ACTG 2010 Notes PDF

ACTG 2010 Section B Tutorial #3  Chapter 1: Overview of Corporate Financial Reporting 1.1 Intro to Financial Reporting The Role of Accounting in Business Growth Accounting information serves as the foundation for business decision-making at various stages of development, whethe...

ACTG 2010 Section B Tutorial #3  Chapter 1: Overview of Corporate Financial Reporting 1.1 Intro to Financial Reporting The Role of Accounting in Business Growth Accounting information serves as the foundation for business decision-making at various stages of development, whether a company is: Raising capital for start-up or expansion, Restructuring its operations, or Evaluating capital expenditures such as purchasing or leasing equipment. Accounting data is critical not only to businesses but also to individuals in making informed decisions, including whether to: Invest in a company's stock, Pursue employment with the firm, or Enter into contractual agreements with it. Financial accounting refers to the process of recording, analyzing, and reporting financial transactions to external stakeholders who are not involved in the daily operations of the organization. It is often termed external financial reporting as its primary audience includes: Investors, who use financial data to assess returns and risks, and Creditors, who require reliable information to determine an organization's creditworthiness. The principal aim of financial accounting is to assist these external users in making economic decisions regarding the organization. As these users typically do not have internal access to the company’s detailed operations, financial accounting provides them with a comprehensive overview, functioning as a critical window into the organization. Financial Accounting vs. Managerial Accounting While financial accounting focuses on external reporting, managerial accounting is intended for internal decision-making. Key differences include:  Financial Accounting: o Audience: External stakeholders such as investors, creditors, and regulators. o Purpose: Supports external economic decision-making by providing a high-level view of the organization’s financial health. Managerial Accounting: o Audience: Internal management. o Purpose: Facilitates operational decisions by providing detailed and segmented financial data, such as specific department or store performance. o Focuses on forward-looking information like budgets and forecasts, unlike the historical nature of financial accounting. Managerial accounting often involves detailed internal reports that are not disclosed to external parties, as they are tailored to meet the specific informational needs of management. Types of Accounting Reports 1. Internal Reports (Managerial Accounting): o These are confidential reports designed to aid management in making day-to-day operational decisions. Examples include budget variance reports, cost analyses, and performance metrics. 2. External Reports (Financial Accounting): o These are formal, standardized reports provided to external stakeholders to inform investment and lending decisions. The most common are the financial statements, including: ▪ Income Statement: Reflects the company’s profitability over a specific period. ▪ Balance Sheet: Provides a snapshot of the organization’s financial position by detailing its assets, liabilities, and shareholders' equity. ▪ Cash Flow Statement: Tracks the inflows and outflows of cash, revealing how the company generates and utilizes cash resources. Financial Statements and Reporting The primary focus of financial accounting lies in producing and reporting financial statements. These reports are typically issued at the end of each accounting period (e.g., quarterly or annually) and offer a comprehensive review of the organization's financial condition. The annual financial statements are included in the organization’s annual report, which serves as a key communication tool to stakeholders. The annual report typically includes: 1. Financial Statements: o Income Statement, Balance Sheet, and Cash Flow Statement, among others. 2. Management Discussion and Analysis (MD&A): o A narrative that provides management’s perspective on the financial results, significant trends, and outlook. Although the primary audience for the annual report is the company’s shareholders, it is also used by a wide range of external parties, including: Lenders assessing the company's ability to meet debt obligations, Financial analysts evaluating the company’s performance and prospects, Credit-rating agencies determining the company’s creditworthiness, and Regulatory bodies ensuring compliance with financial reporting standards. Conclusion In summary, financial accounting serves a critical role in enabling external stakeholders to make informed decisions about the organization by providing standardized, reliable financial data. It contrasts with managerial accounting, which focuses on internal operational needs. A solid grasp of financial accounting principles is essential for anyone participating in financial markets, engaging with business enterprises, or making personal economic decisions. 1.2 Users and Uses of Financial Accounting Financial accounting is essential for providing information that helps various stakeholders make informed decisions about a business. Common Questions Business Stakeholders Ask Different stakeholders have varied information needs, and financial accounting helps answer key questions relevant to each group: Stakeholders Questions They Ask Is the company profitable? Will bonuses be offered? Can wages be Employees, unions increased? How do sales compare to previous years? Are profit margins being Management maintained? Auditors, government Is the financial information presented fairly? Is it compliant with tax officials regulations? Investors, potential What are the long-term prospects of the company? Is it a sound shareholders investment? What are the company’s trends? How does performance align with Stock analysts, brokers expectations? Creditors, suppliers, Should we extend credit to this company? Will they pay back loans or meet landlords obligations? Internal vs. External Users of Financial Statements Financial statement users are categorized into two groups: Internal Users: Primarily management, who use financial data for decision-making, strategic planning, and performance evaluation. External Users: Shareholders, creditors, regulators, and others who require financial statements to assess the company’s financial health, compliance, and long-term prospects. External Users and Their Information Needs 1. Shareholders and the Board of Directors: Shareholders are investors who own a portion of the company. Whether in a public or private  company, shareholders depend on financial reports to evaluate the management’s effectiveness and determine if their investments are yielding returns. Key concerns include: o Is the company generating sufficient returns? o Is the strategic direction contributing to increased sales and profitability? o How is the current board performing in its oversight role? 2. Creditors: Creditors, such as banks or suppliers, lend money or offer goods and services on credit. They rely on financial statements to assess: o The company’s ability to repay loans (e.g., examining cash flows, asset security). o Short- and long-term financial stability to ensure their investments are protected. 3. Regulators: Financial regulators, including stock exchanges and government agencies, monitor whether businesses comply with financial reporting standards. Failure to comply can result in penalties or delisting from stock exchanges, as seen with Wildflower Brands Inc., which faced a cease-trade order for failing to file its financial statements. 