FINANCIAL ACCOUNTING

Session 3: Transaction Analysis and Basic

Preparation of Financial Statements

Ningzhong Li

Objectives

The objectives of this session are to

• Learn how to use the transactions worksheet
• Analyse the effects on the financial statements of some
transactions
• Prepare basic financial statements

Financial Accounting ACCT 6301

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Recording of Transactions

Recall the Fundamental Accounting Equation:

ASSETS = LIABILITIES + EQUITY

Financial Accounting ACCT 6301

Recording of Transactions

Because this is true at any point in time, it is also the case

that over any period of time:

CHANGE IN ASSETS = CHANGE IN LIABILITIES +

CHANGE IN EQUITY

Financial Accounting ACCT 6301

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Recording of Transactions

In particular, this is true for any individual transaction - it

is this fact that forms the foundation of the way in which
we record transactions

Financial Accounting ACCT 6301

Recording of Transactions
Example 1

Suppose that a company buys a machine costing $100,000 on credit.

This transaction has two effects:

• assets increase by $100,000 (the cost of the machine)

• liabilities increase by $100,000 (the amount owed to the supplier
of the machine)

Financial Accounting ACCT 6301

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 Recording of Transactions

Example 2

Suppose that a company has previously sold goods with price

$50,000 to a customer who has yet to pay

The amount owed by the customer is therefore included on the

balance sheet as an asset (accounts receivable)

Financial Accounting ACCT 6301

Recording of Transactions
Example 2 (continued)

When the customer subsequently pays, the transaction has two

effects:

• assets increase by $50,000 (the cash received)

• assets fall by $50,000 (the accounts receivable is no longer shown
on the balance sheet)

Financial Accounting ACCT 6301

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 Recording of Transactions
Example 3
A company receives a telephone bill for $1,000. This has two effects:
• Liabilities increase by $1,000 (the company owes this amount to
the telephone company)
• Shareholders’ equity decrease by $1,000 (this is an expense to the
company and therefore reduces its net income which forms part of
equity through its effect on retained earnings)

Financial Accounting ACCT 6301

Recording of Transactions
Example 4
A company sells goods which originally cost $500 for $750 on
credit. The two effects of this transaction are as follows:
• Shareholders’ equity increase by $250 (by selling for $750
something which originally cost $500, the company has made a
profit of $250 - this forms part of equity); this is reflected in two
separate income statement categories, revenue of $750 and an
expense of $500 (cost of goods sold)
• Assets increase by $250 - this is also split between an increase in
one asset (accounts receivable) of $750 offset by a decrease in a
second asset (inventories) of $500

Financial Accounting ACCT 6301

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Double-Entry Bookkeeping
Accountants have traditionally used a system known as
“double-entry bookkeeping” where each transaction is
recorded as a “debit” and a corresponding “credit”

Debit Credit
Increase in assets Decrease in assets
Decrease in liabilities Increase in liabilities
Decrease in equity Increase in equity

Financial Accounting ACCT 6301

Double-Entry Bookkeeping
In the four examples above, the relevant entries would be:
1 Dr Machines 100,000
Cr Accounts Payable 100,000
2 Dr Cash 50,000
Cr Accounts Receivable 50,000
3 Dr Telephone Expense 1,000
Cr Accounts Payable 1,000
4 Dr Accounts Receivable 750
Cr Sales 750
Dr Cost of Sales 500
Cr Invetories 500
Financial Accounting ACCT 6301

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Double-Entry Bookkeeping

The system we use involves the preparation of transaction

worksheets. This system is conceptually equivalent to double entry
bookkeeping but avoids the use of the terminology of debits and
credits.

