Basic Accounting Concepts

2
Basic Accounting Concepts

Accounting Equation
Learning Objectives
After studying this chapter you should be able to:
1. Explain the accounting equation
2. Explain the underlying accounting concepts
3. Define assets, liabilities and capital
4. Define revenue and expenses
5. Explain the concepts of balance sheet, and profit and loss account
Scenario
A
manullah Khan, an auto engineer, was working with Sindh Motors in 1990
as an Assistant Manager production. Although he was supervising a small
production department he hardly had any opportunity to work practically
with his sides. Most of the time he used to be busy in file work. He was
conscious of this disadvantage and was looking for an opportunity where he could
use his engineering knowledge in an effective manner. In June 1990 he saw an
advertisement in daily Dawn for the post of an Auto Maintenance Engineer required
by Al-Zahid Tractors Ltd., the dealers of Caterpillar Inc. for Saudi Arabia. The
Caterpillar Inc. is a multinational which manufactures heavy machinery for earth
moving. Mr Khan applied and was selected for the job. He reached Saudi Arabia on
January1, 1991. He landed at Jeddah, performed umrah in Mecca and visited Madina
before reporting to his office on January 10. Being an intelligent and motivated
person he could make his place in the organization in a very short time. He worked in
Saudi Arabia till October 2003. By that time Mr Khan had a house in Islamabad and
his two sons and a daughter had completed their education. The elder son completed
20 Financial Accounting: A Managerial Perspective
his Bachelors of Engineering in Autos and the younger one completed his Masters in
Business Administration from well reputed Pakistani universities. The daughter
secured a medical degree.
Mr. Khan returned to Pakistan in November 2003. After consultation with his friends
and family, he established an auto workshop named Khan Autos in Islamabad. His
elder son Umer had to take care of technical aspects whereas the younger Usama was
assigned the responsibilities of maintaining accounts and promote business. Mr. Khan
decided to invest one million rupees in the business.
Usama asked his father to transfer Rs. 1.0 million from his personal account at Habib
Bank Ltd., Super Market branch to a new account titled Khan Autos to be opened in
the same bank. Mr Khan was surprised and asked for the objective of opening a new
account. Why can’t we operate from the same account? He asked.
What do you think?
T he basic function of accounting is to provide information to stake holders of

the business so that they make rational economic decisions. The decisions are
required for investing, financing and operating activities. The stakeholders
include existing and potential investors, creditors, management and all those who are
involved in financial dealing with the business. A stakeholder is a person who has
some sort of interest in the organization. For the optimum utilization of economic
resources timely and reliable financial information is of utmost importance. Every
accounting system strives to achieve this objective. The information generated by the
accounting system is used to evaluate the performance of a business over the years or
for a particular period. It is therefore essential that separate accounts are maintained
for each business entity in order to evaluate its performance periodically. Therefore, a
separate accounting record is to be maintained for Khan Autos. This will help in
evaluating the performance of Khan Autos which will help Mr. Khan to make
economic decisions for his business. For all accounting purposes the Khan Autos
should be treated as an entity separate from the owners or the family. At a later stage
we will learn that when a business is established as a company it is legally treated as
a separate entity. The business organizations are classified into three categories with
respect to their ownership.
1. A Sole Proprietorship is owned by one person. Most of the small service
firms, retail stores and even small manufacturing firms are operated as sole
proprietorships. Khan Autos is one of the examples. A sole proprietorship is
not legally treated as an entity separate from its owner. The proprietor is the
owner of its assets; is legally liable for its debt; and is entitled to its profits.
However, from accounting point of view the business is treated as a separate
entity. The accounting records are maintained from business point of view
and not from owner’s point of view.
2. A Partnership is owned by two or more persons. Its legal status is like that
of sole proprietorship. The partners generally share the responsibilities of
operating the business. Each partner is personally liable for partnership debts.
In partnership the partners are jointly and severally liable for the business
obligations. However, from accounting point of view the business is treated
as a separate entity.
3. A Company is a legally registered entity separate from its owners and
managed by their representatives, the Board of Directors. There are different
types of companies. The most common are Private Limited and Public
limited companies. The liability of the owners is limited to their investment
in the company, a topic to be discussed in detail in subsequent chapters.
The accounting records are to be maintained according to Generally Accepted

Accounting Principles (GAAP). The GAAP provides the guiding element for
accountants in recording the activities of business and in preparing the financial
statements. There are certain basic, concepts, principles and assumptions, which need
to be understood before we can learn the mechanics of accounting and preparation of
financial statements.
The Entity Concept

The business is treated as a separate entity apart from its owners. The accounting
records are maintained for the business entity. It is important in order to evaluate the
performance of the business. A business entity may have many accounting entities in
it. An accounting entity is an individual or organization or a section of an
organization that can be distinguished from other organizations and individuals as a
separate economic unit. From an accounting perspective, sharp boundaries are drawn
around each entity so that it can be evaluated periodically and economic decisions
made accordingly. An entity is assumed to own its assets and incur liabilities.
The Reliability (or Objectivity) Principle

The primary objective of financial reporting is to provide information useful for
making investments and lending decisions. To be useful, this information must be
relevant, reliable and comparable. The accountants strive to meet these goals in the
information they produce. Accounting records and statements must be based on the
most reliable data available so that they are as accurate and useful as possible. This
guideline is the reliability principle, also called the objectivity principle. Reliable data
are verifiable and any independent observer may confirm it.
The Cost Principle

The cost principle states that acquired assets and services should be recorded at their
exchange price (called historical cost) agreed by the parties. The purchaser may
believe the price paid is a bargain (i.e. he may think that the market value of the item
is more and he could buy it at a cheaper price) , but the item is to be recorded at the
actual price in the transaction and not at the ‘expected’ cost. The actual price is
measured by the cash paid or to be paid, if exchange is on credit. In accounting,
transactions are recorded on objective evidence and not on subjective estimates. The
objective evidence could only be for actual price paid.
The Going-Concern Assumption

Another reason for measuring assets at historical cost is the going-concern
assumption. It means that an entity is supposed to remain in operation for the
foreseeable future. The economic resources are acquired by the business for use and
not for resale. The accountants assume that the business will remain in operation,
long enough to use existing assets for their intended purpose. The market value of an
asset – the price for which the asset can be sold – may change during the asset’s life,
therefore, an asset’s current market value may not be relevant for decision making.
Moreover, historical cost is a more reliable accounting measure for assets than is
market value.
It is assumed that the enterprise has neither the intention nor the need to liquidate or
curtail materially the scale of its operations; if such an intention or need exists, the
financial statements may have to be prepared on a different basis and, if so, the basis
used is disclosed.
The Stable Currency Assumption