4. Taxing Authorities: The Canada Revenue Agency (CRA) uses financial accounting information to assess tax obligations. Corporate taxable income is derived from accounting income, making accurate reporting essential for compliance. 5. Other Users: o Competitors: Analyze financial information to evaluate the strength of rivals. o Securities Analysts and Credit Rating Agencies: Assess companies’ financial health for investors and creditors. o Labour Unions: Review company financials during wage and benefit negotiations. o Journalists: Use financial statements to validate company disclosures and report on business performance. Conclusion Understanding financial accounting is crucial for any business professional, regardless of their role. Whether as a manager, investor, creditor, or advisor, being able to interpret and analyze financial statements is essential for making informed decisions. This course will guide you in becoming an informed user of accounting information, equipping you with the skills to understand financial performance and drive business success. 1.3: Forms of Business Organization Key characteristics of a corporation Separate Legal Entity: Corporations are legally distinct from their owners (shareholders). This provides limited liability, meaning that shareholders are only responsible for the company's debts up to the amount of their investment. Ownership: Ownership in a corporation is represented by common shares, which are issued to shareholders in exchange for assets or cash. There are two main types of corporations: 1. Public Corporations: Listed on public stock exchanges (e.g., TSX), with shares that are widely held and frequently traded. 2. Private Corporations: Not listed on public exchanges, and ownership is typically concentrated in a small group of shareholders. Shareholders typically do not participate in day-to-day operations (especially in large corporations). Instead, they elect a board of directors to oversee the management team Key Distinctions Between Forms of Business Feature Corporation Proprietorship Partnership Number of Can have a single owner or multiple Single owner Multiple owners Owners shareholders Yes, with shareholders’ personal Separate Legal No, personal assets No, personal assets are at assets protected from business Entity? are at risk risk liabilities Owners Responsible for Only liable up to their investment Yes, fully liable Yes, fully liable Debts? Taxed Yes, corporation pays taxes on its No, income taxed No, income taxed Separately? earnings through the owner through the partners Moderate, often requires Costs to High, due to legal and regulatory Low, minimal setup a formal partnership Establish requirements costs agreement Low, minimal Moderate, depends on Costs to High, requires regular reporting, administrative the complexity of the Maintain including financial statements requirements partnership Feature Corporation Proprietorship Partnership Financial Yes, publicly traded companies must Information disclose financials regularly (quarterly No, private financials No, private financials Disclosure and annually) 1.4: Activities of a Business Categories of Business Activities: 1. Financing Activities: Financing activities involve securing the funds needed to start and grow a business. There are two main sources of financing: Investors (through issuing shares) Creditors (through loans or credit) Key Points: Investors purchase shares in exchange for cash or assets, seeking a return through dividends and capital appreciation. Creditors lend money to the company, expecting returns in the form of interest and the return of principal. Example of Financing Activities: Inflows: Borrowing money (loans), issuing shares. Outflows: Repaying loans, paying dividends to shareholders. 2. Investing Activities: Investing activities : securing funds: Long-term investments in property, plant, and equipment (PPE). Short-term investments in inventories and materials for day-to-day operations. Key Points: Long-term investing includes purchasing or selling assets like equipment or real estate. Short-term investing includes the buying and selling of shares in other companies or raw materials for production. Example of Investing Activities: Inflows: Proceeds from selling equipment or shares in other companies. Outflows: Purchase of new equipment, acquisition of shares in other companies. 3. Operating Activities: Operating activities are the core day-to-day activities of a business. These activities relate to developing, producing, marketing, and selling the company's products and services. Key Points: Revenues: Cash inflows from sales to customers. Expenses: Cash outflows for the costs of running the business, such as wages, rent, taxes, and interest. Example of Operating Activities: Inflows: Cash received from customer sales, collections of receivables. Outflows: Payments for inventory, wages, rent, utilities, taxes. Operating activities are the most critical to a business. Insufficient cash from operations leads a company to struggle to sustain itself leading to an inability to attract investors or obtain credit. Importance of Understanding Business Activities: Financial statements provide insights into the three categories of activities. A company's success depends on managing these activities effectively: Financing: Ensuring sufficient capital for growth. Investing: Deploying resources to generate returns. Operating: Continuously driving revenue and managing expenses to remain profitable. 1.5: Financial Reporting Components of Financial Statements Statement of Income o Objective: Present results of operating activities over a period (month, quarter, year). o Includes: Revenues, gains, expenses, losses, and profit (net income or net earnings). o Alternative Names: Statement of operations, Statement of net earnings, Statement of earnings, Statement of profit or loss. o Key Points: ▪ Income: Increases in economic resources from ordinary activities (revenues) and outside normal operations (gains). ▪ Expenses: Decreases in economic resources (costs of goods sold, wages, etc.). ▪ Gross Profit: Revenue minus cost of goods sold (expressed as a percentage for better insight). ▪ Net Earnings: Revenue after all expenses (profit margin analysis). ▪ Earnings per Share (EPS): Net income divided by average number of shares; indicates investor's share of earnings. Statement of Changes in Equity o Objective: Show changes in shareholders’ equity over a period. o Includes: Share capital, retained earnings, contributed surplus, and accumulated other comprehensive income. o Alternative Names: Statement of shareholders’ equity, Statement of changes in shareholders’ equity, Statement of equity. o Key Points:  ▪ Share Capital: Changes from issuing or repurchasing shares. ▪ Retained Earnings: Net income - dividends Statement of Financial Position (Balance Sheet) o Objective: Provide a snapshot of assets, liabilities, and shareholders' equity at a specific date. o Includes: Assets (current and non-current), Liabilities (current and non-current), Equity. Statement of Cash Flows o Objective: Show cash inflows and outflows over a period. o Includes: Operating activities, Investing activities, Financing activities. Notes to the Financial Statements o Objective: Provide additional context and details that support the main financial statements. o Includes: Accounting policies, additional details on specific items, and explanations of significant events or transactions. Common Shareholders’ Equity Components Share Capital o Definition: Represents funds received when shares are initially issued to investors. o Types of Shares: ▪ Common Shares: Typically come with voting rights and dividend payments. ▪ Preferred Shares: Often have preferential rights over common shares, such as fixed dividends. o Classes of Shares: Different classes may have distinct rights and privileges. Retained Earnings o Definition: Earnings retained in the company after paying dividends, as reported on the statement of income.  