Chapter 3 - Introduction to Accounts - Student Copy - W2023
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Chapter 3 – Introduction to Accounts
Blast from the Past
BFTP3-1
At the beginning of the year a business has liabilities of $189,500 and equity of $98,250. During the year liabilities increased by $19,700 and the business had additional capital contributions by the owners of $20,000, revenues of $324,600, expenses of $296,750, and dividends of $7,000. What are assets at the end of the year?
Assets are (insert your amount) $
Calculations (show your work):
BFTP3-2
You start a consulting business on May 1 and had the below-noted transactions during the month. Analyze the transactions using the critical and enhancing questions and record the business activities using the expanded accounting equation. The chart is provided on the next page. Ensure the
totals at the bottom of the chart equal! Note: the credit card you use is a business credit card that is used exclusively for business purchases.
1. You invested $2,500 of cash into a business.
2. You borrowed $2,500 from your parents. The loan must be repaid by July 1.
3. Registered a business name with Service Ontario, $60, using a credit card. You will pay off the credit card at the end of this month.
4. Purchased office supplies for $400, plus HST, using a credit card. 5. Paid cash for 500 business cards from Staples for $60. 6. Received cash from customers for consulting services provided, $930.
1 | CH3
7. Attended a one-day conference to network and paid the conference fee of $500, plus HST, using the credit card.
8. Used up half of the business cards during the conference.
9. At the end of the month you had $262 of office supplies remaining.
10. Paid the credit card for all business expenses using cash.
2 | CH3
Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
How profitable was the business? What is the main reason for this outcome?
The conference was quite expensive. Do you think it was worth it? Why or why not?
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BFTP3-2 is continued on the next page.
4 | CH3
BFTP3-2, continued
What is your financial position at the end of the period? Would you consider your financial position good? Why or why not?
You would like to know the breakdown of your assets and your expenses at the end of the month in order to help you make decisions regarding the future. Is this information easy to find when you record transactions using the expanded accounting equation?
BFTP3-3
K12 Inc. is a for-profit education company selling online schooling and curriculum in the United States. Several years ago, the company released its annual report a month late due to issues with their accounting system
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. Investors responded by selling off their shares on the stock exchange, causing the company's share price to decline sharply. What qualitative characteristic did K12 Inc. violate? Why would the delay in releasing financial information concern investors? What type of stakeholder are the investors (external or internal)?
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The answers to the BFTP questions are from the knowledge you gained in Chapter 1 and 2.
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Why is financial information important?
As you can see from BFTP3-2, in order to manage your business, you need to use financial information to make decisions. When the information is not in a form that allows you to quickly evaluate your past activities, it is difficult to make decisions about the future. As shown in Chapter 2 and BFTP3-2, using the expanded accounting equation gives you more information than the basic accounting equation; however, there is not enough information to help you make the decisions you need to make about future operations.
How do businesses produce financial information that is useful for decision-making?
The accounting system should provide information that is useful for decision-making. Looking at BFTP3-2, even with the expanded accounting equation, there is still not enough information for decision-making purposes. For instance, you can't determine if there is enough cash to repay the loan from your parents without manual calculations. A good accounting system subdivides the financial reporting elements so that more detailed information is readily available. For example, an account called Cash under the element assets would track cash transactions so you would know your total cash at the end of the month immediately. Accounts are common subgroups of financial reporting elements that are used to accumulate (gather) business activities. Using BFTP3-2 as an example, assets could be divided into Cash, Business Licence, Business Cards, and Office Supplies. Doing so would allow you, the owner, to better understand your business and make decisions (such as whether you have enough cash to pay off the loan from your parents!) By using accounts to subdivide financial reporting elements, the accounting system can also be used to produce financial statements. Financial statements
tell a business's story, what it does and how well it does it. They provide a business’s financial performance, its current financial position, and its cash flows. Both internal and external stakeholders use the financial statements to analyze a business and answer questions, which
allow them to make decisions and meet their objectives. Are there standard accounts that businesses always use?
Yes, there are, but instead of just listing them and telling you their definitions, let's start a new business, a lawn care company, in May of 2021. You just finished your first year of university and, because you would prefer to work for yourself, you start a business. Let's first analyze all the transactions using the elements (just like you did in Chapter 2) but then you'll take it one step further: use accounts to subdivide the elements and record the business activities. This way you'll practice the concepts from Chapter 2 while learning about standard accounts used by businesses. 7 | CH3
Note that, as you move through the chapters, you'll add to your list of standard accounts. Just like in life, learning continues all the way through this
textbook. You will continue to expand your list of standard accounts as you move through this textbook. You will find an alphabetical list of the accounts used in this course with this chapter’s textbook on the MAIN D2L site.
How do you use account names to record business activities?
First, you need to be introduced to standard account names that are likely to be used when recording transactions in your business. Watch the following 2 videos and answer the question that follows. This will give you a good understanding of the common account names before you begin recording transactions in your new business.
https://www.youtube.com/watch?v=fHZg8nZf0OQ
https://www.youtube.com/watch?v=4dC1UNXZ6Fs
The following is a list of random account names. For each account name indicate the financial reporting element (assets, liabilities, equity, revenue, expenses) it belongs in and provide one important aspect (part) of the definition of the account.
