Unit 3.4 Chp 1-4

32 UNIT 3 FINANCIAL ACCOUNTING FOR A TRADING BUSINESS
about future cash needs or borrowings. (This is, in effect, an assessment of the firm’s
liquidity by calculating its Working Capital Ratio but we will leave this until Chapter 19).
Review questions 2.3
1 Distinguish between current assets and non-current assets.
2 List three current assets and three non-current assets.
3 Distinguish between current liabilities and non-current liabilities.
4 List three current liabilities.
5 Explain how a mortgage should be classified in the Balance Sheet.
6 Referring to one Qualitative characteristic, explain one benefit of classifying
the Balance Sheet.
2.4 Double-entry Accounting
double-entry Accounting
a system that records at least
two effects on the Accounting
equation as a result of each
transaction
Although the Balance Sheet states a firm’s financial position at a particular point in
time, this position is not static: it will change after every transaction. For example, if
the business buys Inventory on credit, its assets (Inventory) will increase, but so will
its liabilities (Accounts Payable); if it pays cash for new carpet, its Bank balance will
decrease, but its Shop fittings will increase.
Specifically, when a business exchanges goods and/or services with another entity,
at least two items will change in its Accounting equation and, therefore, its Balance
Sheet. This is true of every transaction that a firm could have. This means the Accounting
equation and the Balance Sheet will need to be rewritten after every transaction. At
the same time, the Accounting equation must always balance, so even after each
transaction has been recorded, the Accounting equation – and therefore the Balance
Sheet – must still balance.
These two rules form the basis of what is known as double-entry Accounting.
Rules of double-entry Accounting
1 Every transaction will affect at least two items in the Accounting
equation.
2 The Accounting equation must always balance.
Example
Imelda’s Shoe Shop has presented the following transactions:
1 Imelda contributed $20 000 to establish a business bank account and
commence operations as ‘Imelda’s Shoe Shop’.
2 Purchased inventory on credit from Milano Leather Products for $45 000.
3 Paid $12 000 to purchase new shop fittings.
1 Imelda contributed $20 000 to establish a business bank account and
commence operations as ‘Imelda’s Shoe Shop’.
As a result of this transaction, the business now has $20 000 in its Bank account:
an increase in its assets of $20 000. In addition, because that cash came from the
owner (who is assumed to be a separate Accounting entity), the Owner’s equity has
increased by $20 000.
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