o Negative Balance: If net losses exceed net income, it results in a deficit. Statement of Financial Position (Balance Sheet) Objective: Provide a snapshot of the company’s financial status at a specific point in time. 1. Components: o Assets: Resources owned by the company (e.g., cash, inventory, property). o Liabilities: Obligations the company needs to settle (e.g., loans, accounts payable). o Shareholders’ Equity: The residual interest in the assets after deducting liabilities (includes share capital and retained earnings). 2. Format: o Classified Statement: Presents information based on liquidity. ▪ Current Assets: Expected to be converted to cash or used within 12 months. ▪ Non-Current Assets: Expected to be used beyond 12 months. ▪ Current Liabilities: Obligations to be settled within 12 months. ▪ Non-Current Liabilities: Obligations to be settled beyond 12 months. 3. Liquidity Measures: o Working Capital: ▪ Equation: Working Capital = Current Assets - Current Liabilities ▪ Purpose: Measures the company’s ability to meet short-term obligations. ▪ Example: Dollarama had a working capital of negative $220.8 million as of January 31, 2021, indicating a shortfall in current assets relative to current liabilities. Accounting Equation: Assets = Liabilities + Shareholders’ Equity Purpose: Provides the structure for the statement of financial position, ensuring that the balance sheet balances. Assets 1. Definition: o General: Something of value that the company owns or has the right to use. o Accounting Definition: Must meet three criteria (Exhibit 1.18): ▪ Control: The company controls the economic resource. ▪ Future Benefits: The company expects future economic benefits from the resource. ▪ Past Event: The event that gave the company control has already occurred. 2. Examples (Dollarama): o Current Assets: ▪ Cash ▪ Accounts Receivable ▪ Prepaid Expenses ▪ Inventories o Non-Current Assets: ▪ Property, Plant, and Equipment (Capital Assets) ▪ Right-of-Use Assets (Leased assets) ▪ Intangible Assets (e.g., patents, trademarks) ▪ Goodwill Liabilities 1. Definition: o General: Amounts the company owes to others, also known as debt or obligations. o Accounting Definition: Must meet three criteria (Exhibit 1.20): ▪ Present Obligation: The company has a present obligation. ▪ Future Outflow: The company expects to settle it through an outflow of resources. ▪ Past Event: The obligation results from a past event. 2. Examples (Dollarama):  o Current Liabilities: ▪ Accounts Payable ▪ Dividends Payable ▪ Income Taxes Payable ▪ Lease Liabilities o Non-Current Liabilities: ▪ Long-term Debt ▪ Notes Payable ▪ Deferred Income Taxes Shareholders’ Equity 1. Definition: o General: The residual interest in the assets of the company after deducting liabilities. o Accounting Equation Rearranged (Exhibit 1.22): ▪ Formula: Assets - Liabilities = Shareholders’ Equity (Net Assets) 2. Components: o Share Capital: Amount originally invested by shareholders. o Retained Earnings: Accumulated earnings not paid out as dividends. 3. Shareholders’ Equity Example (Dollarama): $330 million as at January 31, 2021. Market Value vs. Book Value o Market value reflects the price of shares in the stock market, which may differ from the book value reported on the financial statements. o Shareholders' equity is a measure of net assets, while market value reflects future expectations. Information Flows Between Financial Statements Statement of Cash Flows 1. Objective: o To assess the company’s cash inflows and outflows related to operating, investing, and financing activities.  o Operating Activities: Cash flows from core operations. o Investing Activities: Cash flows from purchasing/selling long-term assets. o Financing Activities: Cash flows from transactions with investors and creditors. Summary of the Financial Statements 1. Statement of Income Purpose: Measures a company’s operating performance over a period. 2. Statement of Changes in Equity Purpose: Measures changes in equity over time, distinguishing between transactions with shareholders and operational results. 3. Statement of Financial Position Purpose: Measures assets controlled by a company and the claims on these resources (by creditors and investors) at a specific point in time. 4. Statement of Cash Flows Purpose: Measures changes in cash flow from operating, financing, and investing activities over time. Notes to Financial Statements Purpose: Provides additional detail on specific items like inventory types and long-term assets. Helps clarify financial statements and enhance user understanding. Key Notes: o Basis of preparation (e.g., IFRS for Canadian companies) o Significant accounting policies used Climate Change Impact Importance: Increasing interest in how climate change affects financial statements. Current Practice: Majority of Canadian companies report some climate-related information, but inconsistencies exist. Future Developments: IFRS Foundation plans to establish a Sustainability Standards Board to create global sustainability reporting standards. Management Discussion and Analysis (MD&A) Purpose: Provides senior management’s perspective on financial statements. Includes: o Prior year’s financial results  o Risks and future plans o Information on significant events, sales, profits, cash flow, and more Ethics in Accounting Role of Accountants: Expanding to include environmental and social reporting. The concept of the “warrior accountant” reflects the growing role of accountants in sustainability and social issues. Examples of Standards: o Hotels: Energy consumption, water usage, wages o Restaurants: Waste management, packaging materials o Agriculture: Compliance with water quality standards, recall issues o Food Retailers: Fuel consumption, health and nutrition revenue CH 1: Practice Tutorial Questions DQ1-6 1) Investors: Investors use financial statements to assess the profitability of of a company. They analyzie the income statement to evaluate the profit margins, the balance sheet to fish out financial stability, and the cash flow to ensure that the company can meet its debt obligations. 2) Creditors and Lenders: Creditors like banks and other faculties use financial statements to evaluate the company’s ability to repay loans. They focus on the liquidity ratios, solvency, and cash flow the most. 3) Management: Internal Management uses the documents for decision making about performance and strategies. They use it to track revenues, expenses, and profitability to make decisions on budgeting and investing to improve efficiency. UP1-2 What items on your financial statements would be of the most interest to the loan officer? Cash Flow Statement: The bank would like to examine the cash flow, particularly OPERATING CASH FLOW. This ensures that the company has enough cash inflow to pay back loans and other liabilities. Balance Sheet: Current Assets: The bank would asses the liquidity (current ratio: current assets/current liabilities) to determine if your company has enough cash to liquid to cover short term liabilities. Total Assets: To determine sufficient collateral for the loan.  Income Statement: Net Income: Lenders will evaluate profitability over time frames to see if the business is consistent with their profits and can pay back loans. This also shows the how much buffer space the company has between their revenues and expenses. a) Develop four questions that you think the loan officer would be trying to answer by looking at your financial statements. 1) Does the company generate enough cash to repay the loan? 2) Is the company profitable and stable over time? 3) How much debt does the company have? Contrast with their assets 4) Does the company have enough collateral to provide in return for the loan? RI1-1 Determine the number of dividends that Leon’s declared in 2020. On which financial statement(s) did you find this information? 