Accountants assume that the money’s purchasing power is relatively stable and this
concept is the basis for ignoring the effect of inflation in the accounting records. It
allows accountants to add and subtract rupee amounts as though each rupee has the
same purchasing power as any other rupee at any other time.
When inflation rates are high, serious apprehensions are made about the reliability of
financial statements prepared under this assumption. In Britain, after a long debate,
an experiment of preparing financial statements at current cost was made. However,
it could not continue and accountants again reverted to historical cost.
IAS-29 provides guidelines for Financial Reporting in Hyper-Inflationary Economies.
Hyperinflation is indicated if cumulative inflation over three years is 100 per cent or
more (among other factors). In such a circumstance, financial statements should be
presented in a measuring unit that is current at the balance sheet date.
Ethics – the Most Fundamental Principle of Accounting

Though not mentioned by IAS, a universally accepted and all the more important for
the Muslims is the fundamental concept of ethics. Every society has divided the
overall human behaviour into two segments – good behaviour and bad behaviour.
The term ‘ethics’ means the principles of conduct in a society. An ethical behaviour
is an acceptable one by the society and an unethical is not approved by the general
norms of the society. An unethical action may be within the limits of law yet
recognized as ethically wrong. Some actions are not clearly right or wrong but are
ethically questionable.
Islam attaches a great significance to ethics in general and business in particular. It
provides guidelines even for actions that are not clearly right or wrong. It says if you
are not sure whether an action is right or not, don’t do it.
In today’s world, ethics has become a prominent characteristic of the accounting
practice. All professional organizations have their code of ethics which they keep on
revising and improving according to the changes in business environment. The ethics
in accounting are important because accountant’s judgment and results inferred
therefrom affect the interests of shareholder, customers, employees and above all the
allocation of resources in the economy. Allah the Almighty has given the freedom to
each individual to shape one’s moral position. But the individual has not been left
without guidance. Had the accountants followed the ethics provided by Islam, cases
like Taj Company and Cooperatives scandals in our society and cases like Enron in
USA could have been avoided.
ACCOUNTING EQUATION AND TRANSACTION ANALYSIS
To start a business you need funds in order to acquire assets. There are two main
sources of funds, the owners and the creditors. The owners and creditors establish a
claim on the business assets to the extent of funds that they provide. The management
has to make two important decisions. One is about the composition of these funds,
i.e. what should be the ratio of owners’ funds and creditors’ funds in the total
investment at any point of time. This is a financing decision. The other decision is
about the use of these funds, i.e. the composition of assets to be acquired from these
funds. This refers to the investing decisions. However, the total of assets at any point
of time will be equal to the funds mobilised by the business, i.e. the owners’ and the
creditors’ claims. In accounting, this relationship is described as the accounting
equation, which is as follows:
Assets = Creditors’ claims + Owners’ claims, or

Assets = Liabilities + Capital
The owners claim and creditors claim differ in nature. The owner assumes the full
risk and makes the investment for an indefinite period (a going concern assumption).
While the creditor does not assume the business risk of the entity to which the credit
is provided and the credit period is known in definite terms. The amount and time of
return on investment by owner is not certain while in case of creditor it is known and
certain.
Assets
Assets are the economic resources owned by the business which are expected to
provide benefit in future. An asset by definition must have a potential to contribute
towards generating the revenues in the business. We can also say that it contributes
directly or indirectly to the flow of cash and cash equivalents to the enterprise. An
asset performs this function in many ways. For example an asset can be used:
1. alone or in combination with other assets in the production of goods or
services to be sold by the enterprise
2. to exchange for other assets
3. to settle a liability, etc.
Assets having physical form like furniture and fixture, plant and machinery, building,
land, etc. are known as tangible assets. The assets, which do not have physical form,
like copyrights, patents, etc. are called intangible assets.
An enterprise can benefit from an asset when it is legally owned by it. However an
item may more or less satisfy the definition of an asset even when there is no legal
ownership by the enterprise. An example of this is the leasehold property.
The assets are also classified with reference to time span of their utility. The assets
that are supposed to be consumed or converted into cash within one operating cycle,
generally less than a year are called current assets. The assets which are supposed
to contribute towards the generation of revenue for a longer period are called non-
current or long-term assets. The long-term tangible assets are called fixed assets.
Liabilities
Liabilities are creditors’ claims on the assets of the business. It is the consideration
the enterprise owes to outsiders. An essential characteristic of a liability is that it
creates an obligation on the part of the enterprise. An obligation is a duty or
responsibility to act or perform in a certain way. The liabilities result from past
transactions or other past events.
A liability may be settled in number of ways, for example, by:
1. payment of cash
2. transfer of other assets
3. provision of services
4. replacement of that obligation with another obligation
5. conversion of the obligation to equity
The Liabilities are generally classified into two groups- current liabilities and long-
term liabilities. The liabilities which are supposed to be settled within one accounting
period are called current liabilities and the one to be settled over a period of more
than one accounting period are known as long-term liabilities.
Equity/Capital
Capital is the claim of owners on the assets of the business i.e. owners’ stake in the
business. The claim may arise through investment by owners or by earning of profit
by the business. The owners’ claim is defined as the residual interest in the assets of
the enterprise after deducting all its liabilities.
Let us now learn how to analyze a transaction and its effects on the equation. But
before proceeding, one basic fact should be kept in mind that the equation will
always remain an equation. Its composition will change with each transaction but it
will never be an inequality. Therefore, it is a must that a transaction should have at
Point to Think
You buy a soft drink in a disposable bottle. Whenever you buy an item you
do so to satisfy some of your need. In fact, you buy a pack of utility. After
drinking you throw the bottle in the trash bin. Why?
Because empty bottle has no utility for you and most probably you would not
like to call it your asset.
Now, someone, a have-not of the society, picks it up from the trash bin and
puts it in his sack. Why?
It is an asset for him because he now owns it and it has economic utility for
him. He is going to sell it for cash.
It is not the item but the economic utility which makes an item an asset.
Point to Think
Abdur Rehman requested Hamza to lend him Rs. 1,000. Hamza lent him
the amount. Abdur Rehman got Rs. 1,000. What did Mr. Hamza get?
You said nothing!
Think it over again.
Hamza established a claim against Abdur Rehman to receive Rs. 1,000. So
by paying cash, Hamza establishes a claim.
From Abdur Rehman’s point-of-view, he received cash as well as a claim
against him. The deal has a double impact for both of them.
least two impacts. The impacts can be more than two and also either on one side or
on both sides of the equation.
Another important point is that the accounting records are to be kept for Khan Autos
and therefore every transaction is to be analyzed from Khan Autos’ viewpoint. The
role of Mr Khan and his sons is simply that of a manager. They will decide on behalf
of and for the benefit of the Khan Autos.
Let us analyse the investment by Mr. Khan from the Khan Autos’ point-of-view. The
firm received cash of Rs. 1,000,000 and Mr Khan established a claim on the firm’s
assets equal to the same amount. The impact of the transaction is twofold.
Increase in cash Increase in Khan’s claim

