Assets, liabilities income, expense, debit credit... so what?

Afternoon all!

During my time teaching, it never ceases to amaze me how many students fail to create a link between units. For example, the Level 2 unit PBKT and CJBS link naturally to the Level 3 units ACPR and FSTP which, in turn link through FSTM at Level 4.

Throughout these units, basic principles remain constant - an expense is an expense, an asset is an asset etc.

One of the big problems that face students is deciding what type of account and item is - is it an income, expense, liability or asset? You must take time to understand the difference between these types of account (which I will look at next time).

One of the many problems students seem to have is to understand what is going on when we debit or credit an account.

In order to try to help people, why not look at the following table where the effect of a transaction is shown as an increase é or decrease  ê in value.

The effect of a debit or credit on different account types with examples	Debit	Credit
Expense	é	ê
Telephone Rent paid Interest paid Heat & light Motor expenses Repairs Discounts allowed Carriage in/out Administration Loss on disposal Depreciation
Income	ê	é
Sales revenue Rent received Interest received Discounts received Profit on  disposal Commission received
Asset	é	ê
Non-current assets Property Plant Equipment Computers Fixtures Fittings Furniture Motor vehicles Current assets Inventory at end of year Trade receivables(debtors/SLCA) Non trade receivables (prepayments) Bank , Cash and  cash equivalents
Liability	ê	é
Current liabilities Trade payables (creditors/PLCA) Non-trade payables (accruals, VAT Liability) Bank overdraft Non-current liabilities Bank loans Director/partner loans Debentures

Note: Capital is a type of liability as it signifies how much the business owes to its owner(s).

The other problem students have is to remember where each type of account appears in the financial statements - Statement of profit or loss and Statement of financial position.

Statement of Profit or Loss (SPL)

The ‘SPL’ is used to identify how well the business has performed during the year and whether it has achieved a profit or loss. Profit/loss is the difference between Income and Expenditure and the SPL shows two elements:

·      The trading account

This shows the profit or loss generated from the day to day trading activities (i.e. the main activities of the business)

·      The profit and loss account

This shows the profit of loss after taking into account all of the other income received and expenses incurred during the reporting period.

It is important to note that in your assessment in FSTP, the two elements will be combined into the Statement of Profit or Loss.

Statement of profit or loss for the year ending …………………………………

The Trading Account

	£	£
Sales revenue		xx
Less: sales returns		(xx)
		xx
Less: cost of sales
Opening inventory	xx
Purchases	xx
Less: purchases returns	(xx)
	xx
Carriage inwards	xx
Less: closing inventory	(xx)
		(xx)
Gross profit		xx

The Profit and Loss Account

Sundry income
Discounts received		xx
Rent received		xx
		xx
Less expenses
Discounts allowed	xx
All other running expenses	xx
Depreciation charges	xx
Allowance for doubtful debts: adjustments	xx
Irrecoverable debts	xx
		(xx)
Profit for the year		xx

Note:

·         The sales returns and purchases returns are netted off against the sales and purchases respectively.

·         Discounts received have been shown as sundry (miscellaneous) income under gross profit.

·         The profit for the year is transferred to the Statement of Financial Position as an addition to capital

·         All SPL accounts are closed off at the end of the year.

TThe Statement of Financial Position (SFP)

The ‘SFP’ shows a snapshot of the business’ financial position (assets, liabilities and capital) at a specified point in time (normally the reporting period end date).

The SFP reflects the Accounting Equation:

ASSETS – LIABILITIES = CAPITAL

Statement of Financial Position as at ………………………..

	Cost	Accumulated depreciation	Carrying amount
	£	£	£
Non-current assets
Buildings	xx	(xx)	xx
Furniture & fittings	xx	(xx)	xx
Motor vehicles	xx	(xx)	xx
Computers	xx	(xx)	xx
	xx	(xx)	xx
Current assets
Inventory		xx
Receivables	xx
Less: allowance for doubtful debts	(xx)
		xx
Prepayments		xx
Bank		xx
Cash		xx
		xx
Current liabilities
Payables	xx
VAT	xx
Accruals	xx
		(xx)
Net current assets			xx
Non-current liabilities
Loans			(xx)
Net Assets			xx
Financed by
Capital			xx
Profit			xx
			xx
Less: Drawings			(xx)
			xx

x

Note:

The allowance taken off the Receivables figure is the allowance for doubtful debt.

All SFP accounts are carried forward and provide the starting point for the next accounting period.

The highlighted figures should agree (or balance) and this is from where the 'old' name for the financial statement - the balance sheet - takes its name.

Hopefully you can now see the importance of linking units together as, without this basic understanding, none of the financial statements would be possible.