69,977 Find the following amounts in the statements: 1. Revenue in 2020: $2,220,180 2. Cost of sales in 2020: $1,236,258 3. Gross profit (as a dollar amount and as a percentage) in 2020: $983,922 4. Selling, general, and administrative expenses in 2020: $750,951 5. Income tax expense in 2020: $47,235 6. Net income in 2019: $106,929 7. Trade receivables at the end of 2019: $140,535 8. Inventories at the end of 2020: $332,072 9. Trade and other payables at the beginning of the 2020 fiscal year: $256,539 10. Retained earnings at the end of 2020: $842,604 (changes in the shareholders equity and the statements of financial position) 11. Loans and borrowings at the beginning of 2020 (include the current portion): 2,500+70,000 (exists in current and noncurrent: some loans are due within different time frames) 12. Cash flows provided by operating activities in 2020: $511,424 (cash flow) 13. Cash payments to purchase property, plant, and equipment in 2020: $140,535 14. Cash payments for dividends in 2020: $44,636 15. Cash flows generated by (used in) financing activities in 2019: 16. Cash payments to repurchase common shares in 2020: 164,669 List the two largest sources of cash and the two largest uses of cash in 2020. (Consider operating activities to be a single source or use of cash.) Sources: Cash provided by operating activities ( 511,424) and Proceeds on sale of debt and equity instruments ( 30,586) Uses: Payment of lease liability ( 71,076) and Repurchase of common shares ( 48,202) Suggest two reasons why net income was $163,250 thousand in 2020, yet cash provided by operating activities was $511,424 thousand. Net Income is different because it of the difference in accrual and cash accounting. You have to adjust for noncash transactions. For example: Unearned Revenue: you receive cash form selling apple care that has a 2 year coverage. Cash Unearned Revenue (apple care has a 2 year coverage) Now the cash goes up but the net income doesn’t as unearned revenue is not part of revenue but rather liability. During 2020, total revenue was approximately $63,231 thousand lower than in 2019. However, net income in 2020 was $56,321 thousand higher than in 2019. Examine the consolidated statements of income and explain how this was possible. Revenue went down but net income went up (COGS went up and SGNA went down)  Chapter 2: Analyzing Transactions and their Effect on Financial Statements 2.1 Accounting Standards Overview When companies report their financial information, they need to follow specific accounting standards to ensure consistency and clarity. These standards provide guidelines that help companies prepare their financial statements in a standardized manner, which makes the information more useful to users such as shareholders, creditors, and analysts. Without these guidelines, companies would have vastly different methods of reporting, making comparisons between them difficult and unreliable. Types of Accounting Standards in Canada 1) International Financial Reporting Standards (IFRS) Required for public companies (those listed on Canadian stock exchanges like the Toronto Stock Exchange). Used in over 120 countries, including Canada, but not the United States. Essential for companies that are interlisted or cross-listed on international stock exchanges, as it minimizes the need to create separate financial statements for different countries. Many companies, especially those listed on multiple stock exchanges (like the NYSE, London Stock Exchange, etc.), benefit from using IFRS. This allows their financial statements to be accepted across various jurisdictions, saving the company time and resources by avoiding the need to prepare multiple sets of financial statements. 2) Accounting Standards for Private Enterprises (ASPE) Followed by private companies in Canada, but they have the option to use IFRS. ASPE is a simplified version of accounting standards, designed to reduce the reporting burden on private companies. Objective of Accounting Standards The standards prioritize the needs of shareholders and creditors by focusing on information that helps these users make decisions, such as whether to invest or extend credit. Other users, such as employees, unions, and governments, also benefit, although their needs may not align perfectly with shareholders and creditors. Who Sets Accounting Standards in Canada? The Canadian Accounting Standards Board (AcSB) is responsible for developing and establishing accounting standards in Canada. It oversees the standards for both public and private companies. The AcSB made IFRS mandatory for public companies in Canada starting from January 1, 2011. Ongoing development of IFRS is managed by the International Accounting Standards Board (IASB), but the AcSB has ultimate authority over whether Canadian companies continue to use IFRS.  2.2 Qualitative Characteristics of Financial Information Understanding Useful Financial Information The goal of both IFRS (International Financial Reporting Standards) and ASPE (Accounting Standards for Private Enterprises) is to produce financial information that is useful to financial statement users. The IASB (International Accounting Standards Board) and AcSB (Accounting Standards Board in Canada) have developed conceptual frameworks to guide in setting accounting standards, and the framework focuses on two primary aspects: 1. Relevance: Information must matter to users in their decision-making. 2. Faithful Representation: Information must reflect the reality of the transactions and events. These two are fundamental qualitative characteristics, meaning they are essential for information to be considered useful. Without them, financial information is useless. Fundamental Qualitative Characteristics: Relevance: o Predictive Value: Information helps users predict future outcomes. o Confirmatory Value: Information helps users confirm or correct prior expectations. o Materiality: Information is material if its omission or misstatement would influence decisions. Faithful Representation: o Completeness: Information includes all necessary details for users. o Neutrality: Information is unbiased and presented without slant. o Freedom from Error: Information is as accurate as possible, given the current context. Enhancing Qualitative Characteristics: These characteristics improve the usefulness of financial information but cannot make useless information useful. Comparability Users should be able to compare financial information across different companies or periods. Verifiability Independent observers should be able to agree that the information is faithfully represented. Timeliness Information should be provided promptly so that users can make decisions with up-to-date information. Understandability Information should be clear and concise for users with reasonable knowledge of business and accounting. Cost Constraint All financial information is subject to a cost constraint, meaning the costs of providing the information must not exceed the benefits. This balances the need for detailed, useful financial information with the practicalities of gathering and reporting it. 2.3: Accrual vs Cash Basis Accounting Cash Basis of Accounting Definition: Transactions are recorded only when cash is received or paid. Key Points: o Revenues are recognized when cash is received. o Expenses are recognized when cash is paid. Example: o A university records all tuition fees as revenue when students pay at the start of the semester, not as the instruction is delivered. Similarly, employee wages are recorded as an expense only when they are paid, not when the services are provided. Impact on Financial Statements: o Financial statements can be misleading, as