Rs. 1,000,000 Rs. 1,000,000
The important concept is that when the Khan Autos receives funds – in the form of
cash or other asset – a claim is established against it.
SOME ILLUSTRATIVE TRANSACTIONS

Investment by Owner
Mr. Khan invested Rs.1,000,000 of his personal funds in the new business on January
1, 2004. He opened a separate account in National Bank Ltd. in the name of Khan
Autos. This provided cash to business. It resulted in an increase of an asset for the
business and corresponding change in owner’s capital i.e. owner’s claim in the
business.
(Rs. in thousands)
Jan. Bank Khan’s capital
1 1,000 -- 1,000
Purchase of Rights
Khan Autos hired premises for workshop at a monthly rent of Rs.5,000. The landlord
asked for two-year advance of Rs.120,000, which was paid on January 2, 2004. Note
that by paying the rent, Khan Autos has acquired the right to use the premises for one
year. The premises are not the property of Khan Autos. It remains the property of the
landlord, but Khan Autos now has acquired the ‘right to use’. The right to use the
premises has the potential to contribute towards the generation of revenue and hence
is an asset. Khan Autos acquire another asset.

Bank Adv. Rent Khan’s capital
1 1,000 +120 -- 1,000
-120 -- -- --
2 880 120 -- 1,000
Note that the asset in the form of cash maintained in the bank account has decreased
and another asset ‘Prepaid Rent’ has increased. Khan’s claim remains the same. After
each transaction the composition of the equation is changed.
Purchase of Land
Mr. Khan, having a future vision and ambition for success, purchased a plot in the
Industrial Area for Rs.20,000 on January 5, 2004. An important point, just to remind
you, is that Mr. Khan is taking decisions on behalf of Khan Autos. Technically
speaking, it is the Khan Autos that purchased the plot of land and not Mr. Khan. The
decisions taken by the managers are in fact the decisions of the organizations. After
this transaction the composition of equation will be:
Bank Adv. Rent Land Khan’s capital
2 880 120 -- -- 1,000
-20 -- +20 -- --
5 860 120 20 -- 1,000
Note that asset cash is being converted into another asset.
Purchase of Furniture and Fixture

On January 6, 2004 purchased furniture and fixture for Rs.60,000 by paying cash
from the bank as in the earlier cases. A part of cash in bank is converted to another
asset furniture and fixture. We can generalize and say that one asset can be converted
into another asset.
Bank Land Adv. Rent Fur.& Fix. Creditors Khan’s capital
5 860 20 120 -- 1,000
- 60 -- -- +60 --
6 800 20 120 60 1,000
Purchase of Tools
On January 10 purchased tools for Rs.50,000.

Bank Land Adv. Rent F&F Tools Creditors Khan’s capital
6 800 20 120 60 -- 1,000
-50 -- -- -- +50 -- --
10 750 20 120 60 50 1,000
Purchase of Plant and Equipment

Mr. Khan decided to purchase certain equipment like computerised tuning system, a
small lathe machine etc. He estimated the total cost of such items to be about
Rs.700,000. He contacted Bajwa Auto Machines Ltd.(Pvt.) for the purchase of
equipment. BAM is owned by Mr. Azmat Bajwa, one of Khan’s old friends. Mr.
Azmat looked at the list of equipment and informed Khan that the list is worth
Rs.900,000. He also informed Khan that he could pay Rs.700,000 at the time of
purchase and the balance within two years. Khan agreed and purchased the
equipment on January 15.

Bank Land Adv. Rent F&F Tools P&E BAM Khan’s capital
10 750 20 120 50 50 1,000
-700 -- -- -- -- +900 +200 --
15 50 20 120 60 50 900 200 1,000
Important
The Plant and Equipment has been recorded at Rs.900,000 although only Rs.700,000
has been paid. Why?
We need to understand the concept of investing decisions and financing decisions.
Let us suppose you decide to buy a car. This is an investing decision. The next
question is as to how are you going to make the payment. There are couple of options
available to you. For example pay full cash, get a lease from a financial institution,
make some down payment and pay the remaining in instalments etc. This is your
financing decision.
The purchase and sale of an item depends on the conclusion of an agreement which
may or may not involve immediate cash payment. Thus an asset can be financed with
a liability.
Purchase of Workshop Supplies on Credit
Workshop supplies were purchased on January 16 worth Rs.10 thousands on credit
from Kohsar Auto Parts. The payment is due by January 26. In this case an asset
‘workshop supplies’ has increased on one side of the equation and a liability ‘Kohsar
Auto Parts’ (KAP) has increased on the other side of the equation.

Bank Land Ad. Rent F&F Tools P & E W. Sup BAM KAP K’s cap
15 50 20 120 60 50 900 200 1,000
-- -- -- -- -- -- +10 +10 --
16 50 20 120 60 50 900 10 200 10 1,000
Payment of Liability
Rs.10,000 was paid to Kohsar Auto Parts on January 20. It decreases the asset ‘bank’
on one side and the liability ‘KAP’ on the other side of the equation.
16 50 20 120 60 50 900 10 200 10 1,000
-10 -- -- -- -- -- +10 -10 --
20 40 20 120 60 50 900 10 200 -- 1,000
Personal Expenses
Mr Khan renovated his residence by spending Rs.50,000 from another personal
account. This is not a transaction of Khan Autos and the payment has not been made
from the Khan Autos’ account. Therefore, it does not affect the equation.
BALANCE SHEET
The accounting equation, also known as balance sheet equation, provides the
following information at any point of time:
 Sources of funds, i.e. creditors’ and owners’ claims
 Composition of funds provided by different sources, i.e. the total amount
provided each by creditors and by owners
 The use of those funds, i.e. the composition of assets acquired
Note that equation after each transaction has a different composition. Therefore, it is
a must to indicate the date of the equation. That is to say ‘the equation as at Jan.20,
2004’ to describe the position on that date. The balance sheet reports the financial
position of an enterprise at a specific point of time. Its heading comprises the name of
the enterprise, name of the statement and the date of its preparation. It has three main
sections: assets, liabilities and owner’s equity. As we proceed we will see that each
section is further divided into subsection and the format improved to provide more
logical information. Remember the accounting is an information system which
provides the financial information.
The data provided by each equation is sufficient to produce a balance sheet as at that
date. If the data of January 20 were produced as below it would be the balance sheet
as at January 20, 2003.
Fig.2.1 KHAN AUTOS