Account Name
Financial Reporting Element & Partial Definition
Bank loan payable
Accounts receivable
Sales revenue
Prepaid expense
Income tax payable
Equipment
Supplies expense
Accounts payable
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Patent
Service revenue
Owners' capital
Advertising expense
Interest payable
Office supplies
Deferred Revenue
Salaries payable
Wages expense
Cash
Check your understanding (CYU3-2) Note: CYU3-1 has been deleted.
List the critical and enhancing questions.
Critical Questions
Enhancing Questions
1.
1.
2.
2.
3.
9 | CH3
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How would LawnKare record the leasing of the domain name?
On May 1 you pay for the domain name with your business credit card, $16.99 plus HST, on GoDaddy.com. You will pay off the business expenses from the credit card when you receive the bill at the end of the month.
What did LawnKare get? An asset as the fee covers the domain name for 1 year, from May 1, 2021, to April 30, 2022. LawnKare owns the domain name (legal right to use it) for that period of time, it will benefit the business in the future because it can use it, and it is due to a past transaction. Assets increase by $19.20 (16.99 * 1.13).
The account you would use to record this asset is Prepaid Expense
. This account sounds like an expense account (after all, it has the word expense in it!) but it is never
an expense. Why? Because, as noted above, it meets the definition of an asset: it is owned, has future benefit, and is due to a past transaction. So why does this account have the word expense in it? As you use
the domain name the value of the asset will decrease (1/12 every month). That use will cause the asset to become an expense (remember the definition of expense is something used, consumed, or incurred to generate revenue). That's why it's called Prepaid Expense: it is an asset that you pay for in advance and, over time, it will become an expense in the future, as the business uses the asset up.
What did LawnKare give away? An "I owe you" (IOU), a promise to pay the credit card company in the future. Note that you don't owe GoDaddy.com because they received their money immediately from the credit card company. LawnKare owes the credit card company cash in the future due to a past purchase, which meets the definition of a liability.
The account you would use to record this liability is Accounts Payable
. Accounts payable is used when you purchase something from someone (a supplier) and you owe the supplier cash in the future. The credit card company actually supplied you with cash (they paid GoDaddy.com on your behalf) and you owe them cash in the future to settle this debt.
Let's record this in the expanded accounting equation using these account names.
Assets
Liabilities
Equity
Owner's
Retained Earnings
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Capital
Profit
Dividends
Revenue
Expenses
Prepaid
Expense
Accounts
Payable
+19.20
+19.20
How would LawnKare record the other services they receive from GoDaddy.com?
On May 1st you also sign up for GoDaddy.com's website builder and hosting services. It costs $7.99 per month, plus HST, payable on the first day of every month. You set up an automatic monthly charge to the credit card and make the first payment on May 1st.
What did LawnKare get? The use of a website and hosting for 1 month. This is an asset for the month of May but you expense the amount instead
. Why? Because by the end of the month you will have used up all of the asset
. If you record it as a Prepaid Expense on May 1st you would have to move it to an expense account on May 31st. That would mean doing 2 entries this month, 31 days apart. That is not efficient or necessary for decision-making. Instead, you record it immediately as an expense because you know, by the end of the month, it will be
an expense.
So, what is the name of the expense account that you will use for the website and hosting? The names of expense accounts are based on what a business wants to know about its costs. The more detailed the information the better it is for decision-making but too much detail would be overwhelming. Every business has to decide on the expense accounts they want to use. In this case, in order to know what the website is costing you over time, you create an expense account called Website Expenses
. This will allow you to compare the cost of the website to the number of hits to the website. This information will allow you to decide, in the future, if the website is helping your business generate revenue.
What did LawnKare give away? As with the domain name, it gave away an IOU, a promise to pay the credit card company cash in the future. We again use Accounts Payable to record the cash that is owed in the future to a supplier. 11 | CH3
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Let's record the business activity using the expanded accounting equation and these account names.
Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
Prepaid
Expense
Accounts
Payable
Website Expenses
+19.20
+19.20
+9.03
+9.03
Is the accounting equation still in balance?
Note that this transaction LOOKS like the accounting equation is not in balance because, for this transaction, it looks like Assets $0 = Liabilities $9 + Expenses $9 or $0 = $18!! As noted in Chapter 2 you need to flow expenses up into equity to see if the equation balances. Expenses decrease Profit, which decreases Retained Earnings, and therefore decrease Equity. The equation IS in balance because Assets $0 = Liabilities $9 - Equity $9, which also equals $0. Remember that expenses and dividends have a negative effect on equity.
Is every business activity recorded in the accounting system?
