10
1: Introduction to accounting Part A The context and purpose of financial reporting
5.1.3 Capital or equity
The amounts invested in a business by the owner are amounts that the business owes to the owner. This
is a special kind of liability, called
capital. In a limited liability company, capital usually takes form of
shares. Share capital is also known as
equity.
5.1.4 Form of statement of financial position
A statement of financial position used to be called a balance sheet. The former name is apt because assets
will always be equal to liabilities plus capital (or equity). A very simple statement of financial position for a
sole trader is shown below.
A TRADER
STATEMENT OF FINANCIAL POSITION AS AT 30 APRIL 20X7
$
$
Assets
Plant and machinery
55,000
Inventory
5,000
Receivables (from customers)
1,500
Bank
500
7,000
Total assets
62,000
Capital
Balance brought forward
25,000
Profit for the year
10,400
Balance carried forward
35,400
Liabilities
Bank loan
25,000
Payables (to suppliers)
1,600
Total capital plus liabilities
62,000
We will be looking at a statement of financial position in a lot more detail later in this Study Text. This
example is given simply to illustrate what a statement of financial position looks like.
5.2 Income statement
An
income statement is a record of revenue generated and expenditure incurred over a given period. The
statement shows whether the business has had more revenue than expenditure (a profit) or vice versa
(loss).
5.2.1
Revenue and expenses
Revenue is the income for a period. The
expenses are the costs of running the business for the same
period.
5.2.2 Form of income statement
The period chosen will depend on the purpose for which the statement is produced. The income statement
which forms part of the published annual financial statements of a
limited liability company will usually
be for the period of a
year, commencing from the date of the previous year's statements. On the other
hand,
management might want to keep a closer eye on a company's profitability by making up
quarterly
or monthly statements.
A simple income statement for a sole trader is shown on the next page.
Key term
Part A The context and purpose of financial reporting
1: Introduction to accounting
11
A TRADER
INCOME STATEMENT FOR THE YEAR ENDED 30 APRIL 20X7
$
Revenue
150,000
Cost of sales
75,000
Gross profit
75,000
Other expenses
64,600
Net profit
10,400
Once again, this example is given purely for illustrative purposes. We will be dealing with an income
statement in detail later in this Study Text.
5.3 Purpose of financial statements
Both the statement of financial position and the income statement are
summaries of accumulated data.
For example, the income statement shows a figure for revenue earned from selling goods to customers.
This is the total amount of revenue earned from all the individual sales made during the period. One of the
jobs of an accountant is to devise methods of recording such individual transactions, so as to produce
summarised financial statements from them.
The statement of financial position and the income statement form the basis of the financial statements of
most businesses. For limited liability companies, other information by way of statements and notes may
be required by national legislation and/or accounting standards, for example a
statement of
comprehensive income and a
statement of cash flows. These are considered in
detail later in this Study
Text.
Question
Accounting information
The financial statements of a limited liability company will consist solely of the statement of financial
position and income statement.
Is this statement correct?
A True
B False
Answer
The correct answer is B. As shown above other statements, such as a statement of cash flows, are usually
needed.
One of the competences you require to fulfil performance objective 4 of the PER is the ability to prioritise
and plan your work to meet objectives, managing conflicting pressures and making best use of time and
resources. In the course of your F3 studies, you will be demonstrating this competence.
12
1: Introduction to accounting Part A The context and purpose of financial reporting
Chapter Roundup
Financial reporting is a way of recording, analysing and summarizing financial data.
Businesses of whatever size or nature exist to make a
profit.
You should be able to distinguish the following.
– Financial
accounting
– Management
accounting
There
are
various groups of people who need information about the activities of a business.
The principal financial statements of a business are the
statement of financial position and the
income
statement.
Quick Quiz
1
What is financial reporting?
2
A business entity is owned and run by Alpha, Beta and Gamma.
What type of business is this an example of?
A Sole
trader
B Partnership
C
Limited liability company
D Don't
know
3
Identify seven user groups who need accounting information.
4
What are the two main financial statements drawn up by accountants?
5
Which of the following is an example of a liability?
A Inventory
B Receivables
C
Plant and machinery
D Loan
Answers to Quick Quiz
1
A way of recording, analysing and summarising financial data.
2
B.
A partnership, as it is owned and run by 3 people.
3 See
paragraph
4.2
.
4
The income statement and the statement of financial position.
5
D.
A loan. The rest are all assets.
Now try the question below from the Exam Question Bank
Number
Level
Marks
Time
Q1
Examination
2
2 mins