Balance Sheet
as at January 20, 2003
Assets Liabilities and Capital
Bank 40,000 Liabilities
Land 20,000 Loan- BAM 200,000
Advance Rent 120,000 Capital
Furniture and Fixture 60,000 Khan's Capital 1,000,000
Tools 50,000
Plant and Equipment 900,000
Workshop Supplies 10,000
1,200,000 1,200,000
INCOME STATEMENT / PROFIT AND LOSS ACCOUNT

One of the major objectives of business is to earn a reasonable return on capital
employed. The term ‘capital employed’ refers to the total of long-term funds – i.e.
long-term loans and owners’ equity - employed in the enterprise. The profit and loss
account reports the result of business activities for a specific period. Net profit or loss
is the difference between the revenues plus gains, and expenses plus losses. Let us
define these terms.
Revenue
Revenue is the gross inflow of economic benefits during the period arising in course
of ordinary activities of an enterprise when these inflows result in increase in equity
other than increases relating to contributions from equity participants (IAS-18).
The amount of revenue is measured by cash or other assets received or receivable. An
example of other assets is debtors. Debtors are created when goods or services are
sold on credit. The equity means the capital, i.e. owner’s claim. Gains are increases in
owner’s equity from incidental transactions, which are not related to primary business
activities e.g. sale of old assets.
Expenses
The decreases in owner’s equity as a result of costs incurred to generate revenue are
defined as expenses. An expense may be incurred by payment of cash, promise to pay
or consumption of an asset (IAS-18).
Losses are the decrease in owner’s equity as a result of incidental transactions which
are not expenses or withdrawals by owners, e.g. loss on sale of an asset.
Let us go back now to Khan Autos’ equation of January 20, 2004 and see the effect
of transaction involving Revenues and Expenses. The equation on January 20, 2004
was:
20 40 20 120 60 50 900 10 200 -- 1,000
Earning Cash Revenue

The repair work on different vehicles were completed on January 22 and Rs.30,000
cash was collected from the clients which was immediately deposited in the bank.
The receipt of cash increases the asset ‘bank’ on one side and owner’s claim in the
business on the other side. Remember whenever revenue is earned it increases the
owner’s claim i.e. owner’s capital.
Bank Land Ad. Rent F&F Tools P & E W. Sup BAM K’s cap
20 40 20 120 60 50 900 10 200 1,000
+30 -- -- -- -- -- -- -- +30
22 70 20 120 60 50 900 10 200 1030
Providing Services on Credit

The engines of two buses of Muhammad Ali Jinnah University were overhauled. The
university was sent two bills: one for Rs. 30,000 and the other for Rs.20,000 on
January 25. As the job has been completed and delivered to the client, a claim to
receive Rs.50,000 from Jinnah university has been established. Thus an asset
‘debtors’ (those who owe to the organization) has been created. This increases the
assets of Khan Autos on one side and the owners’ claim i.e. Khan’s capital, on the
other side.
Assets = Liab + Capital
Bank Land Ad. Rent F&F Tools P & E W. Sup Debtors BAM K’s cap
22 70 20 120 60 50 900 10 -- 200 1030
-- -- -- -- -- -- -- +50 -- +50
25 70 20 120 60 50 900 10 50 200 1080
Providing Services on Part Payment
Performed services worth Rs.7,000 for a client on January 28 who paid Rs. 3,000
cash immediately and promised to pay the remaining Rs.4,000 in ten days. In this
transaction, two assets have increased, the bank by Rs.3,000 and the debtors by
Rs.4,000. On the other side owner’s claim has increased by Rs.7000. Note that there
have been changes in three items. However, the resultant is again an equation.
Assets = Liab. + Capital

25 70 20 120 60 50 900 10 50 200 1080
+3 -- -- -- -- -- -- +4 -- +7
28 73 20 120 60 50 900 10 54 200 1087
Payment of Expenses
The following expenses were paid on January 30 by cheque.
office supplies (stationary) Rs.2,000; employees’ salaries Rs.22,000; gas and
electricity Rs.5,000. The total expenses were Rs.29,000.
We learnt that the revenue results in increase in the owner’s capital. The expense on
the other hand decreases the owner’s capital. Thus payment of expenses decreases
the asset bank on one side and owner’s capital on the other.
Assets = Liab. + Capital
28 73 20 120 60 50 900 10 50 200 1087
-29 -- -- -- -- -- -- -- -- -29
30 44 20 120 60 50 900 10 54 200 1058
Expense on Credit
Received telephone bill of Rs.12,000 on January 31. It will be paid in next week.
The expense has been incurred as the services have been utilised. The expenses whch
have been incurred but not yet paid create a liability ‘Accrued Expenses’. The result
is increase in a liability and decrease in owner’s capital. Note that both the changes
occurred on the right hand side of the equation.
Bank LandAd. Rent F&F Tools P & E W. Sup Debt. BAM Acc. Exp K’s cap
30 44 20 120 60 50 900 10 54 200 1058
-- -- -- -- -- -- -- -- -- +12 -12
31 44 20 120 60 50 900 10 54 200 12 1046
Withdrawal by Owner for Personal Use
Mr. Khan withdrew Rs.15,000 on January 31, for personal use. The withdrawals by
the owner reduce the owner’s capital. However, as this reduction is not the result of
revenue-producing activities, it is not a business expense. It reduces the asset bank on
one side and the capital on the other side.
Bank Land Ad. Rent F&F Tools P & E W. Sup Debt. BAM Acc. Exp K’s cap
31 44 20 120 60 50 900 10 54 200 +12 1046
15 -- -- -- -- -- -- -- -- -- -15
31 29 20 120 60 50 900 10 54 200 12 1031
Receipt from Debtor

Received Rs.30,000 from Muhammad Ali Jinnah University on January 31. It results
in an increase in one asset, i.e. bank, and decrease in another asset, i.e. debtors.
Bank Land Ad. Rent F&F Tools P & E W. Sup Debt. BAM Acc. Exp K’s cap
31 29 20 120 60 50 900 10 54 200 +12 1031
+30 -- -- -- -- -- -- -30 -- -- --
31 59 20 120 60 50 900 10 24 200 12 1031
Profit and Loss Account

The profit and loss account displays the business’s revenues, expenses and net profit
or loss for a specific period. The expenses are deducted from revenues to get net
profit or loss. The profit increases the owner’s claim i.e. owner’s capital in the
business whereas the loss decreases it. In practice the revenues and expenses are
recorded separately and owner’s capital is not adjusted after each transaction. The
profit or loss for a particular period is calculated by preparing a ‘Profit and Loss
Account’ for that period and the owner’s capital is adjusted accordingly at the end of
the period.
The total revenue of Khan Autos during the month of January 2003 is Rs.87,000. Out
of this Rs.63,000 has been received in cash and the remaining Rs.24,000 are still
receivable. Remember the revenue and expenses are recognised on accrual basis i.e.
when the expense is incurred and the revenue is earned irrespective of the payments
made or not in case of expense and payments received or not in case of revenues..
The total expenses during this period have been Rs.41,000. The profit and loss
account lists revenues first, followed by expenses, which are subtracted from
revenues to get net profit or loss for the period.
Fig. 2.2 KHAN AUTOS

for the period ended January 31, 2003
Revenues Rs. 87,000
Less expenses
Office supplies Rs. 2,000
Salaries 22,000
Gas and electricity 5,000
Telephone 12,000 41,000
Net profit Rs. 46,000
Once the Profit and Loss Account is ready the Balance Sheet is prepared as follows.
Fig. 2.3 KHAN AUTOS