cash received or paid in one period might not reflect when the revenue is actually earned or the expense incurred. For example, a university’s September financials might show high revenue due to tuition payments but no expenses for the services that will be provided in later months. Accrual Basis of Accounting Definition: Transactions are recorded in the period in which they are earned or incurred, regardless of when cash is received or paid. Key Points: o Revenues are recognized when they are earned (when goods or services are provided). o Expenses are recognized when they are incurred (when obligations arise, such as when employees perform work). Example: o A university records tuition as revenue over the semester, in proportion to the weeks of instruction provided, even if the tuition was paid in full at the start. Employee wages are recorded in the periods they work, not when they are paid. Impact on Financial Statements: o Financial statements provide a more accurate reflection of a company’s financial performance. The university's financials would show revenue spread across the semester and wage expenses recognized as work is performed, offering a clearer view of operations. Comparison of Cash vs. Accrual Basis Aspect Cash Basis Accrual Basis Revenue Recognition When cash is received When revenue is earned Expense Recognition When cash is paid When expenses are incurred Financial Statement Impact Can fluctuate based on cash flow More stable and reflective of real events Ethical Considerations Under the cash basis of accounting, it is easier for management to manipulate financial statements. For example: Inflating Revenue: Encourage customers to pay before the period ends to recognize more revenue. Understating Expenses: Delay payments to suppliers or employees to reduce expenses in the current period. Accrual Basis and the Conceptual Framework The IFRS conceptual framework supports the accrual basis because it offers a more faithful representation and is more useful for assessing an entity’s past and future performance. Accrual accounting provides a better basis for decision-making by showing when economic events actually occur, not just when cash flows take place. 2.4: The Accounting Equation Template Approach Accounting Equation Assets = Liabilities + Shareholders’ Equity Template Approach Structure Transaction Analysis Each transaction is analyzed to determine which accounts it affects (e.g., Cash, Accounts Receivable, Equipment, etc.). Expanded Accounting Equation: o The template approach expands the basic equation to include more specific accounts under assets, liabilities, and shareholders' equity. o Example: ▪ Assets: Cash, Accounts Receivable (A/R), Inventory (Inv.), Prepaid Insurance, Equipment, Land ▪ Liabilities: Accounts Payable (A/P), Interest Payable, Bank Loan Payable ▪ Shareholders’ Equity: Common Shares, Retained Earnings (R/E), Retained Earnings from Revenues (R), Expenses (E), and Dividends Declared (DD). Retained Earnings: Retained earnings are affected by: o Revenues (R): Increase retained earnings o Expenses (E): Decrease retained earnings o Dividends Declared (DD): Decrease retained earnings Recording Transactions in the Template Date and Account Columns: Transactions are recorded chronologically in rows, and each row shows the changes in affected accounts.  Key Rules: 1. Two-Account Rule: Every transaction must affect at least two accounts (e.g., Cash and Accounts Payable). 2. Balancing Rule: The accounting equation must stay in balance after each transaction. 3. Retained Earnings Rule: Any change in Retained Earnings (R/E) must be accompanied by an entry explaining if it is due to revenues, expenses, or dividends declared. 2.5: Analyze and Record Transactions **Explanations found in textbook #1 #2 #3 #4 #5 #6 #7 #8 #9 #10 #11 #12 #13 #14 #15 #16 #17 OVERVIEW 2.6: Financial Statements 1. Statement of Income Purpose: Shows a company's revenues and expenses to calculate net income (profitability) during an accounting period. Structure: o Revenues: Sales Revenue o Expenses: Cost of Goods Sold (COGS), Operating Expenses (e.g., wages, rent), and Interest Expense. o Net Income: Revenue minus Expenses. o Gross Profit: Revenue - COGS (e.g., SCL's gross profit was 50% for January). 2. Statement of Changes in Equity Purpose: Reflects changes in shareholders' equity over a period, showing how net income and dividends affect retained earnings. Components: o Common Shares: Number of shares issued and capital received from shareholders. o Retained Earnings: Start with the previous period, add net income, subtract dividends declared. o Example: For SCL, common shares were $250,000, and retained earnings increased by $7,400 (net income) minus $400 (dividends). 3. Statement of Financial Position (Balance Sheet) Purpose: Displays a company’s financial position at the end of an accounting period. Key Accounts: o Assets: Current (e.g., cash, inventory) and non-current (e.g., equipment, land). o Liabilities: Current (e.g., accounts payable) and non-current (e.g., bank loans). o Shareholders’ Equity: Common shares and retained earnings. o Key Metrics: ▪ Working Capital: Current assets minus current liabilities (e.g., SCL had $112,850 in working capital). ▪ Debt-to-Equity Ratio: Percentage of assets financed by equity vs. debt (e.g., 70% of SCL’s assets financed by equity). 4. Statement of Cash Flows Purpose: Shows how cash is generated and used over the accounting period. Activities: o Operating: Cash from sales, payments for expenses (e.g., wages, utilities). Normally a net inflow. o Investing: Cash outflows for long-term assets (e.g., equipment, land). Usually a net outflow. o Financing: Cash inflows from issuing shares or taking loans, outflows for dividends. Generally positive for new businesses. 5. Key Insights Net Income: Important for future financial statements (e.g., contributes to retained earnings). Dividends: Not included in the statement of income; reported on the statement of changes in equity. Liquidity: Working capital and current ratios help assess a company's ability to meet short-term obligations. Financing vs. Equity: Important to analyze how assets are financed and the proportion between debt and equity. 2.7: Ratios Introduction to Ratio Analysis Purpose: Ratios help users compare companies of different sizes and analyze the same company over time. Types of Analysis: o Profitability o Management effectiveness o Debt obligations Profitability Ratios: These compare profit with revenue or the amount invested. Profit Margin Ratio Formula: Profit Margin = Net Income/ Revenue Interpretation: Measures the percentage of sales that results in profit after all expenses. Example (SCL): Aritzia Example: Return on Equity (ROE) Ratio Formula: ROE=Net Income/Shareholders’ Equity Interpretation: Shows how effectively a company generates profit from shareholders’ equity. Example (SCL):  Aritzia Example:. Return on Assets (ROA) Ratio Formula: ROA=Net Income/Total Assets Interpretation: Indicates how effectively a company uses its assets to generate profit. Example (SCL): Aritzia Example: Conclusion Profit Margin: Measures how much profit is earned per dollar of revenue. Return on Equity: Assesses how effectively shareholder investment is used to generate profit. Return on Assets: Indicates how efficiently assets are being used to generate profit  CH 2: Practice Tutorial Questions DQ2-9: 1. Accrual Basis of Accounting The accrual basis of accounting records revenues and expenses when they are earned or incurred, regardless of when cash is received or paid. This method provides a more accurate picture of a company's financial position during a specific period. Advantages of Accrual Basis: More Accurate Financial Picture: It matches revenues with the expenses incurred to generate those revenues, providing a clearer