Unit 3.4 Chp 1-4

20 UNIT 3 FINANCIAL ACCOUNTING FOR A TRADING BUSINESS
However, a present obligation does have consequences for the future. If the obligation
is still ‘present’, it means it must have not yet been ‘met’ or ‘settled’, meaning the
business is still obliged to take action (to settle the debt). The Going concern assumption
allows businesses to report as liabilities these amounts which are due to be settled at
some time in the future.
Transfer an economic resource
In many cases, the economic resource to be transferred will be cash, and the transfer will
occur when the business pays its debts. This would certainly be the case for amounts
owed to Accounts Payable (creditors) and banks for loans.
However, this is not always the case, as there may be an alternative economic
resource that must be transferred. A business that has received cash in advance for
goods yet to be supplied is obliged to transfer the goods. In this case, the resource is the
goods rather than cash that must be transferred to meet its obligation and settle its debt.
Past event
As with assets, this aspect of the definition helps to distinguish between items that are
already liabilities, and items that should not be recognised as liabilities yet. An entity
has a present obligation as a result of a past event only if it has already received the
economic benefits, or conducted the activities, that establish its obligation.
owner’s equity
the residual interest in the
assets of an entity after the
deduction of its liabilities
Owner’s equity
Owner’s equity is the residual interest in the assets of the entity after the deduction
of its liabilities. In effect, owner’s equity is what is left over for the owner once a firm
has met all its liabilities. Because the owner and the firm are considered to be separate
entities, it can also be described as the amount the business ‘owes the owner’.
Given that owner’s equity is derived by deducting liabilities from assets, it is fair
to say that owner’s equity is a function of, and depends on, liabilities and assets. It is
thus the element that makes the Accounting equation balance (but more about this in
Chapter 2).
Revenues and expenses
Whereas assets, liabilities and owner’s equity represent balances – amounts at a
particular point in time – revenues and expenses represent flows: the amounts by which
those balances have increased or decreased during a period.
revenue
increases in assets or
decreases in liabilities that
result in increases in owner’s
equity, other than those relating
to contributions from the owner
Revenues
Revenues are increases in assets or decreases in liabilities that result in increases in
owner’s equity, other than those relating to contributions from the owner.
Applying the Accounting entity assumption, inflows from capital contributions are
excluded because they occur not due to the activities of the business, but rather the
actions of the owner. This means revenue represents the increases in owner’s equity
that occur through business activities.
In most cases revenue will represent what the business has gained from the goods
it has sold or the work it has done. But there are other forms of revenue, and although
revenue may take the form of cash, this is not a requirement. Credit sales would be
revenue in the form of an increase in an asset other than cash (namely, Accounts
Receivable), whereas Discount revenue would take the form of a decrease in a liability
(Accounts Payable). The key is that a revenue must increase owner’s equity, but not as
a consequence of the owner making a contribution.
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