Balance Sheet
As at January 31,2003
Assets Liabilities and Capital
Liabilities
Bank Rs. 59,000 Accrued Rs. 12,000
Expenses
Debtors 24,000 Loan 200,000
Workshop 10,000 212,000
supplies
Prepaid rent 120,000 Capital
Tools 50,000 Khan’s capital 1,000,000
Furniture 60,000 Add: Net 46,000
and Fixture Profit
Land 20,000 1,046,000
Plant and 900,000 Less: (15,000)
Equipment Drawings 1,031,000
Rs. 1243,000 Rs 1,243,000
The Khan’s capital increased by Rs. 46 thousands due to the net profit earned during
the moth. However, it decreased by Rs.15,000 as khan withdrew this amount from the
business operations for his personal use.
Summarized Transactions Analysis
The fig. 2.3 provides a comprehensive view of the analysis of all the transactions. It
shall help you to understand the concept of accounting equation more effectively.
Fig 2.4 Transaction Analysis
Assets Liabilities Capital

Bank Land Adv. F&F Tools P&E Wksp Debt. = BAM Acc. + Khan’s
Rent . Sup Exp . cap ital
1 1,000 1,000
2 -20 20 -
980 20 1,000
5 -120 - 120 --
860 20 120 1000
6 -60 - - 60 -
800 20 120 60 1000
10 -50 - - - 50 -
750 20 120 60 50 1000
15 -700 - - - - 900 200 -
50 20 120 60 50 900 200 1000
16 - - - - - - 10 - 10 -
50 20 120 60 50 900 10 200 10 1000
20 -10 - - - - - - - -10 -
40 20 120 60 50 900 10 200 - 1000
22 30 - - - - - - - - 30
70 20 120 60 50 900 10 200 - 1030
25 - - - - - - - 50 - - 50
70 20 120 60 50 900 10 50 200 - 1080
28 3 - - - - - - 4 - - 7
73 20 120 60 50 900 10 54 200 - 1087
30 -29 - - - - - - - - - -29
44 20 120 60 50 900 10 54 200 - 1058
31 - - - - - - - - - 12 -12
44 20 120 60 50 900 10 54 200 12 1046
31 -15 - - - - - - - - - -15
29 20 120 60 50 900 10 54 200 12 1031
31 30 - - - - - - -30 - - -
59 20 120 60 50 900 10 24 200 12 1031
Each numbered row represents an equation after the impact of a transaction has been
incorporated in the previous equation. Each equation represents a balance sheet as at
a particular date. The last line represents the balance sheet as at 31 st. January. You
need to go line by line to properly understand the transaction analysis.
The relationship between profit and loss account and the balance sheet is explained in
figure2.4
Fig 2.4
Balance sheet at the beginning of the period

(Assets) 1 = (Liabilities) 1 + (Capital) 1
Profit and loss account for the period

Revenues - Expenses = Net profit / loss
Change in owner’s capital

(Capital) 1 + (Net profit / loss) - (Drawings) =
(Capital) 2
Balance sheet at the end of the period

(Assets) 2 = (Liabilities) 2 + (Capital) 2
Revenue Rs. 87 Khan’s capital, as on Jan 1 Rs. -0-

Investment in Jan. 500
Expenses Net profit 46
(itemized) 41 546
Net income Rs. 46 Capital withdrawn in January 15
Khan’s capital, January 31 Rs. 531
Balance Sheet
Assets Liabilities
(itemized) Rs. 553 (itemized) Rs. 22
Capital
Khan’s capital 531
Total liabilities and
Total assets Rs. 553 owner’s equity Rs. 553
Points to Remember
 For accounting purposes Khan Autos is to be treated as an independent entity,
separate from its owners.
 For all practical purposes, Khan and sons are managers of Khan Autos and are
required to make decisions on behalf of Khan Autos.
 They are required to make decisions that are in the best interest of Khan Autos.
This is expected of all business managers.
 Accounts are to be kept for Khan Autos and not for Mr. Khan.
 Each transaction is to be analyzed from Khan Autos’ point-of-view.
 Each transaction always has at least two impacts so that the accounting equation
stays as an equation.
 A transaction is a financial dealing between the business entity and an outsider.
Mr Khan is an outsider for all practical purposes.
 In accounting, capital means owner’s stake in the business.
 Assets are the economic resources owned by the organization.
 Liabilities are the obligations owed by the organization to others.
Demonstration Problem
Note: Figures in demonstration problems, exercises and problem have been kept small to
save space and make the calculation easy.
After planning for several months, Waseem decided to start his own business called
Waseem Electrical Services (WES). During its first month of operation, WES
completed the following transactions during the month of March:
Mar 1 Waseem put Rs. 2,000 of his savings into a bank account in the name of Waseem Electrical
Services in the Bank of Punjab.
2 Bought store supplies for Rs. 600 by issuing a cheque.
3 Paid Rs. 500 rent for the month of March for a small store.
5 Furnished the store by installing new fixtures sold to him on credit by the supplier for
Rs. 1,200. This amount is to be repaid in three equal instalments at the end of March,
April and May.
16 In the first week of business ending March 16, receipts from sales amounted to Rs.
825. All receipts were deposited in bank.
17 Paid Rs. 125 to an assistant for his salary.
30 Receipts from sales during the two-week period ending March 31 amounted to Rs.
1,930.
31 Paid first instalments on the fixtures.
31 Withdrew Rs. 900 from the bank for his personal expenses.
Required
i Arrange the asset, liability and capital as in the illustration. Show by
additions and subtractions the effects of each of the preceding transactions on the
equation.
ii Prepare a profit and loss account for WES for March 1998.
iii Prepare a statement of changes in capital for March 1998.
iv Prepare a balance sheet for the business as at March 31, 1998.
Solution
Planning the solution
1 Set up a table with the appropriate columns. Analyze each transaction and show its
effects as increases or decreases in the appropriate columns of the table, being sure that
the accounting equation remains in balance after each event.
2 To prepare the profit and loss account, find the revenues and expenses. Then list these
items on the statement, calculate the difference and label the result as net profit or net
loss.
3 Prepare the statement of changes in capital using the information shown in the capital
column.
4 Finally, use the information on the last row of the table to prepare balance sheet.

