Instead, a customer becomes a debtor (trade receivable) because they owe money to the business.
The business loses inventory but gains a receivable (another asset).

Example:

• Business sells $2,000 worth of inventory to a customer on credit.

• Inventory decreases (-$2,000) but

• Trade Receivables (Debtor) increase (+$2,000).

• Total Assets = Capital + Liabilities → Still balances!

4) Statement of Financial Position

Definition:

• The statement of financial position (also called the balance sheet) shows the assets and
liabilities of a business on a certain date.

What it shows:

• Assets: What the business owns (e.g., cash, inventory, buildings).

• Liabilities: What the business owes (e.g., loans, creditors).

• Capital: The owner's stake in the business.

Shot Question Answers

1) Define the term Book-Keeping.

Book-keeping is the process of recording all financial transactions of a business in a detailed and
systematic way.

Example:
A business sells goods for $500 cash. In book-keeping, this transaction is recorded as:

• Debit (Dr) Cash $500 (Cash increases).

• Credit (Cr) Sales $500 (Revenue increases).

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2) Define the term Accounting.

Accounting is the process of analyzing and interpreting book-keeping records to prepare financial
statements and help in decision-making.

Example:

• A business records all sales, purchases, and expenses (book-keeping).

• At the end of the year, accounting helps prepare an income statement to calculate profit or loss
and a statement of financial position to show what the business owns and owes.

3) State two reasons why it is necessary to prepare financial statements at regular intervals.

1. To check profit or loss – Businesses need to know if they are making money or losing it.
2. To know the financial position – Helps owners see what they own (assets) and what they owe
(liabilities).

Example:
If a business earns $20,000 in sales and has $15,000 in expenses, the financial statements will show a
$5,000 profit. This helps the owner decide whether to expand the business or cut costs.

4) State what is included in the term Financial Statements.

Financial statements include:

1. Income Statement → Shows profit or loss over a period.
2. Statement of Financial Position (Balance Sheet) → Shows assets, liabilities, and capital on a specific
date.

Example:

• If a business has $50,000 in assets, $30,000 in liabilities, and $20,000 in capital, this information
is recorded in the Statement of Financial Position.

5) Complete the Table show the effect of each of the following transaction

1. Bought a motor vehicle and paid by cheque

2. Bought goods on credit from a credit supplier
3. Received a cheque from a credit customer
4. Sold goods on credit
5. Paid off a loan in cash

Explanation of Each Transaction

(a) Bought a motor vehicle and paid by cheque

• Motor Vehicles (Asset) increases because a new vehicle is purchased.

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• Bank (Asset) decreases because payment is made.

• No effect on liabilities because it was paid immediately.

(b) Bought goods on credit from a supplier

• Inventory (Asset) increases as stock is added.

• Trade Payables (Liability) increases because payment is due to the supplier.

(c) Received a cheque from a credit customer

• Bank (Asset) increases because the cheque is received.

• Trade Receivables (Asset) decreases because the customer no longer owes money.

• No effect on liabilities because it's a customer payment.

(d) Sold goods on credit

• Trade Receivables (Asset) increases because a customer now owes money.

• Inventory (Asset) decreases because goods are sold.

• No effect on liabilities because it’s a credit sale.

(e) Paid off a loan in cash

• Bank (Asset) decreases because cash is used to pay the loan.

• Loan Payable (Liability) decreases because the debt is repaid.

NOTES COMPILED BY WAQAS GHOURI | ACCA, M.com (Hons),923330460661