picture of a company's profitability. REVENUE IS EARNED AND EXPENSES ARE INCURRED Better for Long-Term Decision Making: Accrual accounting reflects the company's obligations and earned revenue, giving a realistic view of future cash flows. Required by Accounting Standards: Public companies and larger organizations are generally required to use accrual accounting to comply with standards like IFRS or GAAP. Increasing the compatibility Disadvantages of Accrual Basis: More Complex to Implement: It requires tracking non-cash transactions such as accounts receivable and payable, which can involve more time and expertise. May Not Reflect Cash Flow: Even if a company is profitable on paper, it may face cash flow issues if it hasn't collected payments. This can lead to difficulties in managing day-to-day operations. Potential for Manipulation: Since revenues and expenses are recorded when they are incurred, there is a risk that management could adjust the timing to make the financial statements look better (e.g., recognizing revenue early). Creates UNCERTAINTY regarding the collectability of future cash flow. They can't tell when the customer is gonna pay. They expect but aren't fully sure. WE SEE REVENUE but dont know how well we can collect it Net Income is not an indication for cash… you have to look at cash flow too cause income is accrual and not cash. 2. Cash Basis of Accounting In contrast, the cash basis of accounting records revenues and expenses only when cash is received or paid. This method is simpler but can provide a less complete view of financial performance. Advantages of Cash Basis: Simple and Easy to Implement: Cash basis accounting is straightforward, making it ideal for small businesses or those with straightforward transactions. Reflects Actual Cash Flow: It provides a clear view of the cash available, making it easier for small business owners to manage cash flow and understand liquidity. Disadvantages of Cash Basis: Less Accurate for Long-Term Decisions: Because it does not match revenues with expenses when they are incurred, it may provide a distorted view of profitability. For example, a company might look profitable during one period but be facing large unpaid bills. Not GAAP or IFRS Compliant: Larger companies or publicly traded companies cannot use cash basis accounting, as it doesn't meet the requirements of financial reporting standards. Ignores Credit and Payables: This method doesn’t account for receivables or payables, which means that financial statements may understate the company’s true financial obligations or earnings. UP2-6: 1. Statement of Income: This shows revenues, expenses, and net income over a period, giving an idea of profitability. However, it doesn't show when cash is actually received or paid, so it may overstate financial health if most sales are on credit. 2. Statement of Financial Position (Balance Sheet): This shows a snapshot of the company's assets, liabilities, and equity at a specific point in time. It tells us about the company’s liquidity (current assets vs. liabilities) and solvency (long-term stability). But again, it doesn’t indicate how cash flows in and out. 3. Statement of Cash Flows: This is essential because it shows how cash moves in and out of the business from operating, investing, and financing activities. A company may look profitable on the income statement but struggle to pay bills if cash flow is poor. For lenders, understanding cash flow is critical because a borrower needs enough liquidity to meet their loan payments. YOu can have a lot of A/R but cant collect it, its not use. If the company is selling a lot of assets, that shows cash crunch By having all three statements, you can: See if profits are backed by actual cash. Understand how the company manages its cash and whether it's able to cover expenses and debt. Get a fuller picture of long-term financial stability beyond just short-term profits or assets. WIP2-3: Correct Elements: 1. Retained Earnings Reflect Profitability: o It's true that retained earnings represent accumulated profits that a company has earned over time and hasn’t distributed as dividends. So, having a large balance in retained earnings suggests the company has been profitable in the past. 2. Retained Earnings Can Be Used for Dividends or Debt Repayment: o A company can choose to distribute dividends from retained earnings to shareholders, or use it to pay off debt. Both are valid uses of retained earnings, depending on the company’s financial strategy and goals. 3. Investing Retained Earnings: o Companies can also reinvest retained earnings in the business, such as in expansion, research and development, or new projects that could generate more income and help the company grow. Incorrect or Incomplete Elements: 1. Retained Earnings ≠ Cash: o Retained earnings are not the same as cash. They represent the portion of net income that has been retained, but the actual cash may have been spent or invested in non- liquid assets. The company needs to have sufficient cash or liquid assets to distribute dividends or pay off debt. It’s incorrect to assume that having a large amount of retained earnings means the company has a large amount of cash available. 2. No Obligation to Distribute Retained Earnings: o A company isn’t obligated to distribute retained earnings as dividends. Companies often retain earnings to reinvest in the business for growth opportunities or to create a financial buffer for future uncertainties. 3. Debt Repayment vs. Other Uses: o While using retained earnings to pay off debt can reduce interest expenses, it might not always be the best option. If a company can generate higher returns by reinvesting the retained earnings, it might choose to do so rather than prioritizing debt repayment. Chapter 3: Double Entry Accounting and the Accounting Cycle 3.1: The Double Entry System How the Double-Entry System Works Basic Principle: Each transaction affects at least two accounts. This ensures that the accounting equation (Assets = Liabilities + Equity) stays balanced. The "double" aspect refers to the fact that the transaction is recorded twice—once as a debit and once as a credit. Balance and Offsetting: The total debits must always equal total credits, ensuring that the system remains in balance, similar to the approach in the template method, but more efficient. Limitations of the Template Method The template method uses a spreadsheet format with columns reflecting the basic accounting equation. While this is manageable for small entities with limited transactions, it becomes cumbersome as the number of transactions and accounts increases. Example: If a business wants to track various categories of inventory (e.g., new textbooks, used textbooks, digital textbooks), each would require its own column. As the number of categories or departments grows, the spreadsheet becomes unmanageable due to the sheer number of columns. How the Double-Entry System Overcomes These Limitations Scalability: The double-entry system can handle hundreds or even thousands of accounts, allowing businesses to track more detailed information without overwhelming complexity. Detailed but Summarize: Each transaction is recorded in detail in individual accounts, but the system also allows for easy summarization across accounts. 3.2: The Normal Balance Concept What Is the Normal Balance Concept? The normal balance concept in accounting refers to the typical balance (either debit or credit) that is associated with different types of accounts. To understand this concept, it is essential to relate it to the accounting equation: Assets = Liabilities + Shareholders’ Equity. This equation can be visualized as a "T," with assets on the left side and liabilities and shareholders' equity on the right side. The terms debit (DR) and credit (CR) represent the "left" and "right" sides of the equation, respectively. Key Points of the Normal Balance Concept 1. Asset accounts normally have a debit balance. 