Bank + Store + Store = + Wasim’s
Supplies Equip. Creditors Capital
a Rs. Rs.
2,000 2,000
b - 600 + 600
Bal 1,400 600 2,000
c - 500 - 500
Bal 900 600 1,500
d +1,200 1,200
Bal 900 600 1,200 1,200 1,500
e +825 +825
Bal 1,725 600 1,200 1,200 2,325
f -125 -125
Bal 1,600 600 1,200 1,200 2,200
g +1,930 +1,930
Bal 3530 600 1,200 1,200 4,130
h - 400 - 400
Bal 3,130 600 1,200 800 4,130
i - 900 - 900
Bal 2,230 + 600 + 1,200 = 800 + 3,230
ii
WASEEM ELECTRICAL SERVICES
for the month ended March 31, 1998
Revenues:
Sales
Rs.2,755
Operating expenses:
Rent expense Rs. 500
Wages expense 125
Total operating expenses 625
Net profit Rs. 2,130
iii
Statement of Changes in Owner’s Capital
for the month ended March 31, 1998
Waseem’s capital on March 1, 1998 Rs. -0-
Add:
Investments by owner Rs. 2,000

Net profit 2,130 4,130
Total Rs. 4,130
Less withdrawals by owner (900)
Waseem’s capital on March 31, 1998 Rs. 3,230
iv
Balance Sheet
March 31, 1998
Assets Liabilities
Cash Rs. 2,230 Creditors Rs. 800
Store supplies 600
Store equipment 1,200 Owner’s Equity
Waseem’s capital 3,230
Total liabilities and
Total assets Rs. 4,030 owner’s equity Rs. 4,030
Questions for Class Discussion

1 What are the basic accounting principles?
2 Explain the difference between the nature of owner’s claim and creditors’ claim.
3 Explain the concept of an asset with an example.
4 What is revenue? And expense?
5 What is information presented in the balance sheet?
6 Why is balance sheet presented as at a particular date?
7 Why is profit and loss prepared for a period instead of as at a date like the
balance sheet?
8 Explain the cost principle.
9 What is the concept of going concern?
10 What could be the benefit of prudence for a business?
True and False
1 From an accountant’s perspective, income is realized only when completed
transactions have occurred.
2 Net profit causes an increase in a firm’s net assets during a period.
3 Revenues and gains represent increases in a firm’s net assets which are directly
related to selling and producing its goods and services.
4 The stable currency assumption takes into consideration the inflationary impact
on transactions.
5 The Going Concern concept means that the business entity will remain in
operation for the foreseeable future.
6 The balance sheet equation assumes that creditors’ claims are equal to the
owners’ claims.
7 The owners assumes full risk but creditors do not.
8 The primary objective of financial reporting is to provide accurate calculation
for tax purposes.
9 Investment and lending decisions need financial information that is partially
provided by financial statements.
10 An expense results in decrease in owner’s capital.
Fill-ins
1 Revenues are gross --------------- in assets or gross --------------- in liabilities from
delivering goods and services during the period.
2 --------------- are increases in net assets from all activities of a firm other than
revenues and investments by owners.
3 --------------- are decreases in net assets from all activities of a firm other than
expenses and withdrawals by owners.
4 Revenues plus gains, less expenses plus losses, equals the --------------- of a firm.
5 Increases in net assets resulting from the successful operations of a firm are
reflected in the --------- account.
6 Increases in owner’s equity result primarily from net profit and ------- by owners.
7 The statement of owner’s capital shows the reader the net ------------ for the
period or the net -------- for the period and the ------------ by the owner during the
period.
8 The individual or organization for which a set of accounts is maintained maybe
referred to as the business ---------------.
9 Economic events entered into the accounting system of an enterprise are referred
to as ---------------.
10 --------------- represent the economic resources of the firm.
11 --------------- represent the obligations or debts of the firm.
12 The total of liabilities and owner’s equity must equal ---------------.
13 --------------- assets have no physical substance and represent legal claims and/or
rights.
14 Businesses are assumed to have an --------------- life unless there is evidence to
the contrary.
Self-Study Questions
Test your understanding of the chapter by marking the best answer for each of the
following questions:
1 You have purchased some goods for Rs. 10,000 and can sell it immediately for
Rs. 15,000. What accounting concept or principle governs the amount at which
to record the goods you purchased?
a Entity concept c Cost principle
b Liability d Asset
2 The economic resources of a business are called:
a Assets c Capital
b Liabilities d Revenues
3 The purchase of office equipment on credit will:

a Increase an asset and increase a liability.
b Increase an asset and increase owner’s capital.
c Increase an asset and decrease another asset.
d Increase an asset and decrease a liability.
4 The performance of a service for a customer or a client on immediate receipt of cash will:
a Increase one asset and decrease another asset.
b Increase an asset and increase owner’s equity.
c Decrease an asset and decrease a liability.
d Increase an asset and increase a liability.
5 The payment to a creditor will:
a Increase one asset and decrease another.
b Decrease an asset and decrease owner’s equity.
c Decrease an asset and decrease a liability.
d Increase an asset and increase a liability.
6 The statement of assets, liabilities and owner’s capital is called the:
a Financial statement c Profit and loss account
b Balance sheet d Statement of owner’s capital
7 The financial statements that are dated for a time period (rather than a specific time) are
the:
a Balance sheet and profit and loss account
b Balance sheet and statement of owner’s equity
c Profit and loss account and statement of owner’s equity
d All financial statements are dated for a time period.
8 Profit and loss account:
a Presents the sum of revenues and expenses.
b Is a report on the profitability of business operations.
c Is a point-in-time description.
d All of the above are correct.
e Only a and c are correct.
9 The balance sheet reveals:
a The profitability of a firm for a period of time
b The assets, liabilities and capital of a firm at a point in time

c The assets , liabilities and capital of a firm for a period of time
d The profitability of a firm at a point in time
e None of the above is correct.
10 Liabilities are:
a Equal to the sum of assets plus capital.
b Obligations of the entity to outsiders.
c Created when stockholders contribute cash to firm and receive shares of the
firm’s stock in exchange.
d All of the above are correct.
e Only b and c are correct.
11 The balance sheet is a list of:
a All revenues and expenses of a firm during a period of time
b The obligations of the business to outsiders
c The resources owned or controlled by the business at their cost
d The capital provided by the owners
e The b, c, and d are all correct.
12 Which of the following is not a correct form of the accounting equation?
a Assets = Claims
b Assets = Liabilities + Owner’s capital
c Assets - Liabilities = Owner’s capital
d Assets + Owner’s capital = Liabilities
13 Revenues may be defined as:
a Increases in assets from all sources
b The amount of capital invested by the owners of a business
c The reduction of liabilities previously owed
d The increases in assets resulting from supplying goods and services to customers
e The collection of cash from customers
14 Faiz Khanyari withdrew cash from his business on January 1, 1996. Faiz’s records with
respect to the withdrawal would reflect:
a An increase in assets and a decrease in owner’s equity
b A decrease in assets and a decrease in owner’s equity
c A decrease in assets and a decrease in liabilities
d A decrease in assets and an increase in liabilities
e An increase in owner’s capital and a decrease in liabilities
15 The prepaid rent account should be classified as:
a An equity account
b An expense
c A liability
d An assets
e A revenue
Exercises
E2.1 On April 30, 1996, the accounting equation for Salman Shoes, a single proprietorship
had the following balances for assets, liabilities and capital (in rupees):
Cash in side .....................… 4,000

