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Hult International Business School - London

International Accounting

Handout 1 – Introduction, Transaction Recognition, Accounts, Financial StatementsModule A - 2015 / 2016

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Introduction to AccountingAccounting is (generally) made out to be a complex subject … however the essence of accounting is simple. Accountant’s 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.

Owner(s)Assets

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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).

• 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.

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Owner(s)Assets Lender(s)

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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.

• 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.Owner(s)Assets Lender(s)

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Accounting Fundamental EquationAll assets must be owned by either lenders of shareholders.

+Assets Liabilities Shareholder Equity=

Owner(s)Assets Lender(s)

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Recording Transaction (II)A transaction is an event that makes a change to:• Assets;• Liabilities;• Shareholder’s Equity

Every transaction must be recorded (how ?)Let’s start with a table below where each asset, liability and equity has a

column (i.e. An account) in which changes are recorded.

= +Shareholder's 

Equity

Cash A/ROffice 

SuppliesPPE

Computer Workstation

= A/P Debt +John Doe Capital

LiabilitiesAssets

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Transactions (I)Transaction impacting Shareholder’s 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).

= + Shareholder's Equity

Cash A/ROffice 

SuppliesPPE

Computer Workstation

= A/P Debt +Winston Wolfe 

CapitalTransaction 1 +20,000 +1,000 +21,000Transaction 2  +2,000 +2,000Transaction 3 +500 +500Transaction 4 +700 +700Balance 20,500 700 1,000 2,000 = 0 0 + 24,200

LiabilitiesAssets

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Revenue RecognitionUnder 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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Shareholder’s Equity in DetailShareholder’s 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);

Dividends Common Stock Expense(s) Revenue(s)

+21,000+2,000

+500+700

0 23,000 0 1,200

Shareholder's Equity

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Transactions (II)Transaction impacting Shareholder’s 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 month’s 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).

= +Shareholder's 

Equity

Cash A/ROffice 

SuppliesPPE

Computer Workstation

= A/P Debt +Winston Wolfe 

CapitalBalance 20,500 700 1,000 2,000 = 0 0 + 24,200Transaction 5 ‐3,000 ‐3,000Transaction 6 ‐200 ‐200Transaction 7 +250 ‐250Transaction 8 ‐300 ‐300Balance 17,300 700 700 2,000 = 250 0 + 20,450

LiabilitiesAssets

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Expense RecognitionUnder 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.

= + Shareholder's Equity

Cash A/ROffice 

SuppliesPPE

Computer Workstation

= A/P Debt + Winston Wolfe Capital

Balance 17,300 700 700 2,000 = 250 0 + 20,450Transaction 9 ‐1,500 +1,500Transaction 10 +200 ‐200Transaction 11 +500 ‐500Balance 16,500 200 2000 2,000 = 250 0 + 20,450

LiabilitiesAssets

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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.

= +Shareholder's 

Equity

Cash A/ROffice 

SuppliesPPE

Computer Workstation

= A/P Debt + Winston Wolfe Capital

Balance 16,500 200 2000 2,000 = 250 0 + 20,450Transaction 12 +2,000 +2,000Transaction 13 +3,000 +3,000Transaction 14 ‐250 ‐250Balance 19,250 200 2000 4,000 = 2000 3000 + 20,450

LiabilitiesAssets

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Transactions Summary (I)Balance of Assets = $25,450;Balance of Liabilities and shareholder’s Equity = $25,450;

= +Shareholder's 

Equity

Cash A/ROffice 

SuppliesPPE

Computer Workstation

= A/P Debt + Winston Wolfe Capital

Transaction 1 +20,000 +1,000 +21,000Transaction 2  +2,000 +2,000Transaction 3 +500 +500Transaction 4 +700 +700Transaction 5 ‐3,000 ‐3,000Transaction 6 ‐200 ‐200Transaction 7 +250 ‐250Transaction 8 ‐300 ‐300Transaction 9 ‐1,500 +1,500Transaction 10 +200 ‐200Transaction 11 +500 ‐500Transaction 12 +2,000 +2,000Transaction 13 +3,000 +3,000Transaction 14 ‐250 ‐250Balance 19,250 200 2000 4,000 = 2000 3000 + 20,450

LiabilitiesAssets

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Transactions Summary (II)Sum total of individual balances in each of Shareholder’s Equity

accounts = $20,450;Shareholder's 

EquityWinston Wolfe 

CapitalDividends Common Stock Expense(s) Revenue(s)

+21,000 Transaction 1 +21,000+2,000 Transaction 2  +2,000+500 Transaction 3 +500+700 Transaction 4 +700

‐3,000 Transaction 5 ‐3,000‐200 Transaction 6 ‐200‐250 Transaction 7 ‐250‐300 Transaction 8 ‐300

Transaction 9Transaction 10Transaction 11Transaction 12Transaction 13Transaction 14

20,450 Balance ‐3,000 23,000 ‐750 1,200

Shareholder's Equity

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Financial ReportingAt 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 Shareholder’s Equity accounts.2. Income Statement presents a summary of revenues and expenses recorded in

the Shareholder’s Equity Account in order to determine the profit earned by the business.

3. Statement of changes in Shareholder’s Equity summarizes the evolution of all Shareholder’s Equity accounts.

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Balance SheetAt the end of an accounting period, financial information needs to be

reported to interested parties.

Assets LiabilitiesCash 19,250 A/P 2000A/R 200 Debt 3000Office Supplies 200 Total Liabilities 5,000PPE 0Computer Workstation 4,000 Shareholder's EquityTotal Assets 25,450 Winston Wolfe Capital 20,450

Total Liabilities & Shareholder's Equity 25,450

Winston Wolfe Services Inc.Balance Sheet ($s)December 31, 20X5

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Income StatementAt the end of an accounting period, financial information needs to be

reported to interested parties.

Revenue(s)Consulting Service Revenues 1,200

Expense(s)Internet Expense ‐200Council Tax Expense ‐250Supplies Expense ‐300Total Expenses ‐750

Net Income 450

Winston Wolfe Services Inc.Income Statement ($s)

For the year ended December 31, 20X5

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Statement of Shareholder’s Equity (I)At the end of an accounting period, financial information needs to be

reported to interested parties.

Winston Wolfe Capital, December 31, 20X4 0Add: Stock Issuance 23,000Add: Net Income 450Total 23,450Subtract: Payment of Dividends ‐3,000Increase in Shareholder's Equity 20,450

Winston Wolfe Capital, December 31, 20X5 20,450

For the year ended December 31, 20X5Statement of Changes in Shareholder's Equity ($s)

Winston Wolfe Services Inc.

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Retained Earnings (I)Retained earnings is the portion of corporation’s 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 shareholder’s equity section of

the corporation's balance sheet.• Net accumulated losses may lead to negative shareholders' equity, also known

as shareholders' deficit.

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Statement of Shareholder’s Equity (II)Since

Net Income – Dividends = Retained EarningsIt is more common to see the following.

Winston Wolfe Capital, December 31, 20X4 0Add: Stock Issuance 23,000Add: Retained Earnings ‐2,550Total 20,450

Winston Wolfe Capital, December 31, 20X5 20,450

For the year ended December 31, 20X5

Winston Wolfe Services Inc.Statement of Changes in Shareholder's Equity ($s)

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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.

= +Shareholder's 

Equity

Cash A/ROffice 

SuppliesPPE

Computer Workstation

= A/P Debt +John Doe Capital

LiabilitiesAssets

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.

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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;