2. Liabilities and shareholders' equity accounts normally have a credit balance. 3. An account’s normal balance is used to increase it, while the opposite balance is used to decrease it. Practical Examples Cash Account (Asset): o Cash is an asset, which means it normally has a debit balance. o To increase the Cash account, you would debit it. o To decrease the Cash account, you would credit it. Accounts Payable (Liability): o Accounts payable is a liability, meaning it normally has a credit balance. o To increase Accounts Payable, you would credit it. o To decrease Accounts Payable, you would debit it. Retained Earnings and Impact Revenues ultimately increase Retained Earnings because they increase net income, which increases retained earnings. Expenses ultimately decrease Retained Earnings because they decrease net income, and a lower net income means lower retained earnings. Dividends declared decrease Retained Earnings because they are a distribution of retained earnings. Revenues: o Revenue accounts normally have a credit balance because they ultimately increase Retained Earnings. Expenses: o Expense accounts normally have a debit balance because they decrease Retained Earnings. Dividends Declared: o Dividends Declared normally have a debit balance because they represent a distribution of retained earnings, thus decreasing Retained Earnings. Helpful Hint Increases in accounts are recorded on the side of their normal balance. o Asset accounts normally have debit balances, so increases are recorded as debits. o Liability and shareholders’ equity accounts normally have credit balances, so increases are recorded as credits. 3.3: The Accounting Cycle 3.4: The Chart of Accounts What Is the Chart of Accounts? The Chart of Accounts is a foundational element of any accounting system. It is a complete listing of all the accounts a company uses to track financial transactions. Each account represents a different item that can be categorized as an asset, liability, equity, revenue, or expense. When a company is first formed, one of the critical tasks is to establish its chart of accounts. This process helps ensure that the company collects the necessary information to manage the business effectively and meet the needs of external stakeholders. Managers ask key questions to decide what information to capture, including: What information is needed by the management team for decision-making? What information is needed by outside users (e.g., investors, creditors)? What information is required to comply with financial reporting standards? Since each business is unique, companies may customize their chart of accounts to meet their specific operational and financial reporting needs. Structure of the Chart of Accounts The chart of accounts organizes financial data by listing all accounts in the order they appear on financial statements. For example: Assets: Accounts related to items of value the company owns. Liabilities: Accounts reflecting what the company owes. Shareholders' Equity: Accounts showing the owners’ interest in the company. Revenues: Accounts tracking the income generated. Expenses: Accounts detailing the costs incurred. Each account in the chart of accounts is typically assigned a number for easier reference in computerized systems In many accounting systems, accounts are grouped by number ranges, such as: 1000–1999: Assets 2000–2999: Liabilities 3000–3999: Shareholders' Equity 4000–4999: Revenues 5000–5999: Expenses 3.5: Opening Balances Permanent Accounts: These accounts retain their balances from one accounting period to the next. They include assets, liabilities, and shareholders' equity accounts. For example, the cash balance at the end of the period becomes the cash balance at the start of the next period. Temporary Accounts: These accounts are reset to zero at the end of each accounting period. They include revenues, expenses, and dividends declared. Management uses these accounts to track performance over specific periods (e.g., monthly, quarterly, annually) but does not carry forward their balances. At the end of the period, the balances in temporary accounts are transferred to Retained Earnings through closing entries, resetting their balances to zero for the next period. Key Points Permanent Accounts: o Include assets, liabilities, and shareholders' equity accounts. o Balances carry over from one period to the next. Temporary Accounts: o Include revenues, expenses, and dividends declared accounts. o Balances are reset to zero at the end of each accounting period. o Balances are transferred to Retained Earnings through closing entries. 3.6: Transaction Analysis and Recording For transactions and analysis, refer back to the textbook Why Record Transactions in the General Ledger? While the general journal provides a chronological record of all transactions, companies need summarized information to manage their accounts effectively. If managers need to check the balance of a specific account like Cash, it would be inefficient to calculate this by adding or subtracting all journal entries for that account each time. To make this process more efficient, the general ledger is used to summarize and track the cumulative effects of transactions on individual accounts. Key Points: General Journal: o Contains detailed information on each transaction. o Provides a chronological record of all entries. DATE DR / CR (Just the initial) Amount DR or CR General Ledger: o Contains summary information for each account. o Provides a consolidated view of transactions affecting each account. o Each account in the ledger has its own "T account" where debits and credits are recorded and totaled. Posting Process The process of transferring debit and credit information from the general journal to the general ledger accounts is called posting. This helps to consolidate the details and prepare accounts for easier access and reporting. For example, the Cash account would be updated with all transactions affecting Cash, which are posted from the general journal. Exhibit 3.10 illustrates how January transactions are posted to the Cash account, showing the opening balance, individual entries, and the ending balance. Subledgers: In addition to the general ledger, subledgers capture additional details related to specific accounts. For instance, the Accounts Receivable subledger provides detailed information on each customer's account, which is then summarized in the general ledger. Purpose of Preparing a Trial Balance: The trial balance lists all account balances from the general ledger at a specific point in time, divided into debit and credit columns. It ensures that the total of all debit balances equals the total of all credit balances. This step helps in detecting errors in the recording process. Key Points: Trial Balance Purpose: o Helps detect errors in the recording process. o Ensures that debits equal credits. o Does not identify all types of errors, such as misposted amounts or complete omissions of entries. 