Cash in bank ………………. 6,000
Other assets .....................…. 75,000
Creditors …......................…. 40,000
Salman’s capital ................… 45,000
On that date, Salman sold the ‘other assets’ for Rs. 50,000 cash. He wanted
to close the shop.
Required
i Prepare a balance sheet, as it would appear immediately before the sale.
ii Prepare a balance sheet, as it would appear immediately after the sale.
iii State how the shop’s cash should be distributed in ending the business and why.
E2.2 On October 1, 1997, Raja Aslam began operating a new travel agency. After each of the
agency’s first five transactions, the accounting equation for the agency showed the
following balances. Analyze the equations and describe the probable nature of the five
transactions with their amounts.
Cash Debtors Office Supplies Office Furniture Creditors Raja’s Capital

Rs. Rs. Rs. Rs. Rs. Rs.
1 25,000 -0- -0- -0- -0- 25,000
2 23,800 -0- 2,000 -0- 800 25,000
3 13,800 -0- 2,000 10,000 800 25,000
4 13,800 2,300 2,000 10,000 800 27,300
5 12,100 2,300 2,800 10,900 800 27,300
E2.3 Dr Imran Baig opened a clinic on November 1, 1997. He prepared accounts at the end
of each month. During November 1997, Dr Baig completed the following transactions:
a Invested Rs. 65,700 in cash and medical equipment having a Rs. 34,300 fair
market value.
b Paid the rent on the office space for November, Rs. 12,800.
c Purchased additional medical equipment on credit, Rs. 7,600.
d Provided medical services to a client and received Rs. 4,260 cash for the work.
e Provided medical services to a client on credit, Rs. 2,800.
f Purchased medical supplies for cash, Rs. 5,590.
g Paid the medical assistant’s salary for November, Rs. 2,900.
h Collected Rs. 2,000 of the amount owed by the client of transaction e.
i Paid for the equipment purchased in transaction c.
Required
Arrange the following titles in the accounting equation form:
Cash, debtors, medical equipment, office supplies, creditors’ and Imran’s

capital. Show by additions and subtractions the effect of each transaction on the
elements of the equation.
E2.4 On March 1, 1997, Syed Nauman Shah began the practice of tax accounting under the
name of Sadat Tax Advisors. On March 31, 1997, his record showed the following
assets, liabilities, owner’s investments, owner’s withdrawals and expenses:
Bank .............................. Rs. 32,600 Owner’s withdrawals ....……..... Rs. 23,000
Debtors ............................… 28,400 Fees earned ................................ 34,900
Office supplies ...................... 5,800 Miscellaneous expense ............... 3,475
Professional library ............. 44,000 Rent expense ............................... 4,700
Office equipment ..........….. 62,600 Salaries expense .......................... 5,000
Creditors ....................…..… 42,775 Telephone expense ...................... 2,500
Owner’s investments ......………. ?
Required
From the preceding information, prepare a March 1997 profit and loss
account and the balance sheet.
E2.5 Use the accounting equation to answer each question below. Show any calculations you
make.
a The assets of Khan Company are Rs. 650,000 and the owner’s capital is Rs.
360,000. What is the amount of the liabilities?
b The liabilities and owner’s equity of Faraz Enterprises are Rs. 95,000 and Rs.
32,000 respectively. What is the amount of the assets?
c The liabilities of Imran Co. equal one-third of the total assets, and owner’s
equity is Rs. 120,000. What is the amount of the liabilities?
d At the beginning of the year, Sohail Sons’ assets were Rs. 220,000, and owner’s
equity was Rs. 100,000. During the year, assets increased Rs. 60,000, and
liabilities decreased Rs. 10,000. What was the owner’s capital at the end of year?
E2.6 Identify the following transactions by type of owner’s capital transaction by marking
each as either an owner’s investment (I), owner’s withdrawal (W), revenue ®, expense
(E), or not an owner’s capital transaction (NOC):
a Received cash for providing a service.
b Took assets out of business for personal use.
c Received cash from a customer previously billed for a service.
d Transferred assets to the business from a personal account.
e Paid the service station for car service.
f Performed a service and received a promise of payment.
g Paid cash to purchase equipment.
h Paid cash to employee for services performed.
E2.7 During April 1998, Al-Muneer Electronics had the following transactions:
a Paid salaries for April, Rs. 1,800.
b Purchased equipment on credit, Rs. 3,000.
c Purchased supplies with cash, Rs. 100.
d Additional investment by owner, Rs. 4,000.
e Received payment for services performed Rs. 600.
f Paid for part of equipment previously purchased on credit, Rs. 1,000.
g Billed customers for services performed Rs. 1,600.

h Withdrew cash, Rs. 1,500.
i Received payment from customers billed previously, Rs. 300.
j Received utility bill, Rs. 70.
On a sheet of paper, list the letters a through j, with columns for Assets, Liabilities
and Owner’s capital. In the columns, indicate whether each transaction caused an
increase (+), a decrease (-), or no change (NC) in assets, liabilities and owner’s
capital.
E2.8 For each of the following categories, describe a transaction that will have the required
effect on the elements of the accounting equation:
a Increase one asset and decrease another asset.
b Decrease an asset and decrease a liability.
c Increase an asset and increase a liability.
d Increase an asset and increase owner’s equity.
e Decrease an asset and decrease owner’s equity.
E2.9 State below whether each account is an asset (A), a liability (L), or a part of owner’s
capital (OC):
Cash, salaries payable, debtors, Khan’s capital, land, creditors, supplies.
Indicate below whether each account would be shown on the profit and loss (PL), or the
balance sheet (BS):
Automobile, fuel expense, cash, rent expense, creditors and Khan’s withdrawals, repair
revenue.
E2.10 Appearing in random order below are the balances for balance sheet items for Haroon
& Co. as of December 31, 1997.
Creditors Rs. 40,000 Debtors Rs. 50,000
Building 90,000 Cash 20,000
Haroon’s capital 170,000 Equipment 40,000
Supplies 10,000
Required
Sort the balances and prepare a balance sheet.
Hint: The amount given for Khawar’s capital is the beginning balance.
Problems
P2.1 Selected transactions for Shah Transport Services, began on June 1, 1997 by Zahid
Shah, are as follows:
a Zahid Shah invested Rs. 600,000.
b A truck was purchased by the business for Rs. 430,000.
c Equipment purchased on credit for Rs. 9,000.
d A bill of Rs. 7,200 for transporting goods was sent to Mr Ashraf Abbasi, a
customer.
e Cash of Rs. 6,000 is received from the customer who was billed in d.
f Received Rs. 22,300 in cash for transporting goods.
g A payment of Rs. 5,000 was made on the equipment purchased in c.
h Paid expenses of Rs. 1,700 in cash.