Financial Accounting ACCT 6301

The Transaction Worksheet

ASSETS LIABILITIES EQUITY

Long-term Bank Accounts Common Net Retained

Assets Inventory Cash Loan Payable Stocks Income Earnings

Opening balances
Capital contribution 1
Bank loan 2
Purchase of shop 3
Purchase of books 4
8
Sales 5
9
Cost of sales 5 Use this column
Electricity bill
9
6 To prepare the cash flow Use this
Interest 7 statement Column to
Salary 10
Payment to creditors 11 Prepare the
Income Statement
Transfer net income to
retained earnings

Closing balances

The closing balances row is the basis for the balance sheet
Financial Accounting ACCT 6301

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The Transaction Worksheet
Example 1

ASSETS LIABILITIES

Long-term Accounts
Assets Payable

Purchase of machine 100,000 100,000

Change in assets = Change in liabilities + change Equity =100,000

Financial Accounting ACCT 6301

The Transaction Worksheet

Example 2

ASSETS

Cash Accounts
Receivable
Customer payment 50,000 (50,000)

Change in assets = Change in liabilities + Change in Equity = 0

Financial Accounting ACCT 6301

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The Transaction Worksheet

Example 3

LIABILITIES EQUITY

Accounts Payable Net Income

Telephone bill 1,000 (1,000)

Change in assets = Change in Liabilities + Change Equity= 0

Financial Accounting ACCT 6301

The Transaction Worksheet

Example 4

ASSETS EQUITY

Inventories Accounts Net Income

Receivable
Sales 750 750
Cost of sales (500) (500)

Change in assets = Change in Liabilities + Change in Equity = 250

Financial Accounting ACCT 6301

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Retaining Earnings
Consider Example 4. Suppose EQUITY
that the profit for the year is
$250. This profit should be
retained at year-end. It is thus Net Retained
transferred from the Income Income Earnings
Statement to the Balance Sheet. Profit for 250
Specifically, the profit is the year
“stored” in Retained Earnings,
which is an account within Transfer to (250) 250
Retained
shareholders’ equity.
earnings

Financial Accounting ACCT 6301

Declaration and Payment of Dividends

• When a company declares a dividend, it should take the
dividend out from retained earnings. Suppose that in the
previous example the company declares dividend $100. This
gives rise to a current liability – Dividend Payable. When the
payment is made to shareholders, Dividend Payable and Cash
are both reduced
• Dividends are not expense!

Financial Accounting ACCT 6301

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Declaration and Payment of Dividends
Assets - Cash Liabilities – Equity –
Dividend Retained
Payable Earnings
Opening 500 250
balance
Dividend 100 (100)
Payment (100) (100)
Closing 400 0 150
balance

Financial Accounting ACCT 6301

Example 1: Miranda’s Bookstore

On 1 January 2010, Miranda decides to set up a company which will
own and operate an antiquarian book shop in Dallas. She has
estimated that to put the business on a sound financial footing, she
actually needs $40,000. This will be provided as follows:

1. $10,000 from a friend who will be a 50% shareholder along with

Miranda who will also contribute $10,000

2. a $20,000 3 year bank loan

Financial Accounting ACCT 6301

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Miranda’s Bookstore (cont’d)
During the first year of trading, the company has the
following transactions:
3. purchase of a shop for $20,000 cash
4. purchase of books on credit for $10,000
5. sale of books originally costing $5,000 for $10,000
cash
6. payment of $2,000 electricity bill
7. payment of interest on bank loan of $3,000

Financial Accounting ACCT 6301

Miranda’s Bookstore (cont’d)

8. purchase of books costing $30,000 on credit
9. sale of books originally costing $20,000 for $35,000
cash
10. payment of salary to bookshop manager of $10,000
11. payment of $25,000 to book suppliers
Prepare a worksheet to record these transactions

Financial Accounting ACCT 6301

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Transaction Worksheet
ASSETS LIABILITIES EQUITY

Long-term Bank Accounts Common Net Retained

Assets Inventories Cash Loan Payable Stocks Income Earnings

Opening balances
Capital contribution 1
Bank loan 2
Purchase of shop 3
Purchase of books 4
8
Sales 5
9
Cost of sales 5
9
Electricity bill 6
Interest 7
Salary 10
Payment to book 11
suppliers