3.7: Adjusting Entries Adjusting entries involve both a statement of financial position account and a statement of income account. That is, one-half of each adjusting entry (either the debit or the credit) is an asset or liability account, while the other half of the entry is a revenue or expense account. What Are Adjusting Entries and Why Are They Necessary? Adjusting entries are journal entries made at the end of an accounting period to update account balances. They are necessary for events that occur over time, such as the passage of time in rent or interest, or gradual asset depreciation. Adjusting entries are categorized into two broad types: 1. Accruals: Recognize revenue or expenses before cash is received or paid. 2. Deferrals: Record revenue or expenses after cash is received or paid. Accrual Entries Accrued Revenue: Revenue is recognized before cash is received. Example: Interest revenue on loans that have not yet been paid. o Entry: ▪ DR: Interest Receivable ▪ CR: Interest Revenue o Impact: ▪ Revenue increases on the income statement. ▪ Assets increase on the balance sheet. ▪ No effect on the cash flow statement. Accrued Expense: Expenses recognized before cash is paid. Example: Wages earned by employees but not yet paid. o Entry: ▪ DR: Wages Expense ▪ CR: Wages Payable o Impact: ▪ Expenses increase on the income statement. ▪ Liabilities increase on the balance sheet. ▪ No effect on the cash flow statement. Deferral Entries Deferred Revenue: Revenue is recognized after cash is received. Example: Prepaid tuition for a university semester. o Entry: ▪ DR: Deferred Revenue ▪ CR: Tuition Revenue o Impact: ▪ Revenue increases on the income statement. ▪ Liabilities decrease on the balance sheet. ▪ No effect on the cash flow statement. Deferred Expense: Expenses are recognized after cash is paid. Example: Prepaid insurance. o Entry: ▪ DR: Insurance Expense ▪ CR: Prepaid Insurance o Impact: ▪ Expenses increase on the income statement. ▪ Assets decrease on the balance sheet. ▪ No effect on the cash flow statement. Depreciation: Depreciation is treated as a deferral entry where the cost of an asset is expensed over its useful life. o Entry: ▪ DR: Depreciation Expense ▪ CR: Accumulated Depreciation o Impact: ▪ Expenses increase on the income statement. ▪ Assets decrease on the balance sheet. ▪ No effect on the cash flow statement. Key Points About Adjusting Entries 1. No Cash Involvement: Cash is never part of adjusting entries because those transactions have already been accounted for.  2. Income and Balance Sheet Impact: Adjusting entries always affect one account from the income statement (revenue or expense) and one from the balance sheet (asset or liability). 3. End of Period Entries: They are made at the end of each accounting period (month, quarter, or year). Example Entries #15 DR: Depreciation Expense 850 CR: Accumulated Depreciation 850 #16 #17 ***After all the adjusting entries have been recorded and posted, an adjusted trial balance is prepared. 3.8: Preparing Financial Statements and Closing Entries Steps in the Accounting Cycle: After the adjusted trial balance is prepared, financial statements can be generated: 1. Statement of Income: Uses revenue and expense accounts. 2. Statement of Changes in Equity: Shows how equity changes over time. 3. Statement of Financial Position: Displays assets, liabilities, and shareholders’ equity. Note: The statement of cash flows is covered in Chapter 5. The Role of Closing Entries: Temporary accounts (revenues, expenses, and dividends declared) must be reset to zero at the end of the year. These balances are transferred to Retained Earnings. This step ensures that temporary accounts begin the next period with a zero balance, which allows financial results for each period to be clear. Closing entries reset: 1. Revenue 2. Expenses 3. Dividends Declared This process helps provide users with a clear view of revenue and expenses for a specific period. Closing Entry Process: REID There are four main closing entries: 1. Close revenue accounts to Income Summary: Example: o DR Sales Revenue: $34,000 o CR Income Summary: $34,000 2. Close expense accounts to Income Summary: Example: o DR Income Summary: $26,600 o CR various expense accounts (e.g., Cost of Goods Sold, Wages, Utilities, etc.) 3. Close Income Summary to Retained Earnings: Example:  o DR Income Summary: $7,400 o CR Retained Earnings: $7,400 4. Close Dividends Declared to Retained Earnings: Example: o DR Retained Earnings: $400 o CR Dividends Declared: $400 Key Points: Closing entries: o Transfer balances from temporary accounts to Retained Earnings. o Reset all temporary accounts to zero. o Are made annually. What Retained Earnings Reveal: A company with retained earnings has been profitable historically and has reinvested some earnings back into the business rather than distributing them all as dividends. Additionally, the company is at least in its second year of operations. LECTURE: Company “promise” ( to buy inventory) DOES NOT COUNT as a transaction *** exceptional promise = dividends declared Shipper tells accountants shipment arrived (need paper work) # DATE ACCOUNT DEBIT CREDIT 1 Jan 1/24 Cash 250,000 Common Shares 250,000 2 Jan 1 Cash 100,000 Bank Loan 100,000 3 Jan 1 Rent Expense 1,100 Cash 1,100 4 Jan 1 Equipment 65,000 Cash 65,000 5 Jan 1 Pre-paid insurance 1,800 Cash 1,800 6 Jan 6 Land 180,000 Cash 180,000 7 Jan 10 Inventory 23,000 A/P 23,000 8a Jan 12 Cash 21,000 A/R 13,000 Revenue 34,000 8b COGS (Expense) 17,000 Inventory 17,000 9 Jan 20 Cash 11,000 A/R 11,000 10 Jan 22 A/P 13,500 Cash 13,500 11 Jan 25 Utility Expense 1,900 Cash 1,900 12 Jan 26 Ad Expense 2,200 Cash 2,200 13 Jan 28 Wages Expense 2,900 Cash 2,900 14 Jan 31 Dividends Declared 400 Cash 400 Ch3 Practice Questions DQ3-2 Under the accrual basis of accounting, when cash is collected on accounts receivable, revenue is recorded. False. Revenue is recorded when it is earned, not when cash is collected. When cash is collected on accounts receivable, there is no additional revenue recorded, only a reduction in Accounts Receivable. Cash receipts from customers are debited to Accounts Receivable. False. When cash is received from customers on credit sales, the entry is a debit to Cash and a credit to Accounts Receivable, reducing the receivable balance. The cash basis of accounting recognizes expenses when they are incurred. False. The cash basis recognizes expenses when they are paid, not when they are incurred. Under the cash basis of accounting, there is no such thing as a Prepaid Expenses account. `True. Under cash basis accounting, expenses are recorded when paid, so Prepaid Expenses (an asset account under accrual accounting) wouldn't exist. Asset accounts and expense accounts normally have debit balances. True. Assets and expenses increase with debits, so they normally have debit balances. Credits increase asset accounts. False. Credits decrease asset accounts. Revenues are recorded with credit entries. True. Revenues increase equity, which is recorded with a credit entry. Dividends are an expense of doing business and should appear on the statement of income. False. Dividends are distributions of earnings to shareholders and do not appear on the income statement DQ3-14 Q: Failed to record an accrued expense Current Period's Financial Statements: 1. Expenses: Will be understated 2. Net Income: Will be overstated because expenses are understated, leading to a higher reported profit than it should be. 3. Liabilities: Will be understated because accrued expenses (a liability) are not recorded.  4. Equity: Will be overstated due to the higher net income. Retained earnings will be higher than it should be. Next Period's Financial Statements: 1. Expenses: Will be overstated when the company eventually records the expense in the next period. 2. Net Income: Will be understated in the next period because expenses will be higher than they should be. 3. Liabilities: Overstates since now it will be added to the new time frame 4. Equity: Will be corrected once the overstatement in the current period's net income is offset by the understatement in the next period. # DATE ACCOUNT DEBIT CREDIT 1 Jan 1/ 24 Cash 250,000 Common Shares 250,000 2 Jan 1 Cash 100,000 Bank Loan 100,000 3 Jan 1 Rent Expense 1,100 Cash 1,100 4 Jan 1 Equipment 65,000 Cash 65,000 5 Jan 1 Prepaid Insurance 1,800 Cash 1,800 6 Jan 6 Land 180,000 Cash 180,000 7 Jan 10 Inventory 23,000 A/P 23,000 8a Jan 12 Cash 21,000 A/R 13,000 Revenue 34,000 8b Jan 12 COGS 17,000 Inventory 17,000 9 10 11 12 13 14