Cambridge University Press
978-1-108-33917-9 — Cambridge IGCSE® and O Level Accounting Coursebook with Cambridge Elevate Enhanced Edition (2 Years)
Catherine Coucom
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Chapter 1
Introduction to accounting
Learning objectives
In this chapter you will learn to:
■ understand and explain the difference between book-keeping and accounting 1.1
■ state the purposes of measuring business profit and loss 1.1
■ explain the role of accounting in providing information for monitoring progress and
decision-making 1.1
■ explain the meaning of assets, liabilities and owner’s equity 1.2
■ explain and apply the accounting equation 1.2
■ understand that statements of financial position record assets and liabilities on a
specified date. 5.5
© in this web service Cambridge University Press www.cambridge.org
Cambridge University Press
978-1-108-33917-9 — Cambridge IGCSE® and O Level Accounting Coursebook with Cambridge Elevate Enhanced Edition (2 Years)
Catherine Coucom
Excerpt
More Information
Chapter 1: Introduction to accounting
1.1 Introduction
Accounting is regarded as the language of business. Accounting can be divided into
two sections:
KEY TERMS
Book-keeping
Book-keeping is a process of detailed recording of all the financial transactions of a Book-keeping is the
business. It is necessary for even the smallest business to make a record of every transaction detailed recording
of all the financial
which affects the business. If the records are not maintained, it is likely that something
transactions of a
will be forgotten or overlooked. The basis of maintaining these detailed records is double business.
entry book-keeping. The actual records maintained by one business may vary from those
Accounting is using
maintained by another business because each business is different. However, all businesses book-keeping records
apply the same principles while maintaining double entry records. to prepare financial
statements and to assist
in decision-making.
Accounting
A statement of
Accounting uses the book-keeping records to prepare financial statements at regular financial position
intervals. The owner of a business needs to know whether the business is making a profit or shows the assets and
a loss. Periodically (often at yearly intervals), an income statement is drawn up. This shows liabilities of a business
the calculation of the profit or loss earned by the business. If the business has earned a profit on a certain date.
then the owner is receiving a return on his investment and funds are available for expanding
or improving the business. However, if the business has made a loss then it may eventually
close down as the owner is not receiving any return on his investment and funds are not
available for running or maintaining the business.
You can now answer Question 1 at the end of this chapter. 3
LINK
The owner of the business also needs to know the financial position at regular intervals so
You will learn more
a statement of financial position is prepared. This shows what the business owns and
about financial
what is owing to it, its assets; and what the business owes, its liabilities. The term financial statements in Chapters
statements is often used as a collective name for an income statement and a statement of 8 and 9.
financial position.
The progress of the business can be measured by comparing the financial statements of one
year with those of previous years, or with those of other similar businesses. The calculation of
various accounting ratios is used to measure the relationship between figures within a set of
financial statements. These are also useful for comparison purposes.
The information provided by the financial statements shows the owner of the business what
has happened during a certain period of time and helps in monitoring the progress of the
business. The plans for the future development of the business are also based on these
financial statements.
TEST YOURSELF 1.1
1 Define the term book-keeping.
2 Define the term accounting.
3 State two reasons why it is necessary to prepare financial statements at regular intervals.
4 State what is included in the term financial statements.
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Cambridge University Press
978-1-108-33917-9 — Cambridge IGCSE® and O Level Accounting Coursebook with Cambridge Elevate Enhanced Edition (2 Years)
Catherine Coucom
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Cambridge IGCSE and O Level Accounting
LINK 1.2 Assets, liabilities and capital
You will learn more It is important to remember that the accounting records of a business relate only to the
about assets and
business. From an accounting viewpoint, the owner of that business is regarded as being
liabilities in Chapter 9.
completely separate from the business.
KEY TERMS
When a person decides to start a business he will have to provide the necessary funds
(resources). This is often in the form of monetary funds, but may consist of buildings, motors,
Capital is the total goods and so on. Any resources provided by the owner of the business are known as capital.
resources provided This represents the amount owed by the business to the owner of that business.
by the owner and
represents what the Once the business is formed and capital introduced, the business will own the money or
business owes the other items provided by the owner. Things owned by the business (or owed to the business)
owner. are regarded as the resources of the business or the assets of the business.
Assets represent
anything owed by or In addition to the owner, other people may also provide assets to the business. The amount
owing to the business. owed by the business to these people is known as liabilities.
Liabilities represent
anything owed by the
business. TIP
Anything provided for a business by the owner represents capital. This is not necessarily in the
form of money.
Many businesses are set up and operated by one person. These are known as sole traders.
LINK The early chapters in this book cover accounts maintained by sole traders.
4
You will learn about TEST YOURSELF 1.2
the accounting records
of partnerships and
1 Define each of the following terms.
limited companies in
Chapters 19 and 21. a assets b liabilities c capital
1.3 The accounting equation
Like any other mathematical equation, the two sides of the equation will always be equal.
