Paul Grimes has recenty been made redundant from his job as a computer engineer with a multinational company. He received redundancy pay of 30,000, and he has decided to use this, together with his savings of 10,000, to set up business as a sole trader, offering computer sales and services to the local community where he lives. He has been in business for three months now, and things seem to be going well, but he is very confused by the concepts of capital, assets, liabilities, revenue and expenses and how these affect the way in which the various day to day activities of his business are recorded. He comes to you, his friend, for help, knowing that you are studying an accounting and finance module. He gives you the following list of transactions and 6 asks you to explain to him how each of the items listed will be classified, and why, and where each will appear in the financial statements. He understands the basic ideas underlying an income statement and a balance sheet but does not understand how transactions end up in one statement or the other. Below are 7 transactions listed: Putting 40,000 in a business bank account on 1 September 2020. Renting a small shop/workshop in the high street of the village in which he lives for 12,000 per annum, initially for a three-year period, with a penalty of 2,000 if he ends the lease before the three-year period is over. The $12,000 was paid by check on 1 October 2020, a month after Paul set up business. He managed without business premises initially, but his wife became annoyed at constantly finding computer bits all over the lounge carpet, so he decided to rent somewhere near to home. The rent includes a charge for heating, lightning, business rates and property maintenance and Paul thinks the lease agreement is a good deal. Purchasing a computer on 2 September 2020 for use in his business for 1,500 on credit. Paul estimates that the computer will have a useful life of three years, after which it will be scrapped, as Paul thinks he will be unable to sell it. Paul thus plans to charge 500 per annum (pro-rated as necessary) as an expense for depreciation in his income statement. Purchasing five computers on 10 September 2020 on credit for inventory, each costing 1,000 which he can customize to specific clients requirements. Purchasing computer components for 3,000 cash on 11 September 2020. Selling three of the five computers above, for 2,000 each, to three different clients, one for cash and two on credit, in November 2020. He used components, which had cost 500 in total, to customize these computers to clients requirements (The unsold computers and unused computer components should be included as closing inventory items when any income statement is prepared). Purchasing a van for business use for 12,000 cash on 2 September 2020. He thinks this will last for five years, and then will be scrapped for 2,000. Paul thinks that an annual charge for depreciation (an expense) should be 2,000 (pro-rated as necessary). His van running expenses for the first three months are 400. Paul decided to have 31 August each year as his accounting date.

questions

i. For each of the seven items listed above, explain to Paul how these transactions will be treated in his financial statements for the year ended 31 August 2021, that is, as capital, assets, liabilities, revenue or expenses, and state whether they will appear in the income statement and/or balance sheeet. You can make reasonable accounting assumptions if necessary.

ii. Paul thinks his business is going reasonably well. Is it? Work out whether Paul has made a profit or loss for this first three months of trading and comment on your findings.