i Cash of Rs. 1,200 was withdrawn from business for Zahid Shah’s personal use.
Required
i Arrange the asset, liability and owner’s equity accounts in an equation, using the
following account titles: cash, debtors, trucks; equipment, creditors and Zahid Shah’
capital.
ii Show by addition and subtraction the effects of the transactions on the balance
sheet equation. Show new balances after each transaction and identify each owner’s
equity transaction by type.
P2.2 Sameena, after receiving her degree in computer science, began her own business called
Sameena Computing Services. She completed the following transactions soon after
starting the business:
a Sameena began her business with Rs. 90,000 cash investment, which she
deposited in the United Bank Ltd, Blue Area, Islamabad, branch. She also
brought a systems library, which cost Rs. 30,920.
b Paid Rs. 5,000 as one month’s rent for an office.
c Purchased a computer for Rs. 57,000 paying by cheque.
d Purchased computer supplies on credit, Rs. 6,000.
e Developed a software and collected revenue from a client, Rs. 8,000.
f Billed a client Rs. 3,710 upon completion of a composing assignment.
g Paid expenses of Rs. 400.
h Received Rs. 2,710 from the client billed previously.
i Withdrew Rs. 1,250 for personal expenses.
j Paid Rs. 2,000 of amount owed on computer supplies purchased in d.
Required
i Arrange the asset, liability and owner’s capital accounts in an equation using the
following account titles: cash, debtors, supplies, equipment, systems library,
creditors and Sameena’s capital.
ii Show by addition and subtraction the effects of the transactions on the balance
sheet equation.
P2.3 Dr Rahim, a psychologist, moved from Shikarpur to set up an office in Islamabad. After
one month, the business had the following assets: cash in side, Rs. 2,800; cash at bank,
Rs. 25,000; debtors, Rs. 12,680; office supplies, Rs. 8,000; and office equipment, Rs.
70,500. The creditors were Rs. 12,600 for purchases of office equipment on credit.
During March 1997, the following transactions were completed:
a Paid one month’s rent by cheque for the office, Rs. 3,500.
b Billed Rs. 2,460 for services rendered to a client.
c Paid Rs. 3,000 by cheque for office equipment previously purchased.
d Paid for office supplies, Rs. 1,000 in cash.
e Paid secretary’s salary, Rs. 3,000 by cheque.
f Received a cheque for Rs. 23,800 from ICI for services provided to their
employees.
g Made payment on accounts owed Rs. 3,600 by cheque.
h Withdrew Rs. 5,500 from bank for living expenses.
i Paid telephone bill for the current month, Rs. 970 in cash.
j Received Rs. 1,290 cash from patients previously billed.
Profit
Statement
and loss
of
Owner’s
Account
Capital
k Purchased additional office equipment on credit, Rs. 33,600.
Required
Prepare balance sheet after transaction k has occurred.
P2.4 At the end of October 1997, Qasim Khoso’s capital account had a balance of Rs. 137,300. After
operating during November, he had the following account balances:
Bank Rs. 3 8,700 Building Rs. 100,000
Debtors 21,200 Motors 115,000
Supplies 11,000 Creditors 37,800
Land 81,000
In addition, the following transactions affected owner’s capital during
November:
Withdrawal by Qasim Rs. 33,200 Salaries expense Rs. 12,300

Investment by Qasim 16,000 Fuel expense 81,000
Passenger service revenue 216,200 Utility expense 15,600
Cargo service revenue 101,700
Required
Prepare profit and loss, and balance sheet after November transactions.
P2.5 At the end of its first month of operation – June 1998 – Khalid Plumbing Services had
the following account balances:
Cash Rs. 29,300 Tools Rs. 23,800
Debtors 15,400 Creditors 1,400
Delivery truck 69,000
In addition, during June, the following transactions affected owner’s equity:
Investment by Khalid Rs. 20,000 Repair revenue Rs. 32,800
Withdrawal by Khalid 12,000 Salaries expense 28,300
Further investment by Khalid 30,000 Rent expense 7,000
Contract revenue 51,600 Fuel expense 4,200
Required
Prepare profit and loss, and balance sheet.

Basic Accounting Concepts

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Basic Accounting Concepts

T he basic function of accounting is to provide information to stake holders of

The accounting records are to be maintained according to Generally Accepted

The Entity Concept

The Reliability (or Objectivity) Principle

The Cost Principle

The Going-Concern Assumption

The Stable Currency Assumption

Ethics – the Most Fundamental Principle of Accounting

Assets = Creditors’ claims + Owners’ claims, or

Increase in cash Increase in Khan’s claim

SOME ILLUSTRATIVE TRANSACTIONS

Assets = Liabilities + Capital

Note that asset cash is being converted into another asset.

Purchase of Furniture and Fixture

Assets = Liabilities + Capital

Purchase of Plant and Equipment

Assets = Liabilities + Capital

Assets = Liabilities + Capital

Fig.2.1 KHAN AUTOS

INCOME STATEMENT / PROFIT AND LOSS ACCOUNT

Earning Cash Revenue

Providing Services on Credit

Assets = Liab. + Capital

Receipt from Debtor

Profit and Loss Account

Fig. 2.2 KHAN AUTOS

Fig. 2.3 KHAN AUTOS

Fig 2.4 Transaction Analysis

Assets Liabilities Capital

Balance sheet at the beginning of the period

Profit and loss account for the period

Change in owner’s capital

Balance sheet at the end of the period

Revenue Rs. 87 Khan’s capital, as on Jan 1 Rs. -0-

Assets = Liabilities + Capital

Investments by owner Rs. 2,000

Questions for Class Discussion

3 The purchase of office equipment on credit will:

b The assets, liabilities and capital of a firm at a point in time

Cash in side .....................… 4,000

Cash Debtors Office Supplies Office Furniture Creditors Raja’s Capital

Cash, debtors, medical equipment, office supplies, creditors’ and Imran’s

g Billed customers for services performed Rs. 1,600.

h Paid expenses of Rs. 1,700 in cash.

Withdrawal by Qasim Rs. 33,200 Salaries expense Rs. 12,300

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