The formula for this equation is:
Assets = Capital + Liabilities.
Capital is sometimes referred to as owner’s equity. So the previous equation can also be
written as:
Assets = Owner’s equity + Liabilities.
TIP Like any mathematical equation, the accounting equation can be used to find any one of the
If you know two three elements if the other two are present.
elements of the
This equation illustrates that the assets of a business (the resources used by a business)
accounting equation
you can easily calculate are always equal to the liabilities and capital of a business (the resources provided for the
the third element. business by others). The assets represent how the resources are used by the business and
the liabilities and capital represent where these resources come from.
© in this web service Cambridge University Press www.cambridge.org
Cambridge University Press
978-1-108-33917-9 — Cambridge IGCSE® and O Level Accounting Coursebook with Cambridge Elevate Enhanced Edition (2 Years)
Catherine Coucom
Excerpt
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Chapter 1: Introduction to accounting
Walkthrough 1.1
20–7
January 1 Leena set up a business to trade under the name of The Dress Shop. She opened
a business bank account and paid in $20 000 as capital.
2 The business purchased premises, $15 000, and paid by cheque.
3 The business purchased goods, $3 000, on credit.
4 The business sold goods, at the cost price of $1 000, on credit.
Show the accounting equation after each of the above transactions. LINK
Date Assets = Capital + Liabilities You will learn more
about buying and
1 January Bank $20 000 $20 000 Nil selling on credit in
2 January Premises 15 000 Chapter 2.
Bank 5 000
$20 000 $20 000 Nil
3 January Premises 15 000
Inventory 3 000
Bank 5 000
$23 000 $20 000 Trade payable $3 000
4 January Premises 15 000
Inventory 2 000
Trade receivable 1 000 5
Bank 5 000
$23 000 $20 000 Trade payable $3 000
• 1 January The assets of the business are equal to the capital of the business.
• 2 January The money in the bank has decreased because a new asset has been
KEY TERMS
bought. The total assets are equal to the capital.
• 3 January Purchasing on credit means that the business does not pay immediately. Inventory is the
goods a business has
A new asset inventory has been acquired, but the business has also
available for resale.
acquired a liability as it owes money to the supplier (who is known as a
Trade payables
creditor). In a statement of financial position this is described as a trade
represent the amount
payable. The total assets are equal to the capital plus the liabilities. the business owes to
• 4 January Selling on credit means that the business does not immediately receive the the credit suppliers
of goods (the trade
money. The inventory has decreased but a new asset has been acquired in
creditors).
the form of money owing to the business by a customer (who is known as
Trade receivables
a debtor). In a statement of financial position this is described as a trade represent the amount
receivable. The total assets are equal to the capital plus the liabilities. owed to the business
(For the sake of simplicity, the goods were sold to the customer at cost by its credit customers
price. In practice, they need to be sold at a price above cost price to enable (the trade debtors).
the business to make a profit.)
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Cambridge University Press
978-1-108-33917-9 — Cambridge IGCSE® and O Level Accounting Coursebook with Cambridge Elevate Enhanced Edition (2 Years)
Catherine Coucom
Excerpt
More Information
Cambridge IGCSE and O Level Accounting
TEST YOURSELF 1.3
1 Fill in the missing figures in the following table.
Assets Capital Liabilities
$ $ $
a 35 000 ? 12 500
b ? 44 400 19 300
c 67 300 55 000 ?
You can now answer Question 2 at the end of this chapter.
1.4 The statement of financial position
The accounting equation may be shown in the form of a statement of financial position.
This shows the three elements of the accounting equation – the assets, the capital and the
liabilities. The statement of financial position will be affected every time the business makes
changes to the assets, liabilities or capital.
Walkthrough 1.2
Prepare the statement of financial position of The Dress Shop after each of the transactions
shown in Walkthrough 1.1.
6 The Dress Shop
Statement of financial position at 1 January 20–7
Assets $ Liabilities $
Bank 20 000 Capital 20 000
20 000 20 000
The Dress Shop
Statement of financial position at 2 January 20–7
Assets $ Liabilities $
Premises 15 000 Capital 20 000
Bank 5 000 20 000
20 000 20 000
The Dress Shop
Statement of financial position at 3 January 20–7
Assets $ Liabilities $
Premises 15 000 Capital 20 000
Inventory 3 000 Trade payable 3 000
Bank 5 000 20 000
23 000 23 000
© in this web service Cambridge University Press www.cambridge.org
Cambridge University Press
978-1-108-33917-9 — Cambridge IGCSE® and O Level Accounting Coursebook with Cambridge Elevate Enhanced Edition (2 Years)
Catherine Coucom
Excerpt
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Chapter 1: Introduction to accounting
The Dress Shop
Statement of financial position at 4 January 20–7
Assets $ Liabilities $
Premises 15 000 Capital 20 000
Inventory 2 000 Trade payable 3 000
Trade receivable 1 000
Bank 5 000 20 000
23 000 23 000
TEST YOURSELF 1.4
1 Give two examples of each of the following (excluding those shown in Walkthrough 1.1
and 1.2):
a asset b liability.
