20100726090748 chapter 4 the effect of p&l on capital

CHAPTER 4

THE EFFECT OF PROFIT OR LOSS TO CAPITAL (Income statement)(balance sheet, owner equity statement, statement of cash flow)

Companies prepare four financial statements from the summarized accounting data:Companies prepare four financial statements from the summarized accounting data:

Balance Sheet

Income Statemen

t

Statement of Cash

Flows

Owners’ Equity

Statement

Financial StatementsFinancial Statements

LO 8 Understand the four financial statements and how they are LO 8 Understand the four financial statements and how they are prepared.prepared.

Net income will result during a time period when:

a. assets exceed liabilities.

b. assets exceed revenues.

c. expenses exceed revenues.

d. revenues exceed expenses.



Review Question

Income Statement



Reports the revenues and expenses for a specific period of time.

Net income – revenues exceed expenses.

Net loss – expenses exceed revenues.

Revenues:

Service revenue 5,850$ Expenses:

Salary expense 2,000 Rent expense 400 Advertising expense 250

Total expenses 2,650 Net income 3,200$

Barone’s Repair Shop

I ncome Statement

For the Month Ended May 31, 2007

Revenues:

Service revenue 5,850$ Expenses:

Salary expense 2,000 Rent expense 400 Advertising expense 250

Total expenses 2,650 Net income 3,200$


I ncome Statement


Income Statement



Barone's, Capital May 1 -$

Add: I nvestment 10,000

Net income 3,200

13,200 Less: Drawings 1,000 Barone's, Capital May 31 12,200$


Owners' Equity Statement


Owners’ Equity Statement

Net income is needed to determine the ending balance in owner’s

equity.

NATURE OF PROFIT OR LOSS

Profit means the amount by which revenues are greater than expenses for a set of transactions.

Revenues > Expenses = Profit

Revenues = sales value of goods and services

Expenses = cost value of asset to obtain revenues

Eg…..

If we supplied goods and supplies valued for sale at RM100,000 to customers, and the expenses incurred by us in order to supply those goods and services amounted to RM70,000…thus the profit;

Revenues – Expenses= Profit

RM100,000 – RM70,000 = RM30,000

Loss

If expenses exceed revenues

That is…..

Expenses > Revenues = Loss

Expenses – Revenues = Loss

RM80,000 – RM60,000 = RM20,000

Loss

Expenses – Revenues = Loss

RM120,000 – RM100,000 = RM20,000

If we supplied goods and supplies valued for sale at RM100,000 to customers, and the expenses incurred by us in order to supply those goods and services amounted to RM120,000…thus the loss;

THE EFFECT OF PROFIT AND LOSS ON CAPITAL

o On 1 January the assets and liabilities of a business are:

Asset: Fixtures RM10,000; stock RM7,000; cash at the bank RM3,000.

Liabilities: Creditors RM2,000


o The Accounting Equation:

o Asset = Liabilities + Owner Equity (Capital) or

Capital = Assets – Liabilities

Therefore Capital=

(10,000+7,000 + 3,000) – 2,000 = 18,000


o During January, the whole of the RM7,000 stock is sold for RM11,000 cash. Therefore on 31 January the asset and liabilities have become;

o Assets : Fixtures RM10,000, stock Nil, cash at bank RM14,000.

o Liabilities: Creditors RM2,000


o Capital is now RM22,000:

Assets (10,000 + 14,000) – Liabilities (2,000)

So capital increased by RM4,000 (from RM18,000 to RM22,000)

It has increased by RM4,000 because the RM7,000 stock was sold at a profit of RM4,000 for RM11,000


o Profit, therefore increase Capital

Old Capital + Profit = New Capital

18,000 + 4,000 = 22,000

o Loss, reduce the capital

Old Capital – Loss = New Capital

Profit or loss and sales

o Profit = Goods or services are sold for more than it cost.

o Loss = Goods or services are sold less than it cost.