Transfer net income to

retained earnings

Closing balances

Financial Accounting ACCT 6301

Balance Sheet as at 31 December

Assets
Current Assets
Cash
Inventories

Long-term Assets

Total assets

Liabilities
Accounts Payable
Bank Loan
Total Liabilities

Equity
Common Stocks
Retained Earnings
Total Equity

Total Liabilities and Equity

Financial Accounting ACCT 6301

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Income Statement for the Year Ended
31 December
Revenue
Cost of Goods Sold

Gross Profit
Selling and Administrative Expenses

Interest Expense

Net Income

Financial Accounting ACCT 6301

Miranda’s Bookstore: Cash Flow Statement

Year 2010
Book Sales in cash 45,000
Paid Electricity Bill (2,000)
Paid Interest to bank (3,000)
Paid Salaries (10,000)
Paid suppliers (25,000)
Cash from Operations 5,000
Purchase of Shop (20,000)
Cash from Investing Activities (20,000)
Equity contribution (Miranda & Partner) 20,000
Bank Loan 20,000
Cash from Financing Activities 40,000

Total Change in Cash for Year 2010 25,000

(Notice that this is also the amount reported on the Balance Sheet)

Financial Accounting ACCT 6301

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Example 2: The Live Bait Retail Comp Ltd
The Live Bait Retail Company Limited started trading on 1 July
2008 and at 30 June 2009 had the following summary Balance
Sheet:

Cash 400
Inventories 200
Long-term Assets 900
Total Assets 1,500

Bank Loan 500

Total Liabilities 500

Common Stock 750

Retained Profit 250
Total SHs’ Equity 1,000
Total Liab. and SHs’ Equity 1,500

Financial Accounting ACCT 6301

The Live Bait Retail Company Limited

During the year ended 30 June 2010 (i.e., second year of operation),
the company engages in the following transactions:
1. purchase of bait on credit for $700
2. sale of bait originally costing $600 for $1,200 of which
$800 on credit, the remainder in cash
3. payment of salaries to office staff ($85) and van driver ($75),
both in cash
4. payment of interest on bank loan of $100
5. increase bank loan by $500

Financial Accounting ACCT 6301

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 The Live Bait Retail Company Limited

6. payment of 80% of accounts payable, collection of 80% of

accounts receivable
In addition, as a result of these transactions, the company will engage
in the following two transactions which need to be recorded in the
2009/10 accounts:
7. Tax (at a rate of 33%) is payable on the company’s income before
tax and is due on 31 March 2011

Financial Accounting ACCT 6301

The Live Bait Retail Company Limited

8. On 30 September 2010, the company will pay a dividend of

$100

Required:
Prepare a worksheet to record these transactions and use this
worksheet to prepare a Balance sheet and Income statement

Financial Accounting ACCT 6301

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 Transaction Worksheet
ASSETS LIABILITIES EQUITY

Long-term Accounts Bank Accounts Tax Dividends Common Net Retained

Assets Inventory Receivable Cash Loan Payable Payable Payable Stocks Income Earnings

Opening balances
Purchase of bait 1
Sales 2
Cost of sales 2
Salaries 3
3
Interest 4
Increase loan 5
Payment of 6
payable
Collection of 6
receivable
Tax 7
Dividends 8

Transfer of
retained earnings

Closing balances

Financial Accounting ACCT 6301

Balance Sheet as at 31 December

Current Assets
Cash
Accounts Receivable
Inventories

Long-term Assets
PP&E

Total assets

Current Liabilities
Accounts Payable
Tax Payable
Dividends Payable

Long-term liabilities
Bank Loan
Total liabilities

Equity

Common Stocks
Retained Earnings

Total Liabilities and Equity

Financial Accounting ACCT 6301

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Income Statement for the Year Ended
31 December
Revenues
Cost of Sales

Gross Profit
Selling and Administrative Expenses

Interest Expense

Income before Tax

Tax expense

Net Income

Financial Accounting ACCT 6301

Summary

In this session we
• Learned how to use the transactions worksheet
• Analysed the effects on the financial statements of
some transactions
• Prepared basic financial statements

Financial Accounting ACCT 6301

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