2 Explain the meaning of each of the following terms: LINK
a trade payable b trade receivable
You will learn more
about statements of
financial position in
The statements of financial position shown in Walkthrough 1.2 were presented in a Chapter 9.
horizontal format. There are different ways to present a statement of financial position and
these are explained in Chapter 9 . A statement of financial position is also more useful if the 7
assets and liabilities are divided into different types (see Chapter 9 ).
TIP
Walkthrough 1.1 showed that every single transaction involves a change to the assets The totals of a
and/or the liabilities and/or the capital. This means that it is necessary to prepare a statement of financial
statement of financial position after every single transaction, as shown in Walkthrough position must always
1.2. However, this is not possible in practice as many transactions can take place every agree: if they do not
you know that there is
hour of each working day. In practice, the day-to-day business transactions are recorded
an error.
using double entry book-keeping and a statement of financial position is prepared only
periodically. This is usually done at the closing of a business on the last day of the financial
year as part of the financial statements. As the business can be started on any day of the LINK
year, its financial year may not necessarily match the calendar year (i.e. from 1 January to You will learn more
31 December). The financial statements are prepared for 12 month periods from the date about double entry
the business started. book-keeping in
Chapters 2 and 4.
You can now answer Questions 3–6 at the end of this chapter.
Revision checklist
■ Book-keeping is the detailed recording of all the financial transactions of a business. Accounting uses
these book-keeping records to prepare financial statements.
■ It is necessary to prepare financial statements to show the profit or loss of the business and the financial
position of the business and to help in decision-making.
■ The accounting equation shows that the assets are always equal to the capital plus the liabilities of the
business.
■ A statement of financial position shows the assets and liabilities of a business on a certain date.
© in this web service Cambridge University Press www.cambridge.org
Cambridge University Press
978-1-108-33917-9 — Cambridge IGCSE® and O Level Accounting Coursebook with Cambridge Elevate Enhanced Edition (2 Years)
Catherine Coucom
Excerpt
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Cambridge IGCSE and O Level Accounting
Exam-style questions
1 Which task is performed by a book-keeper?
A analysing the trading results
B entering transactions in the ledger
C preparing year-end financial statements
D providing information for decision-making
2 A trader provided the following information:
$
Premises 180 000
Inventory 23 420
Trade payables 26 180
Trade receivables 21 710
Office fixtures and fittings 32 600
Loan from bank 80 000
Cash at bank 2 550
Motor vehicles 15 900
a Calculate the value of the assets.
b Calculate the value of the liabilities.
8 c Use the accounting equation to calculate the trader’s capital.
3 What is a statement of financial position?
A a calculation of the amount owed to the owner of the business
B a list of assets and liabilities of a business on a certain date
C a list of everything owned by and owed to a business
D a summary of money paid to and received by a business
4 A business had $9 420 in its bank account. The following transactions took place:
$
Bought goods on credit 250
Sold goods on credit 1 100
Repaid a loan by cheque 5 000
How much was there in the bank after these transactions?
A $3 570 B $4 420 C $4 670 D $5 270
© in this web service Cambridge University Press www.cambridge.org
Cambridge University Press
978-1-108-33917-9 — Cambridge IGCSE® and O Level Accounting Coursebook with Cambridge Elevate Enhanced Edition (2 Years)
Catherine Coucom
Excerpt
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Chapter 1: Introduction to accounting
5 Complete the following table to show the effect of each of the following transactions.
The first one has been completed as an example.
a Bought a motor vehicle and paid by cheque
b Bought goods on credit from a credit supplier
c Received a cheque from a credit customer
d Sold goods on credit
e Paid off a loan in cash
Effect on assets $ Effect on liabilities $
a Motor vehicles Increase No effect
Bank Decrease
b
6 The statement of financial position of Bharwani Traders on 31 October 20–4 is shown below.
9
Bharwani Traders
Statement of financial position at 31 October 20–4
Assets $ Liabilities $
Machinery 19 000 Capital 35 000
Motor vehicles 6 000 Trade payables 8 000
Inventory 4 900
Trade receivables 3 000
Bank 10 100 20 000
43 000 43 000
On 1 November 20–4 the following transactions took place:
A cheque for $3 000 was paid to a credit supplier.
A credit customer paid $500 in cash.
A loan for $8 000, which was paid into the bank, was received from Lenders Limited.
A cheque for $7 000 was paid for an additional machine.
Prepare the statement of financial position of Bharwani Traders on 1 November 20–4 after
the above transactions have taken place.
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