Revenue & Expenses Account

o In order to calculate profit and losses, revenues and expenses must be entered into appropriate account.

o Identify the account:

Commissions account Subcriptions account

Bank interest account Motor expense account

Rent account Wages account

Rent receivables acct General exp. account

Overdraf Interest acct Audit fees account

1.Rent of RM200 is paid in cash

2. Motor expenses of RM355 are paid by cheque.

3. RM60 cash is received for commission earned by business.

4. June 1 Paid for postage stamps by cash RM50.

5. June 2 Paid for electricity by cheque RM229.

6. June 3 Received rent in cash RM138.

7. June 4 Paid insurance by cheque RM142.

REVIEW QUESTIONSREVIEW QUESTIONS

Debit or Credit….

Expenses Account = Debit

Revenues Account = Credit

Why?

1. Because expense account is an asset account

2. Asset and expenses must ultimately be paid for.

Eg. If you pay rent of RM500 in cash, so the asset cash decreased by RM500 means the capital is reduced by expense.

Note:

Means:

If assets decrease , so does capital

If liabilities increase, capital decrease.

Expenses RevenuesLosses ProfitsAssets Liabilities

Capital

Debit Kredit




Add: I nvestment 10,000 Net income 3,200






Statement indicates the reasons why owner’s equity has increased or decreased during the period.




Add: I nvestment 10,000 Net income 3,200






Assets

Cash 6,820$ Accounts receivable 630 Equipment 5,000

Total assets 12,450$

Liabilities

Accounts payable 250$ Owners' Equity

Barone's, capital 12,200

Total liab. & equity 12,450$

Balance Sheet


May 31, 2007

The ending balance in owner’s equity is needed in preparing the

balance sheet

Balance Sheet

Balance Sheet



Reports the assets, liabilities, and owner’s equity at a specific date.

Assets listed at the top, followed by liabilities and owner’s equity.

Total assets must equal total liabilities and owner’s equity.

Assets

Cash 6,820$ Accounts receivable 630 Equipment 5,000


Liabilities


Barone's, capital 12,200 Total liab. & equity 12,450$

Balance Sheet


May 31, 2007

Balance Sheet



Assets

Cash 6,820$

Accounts receivable 630 Equipment 5,000


Liabilities


Barone's, capital 12,200 Total liab. & equity 12,450$

Balance Sheet


May 31, 2007 Cash flow from Operations

Cash receipts f rom customers 5,220$ Cash paid f or expenses (2,400) Cash provided by operations 2,820

Cash flow from I nvesting

Purchase of equipment (5,000) Cash flow from Financing

I nvestment by owners 10,000 Drawings by owners (1,000) Cash provided by financing 9,000

Net increase in cash 6,820

Cash balance, May 1 -

Cash balance, May 31 6,820$

Statement of Cash Flows






Cash flow from Operations

Cash receipts f rom customers 5,220$ Cash paid f or expenses (2,400) Cash provided by operations 2,820

Cash flow from I nvesting

Purchase of equipment (5,000) Cash flow from Financing

I nvestment by owners 10,000 Drawings by owners (1,000) Cash provided by financing 9,000

Net increase in cash 6,820

Cash balance, May 1 -

Cash balance, May 31 6,820$





Information for a specific period of time.

Answers the following:1. Where did cash

come from?

2. What was cash used for?

3. What was the change in the cash balance?

Which of the following financial statements is prepared as of a specific date?

a. Balance sheet.

b. Income statement.

c. Owner's equity statement.

d. Statement of cash flows.



Review Question

Discussion Question

Q19. “A company’s net income appears

directly on the income statement and the

owner’s equity statement, and it is included

indirectly in the company’s balance sheet.”

Do you agree? Explain.

See notes page for discussion



DRAWINGS

o Sometimes the owners will want to take cash out of the business for their private use.

o Drawing will reduce capital

o Drawing are never expenses of business.

Eg 1 …..

o On 25 August, the owner takes RM50 cash out of the business for his own use.

Effect Action

1. Capital is decreased by RM50

Debit the drawing account RM50.

2. Cash is decreased by RM50

Credit the cash account RM50.

Answer…

Aug 25 Cash 50 Aug 25 Drawings 50

Drawing Cash

Eg 2

Aug 28 Purchases 400 Aug 28 Draw 400

Drawing Purchases

On Aug 28, the owner takes RM400 of goods out of the business for his own use.

End – Chapter 4

20100726090748 chapter 4 the effect of p&l on capital

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