A business may be involved in many business activities but not all of them are recorded in the accounting records. An event
is a business activity of importance to a business. What is necessary for an event to be recorded in the accounting system? If the event is measurable (we have a dollar value) and realized (the exchange has already happened) then it is recorded in the accounting system. This is called a transaction
, which is an event that is measurable and realized. So, if an event is measurable and realized it is a transaction and will be recorded in the accounting system. If an event is measurable but not realized OR realized but not measurable, then it is an event but NOT a transaction. Events are never recorded in the accounting system
.
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Here’s another way to think about it. A transaction involves an exchange between two parties. Usually goods or services go one way, and cash goes
the other way. If EITHER party has done his part, then BOTH must record the transaction. If NEITHER party has done anything, then the agreement to make the exchange is still an event and does not have to be recorded. Note that either the goods/services or the cash can change hands first – a transaction does not have to involve cash. Quite often, the goods/services change hands first and the cash later. That’s how receivables and payables happen!
Let's do an example to make it clearer. You want to sign up for a gmail.com account using LawnKare but someone already owns that email account. Instead, you sign up for lawnkare@hotmail.com.
What did LawnKare get? The use of an email account, which it has a legal right to use and also has future benefit, all due to a past activity. That's an asset. What did LawnKare give away? Nothing because the email account is free.
There is no dollar value attached to this business activity so it is an event but not a transaction. When a business has an event, it does not record an entry into the accounting system.
Remember that every business activity is either an event (measurable OR realized but not both so it is NEVER recorded) or a transaction (recorded because it is both measurable AND realized).
Check your understanding (CYU3-3)
Indicate which of the following business activities are events and which are transactions. Description
Event (E) or Transaction (T)
The business hires a new administrative assistant at $1,200 per week. He will start next month.
The business purchases a computer for $900.00 cash, plus HST.
The owner decides to relocate to a new office and pays $2,500 cash in advance to secure the space.
A new advertising company is hired to develop an ad for a new product. A fee of $32,000 is negotiated and will be paid in installments as the work is completed.
Testing Tip!
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For a super quiz, midterm or final exam, transaction analysis questions will usually be multi-select (i.e. select all that apply), and you have to select ALL the accounts affected by the transaction you are asked to analyze. There may be more than two! The number of marks available will usually be the number of correct choices – but if the question is worth 2 marks and you are being asked for an event rather than a transaction, that one choice (No Entry) will be worth both marks all by itself. In this type of question you get part marks for selecting the correct choices and also for NOT selecting the incorrect choices – so don’t just select everything thinking you’ll get full marks – you won’t. D2L is smarter than that.
What accounts should LawnKare use when they purchase a business licence?
On May 2 you register the name, LawnKare, at Service Ontario for $60 using a credit card. Is this an event or a transaction? It's a transaction because it is measurable ($60) and realized.
What did LawnKare get? The business got a licence to run the business for 5 years, something it owns which it will use in the future and is due to a past activity. Assets increase by $60.
The cost of a licence is capitalized
, meaning the cost is recorded as an asset because it has future benefit for the company. When an asset will last a
long time (over the long term) it is called a long-lived asset
. Long-lived assets are divided into tangible assets
(physical assets such as land or buildings) and intangible assets
(non-physical assets which represent legal rights, such as a licence, trademark or brand name). One type of intangible asset is a licensing right
, which is the permission to use something (ability to run a business) for a specific period of time (5 years). We'll record the licensing costs as a long-term asset account named Business Licence
. Mind you, the vast majority of real-life businesses would not capitalize this – they’d expense it right away, because the amount is so small. But that’s a topic for chapter 8 – for now we’ll stick to capitalization, which is theoretically correct even if not practical in reality.
What did LawnKare give away? As with the domain name and webhosting service, it gave away an IOU, a promise to pay the credit card company cash in the future. We again use Accounts Payable to record this business activity. Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
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Prepaid
Expense
Business
Licence
Accounts
Payable
Website Expenses
+19.20
+19.20
+9.03
+9.03
NO
ENTRY
+60
+60
What accounts should be used to record contributions by owners?
You contribute all of your savings, $500 cash, to the business. Is this an event or a transaction? It's a transaction because it is measurable ($500) and realized (the business received the cash already). What did LawnKare get? LawnKare received cash of $500. The cash has future benefit for the business since LawnKare can buy things with it, and the event already happened in the past (contribution by the owner, you!). Assets would increase by $500.
The account you would use to record this asset is Cash
. The cash account is used when you receive either cash or cheques. Cheques are recorded as cash because they are considered equivalent to (the same as) cash. Once cheques are deposited into a bank account they are immediately converted into cash by the bank, which is why businesses record cheques as cash.
What did LawnKare give away? The business gave away ownership in the business, which is represented by owner's capital. Owner's capital is part of equity so equity increases by $500.
The account used to record owners' capital is actually called Owner's Capital. It represents the capital contributions (cash investment) made by the owners to the business and is part of the equity that is owed to the owners by the business.
Let's record this in the expanded accounting equation using these account names.
Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
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Profit
Dividends
Revenue
Expenses
Cash
Prepaid
Expense
Business
Licence
Accounts
Payable
Owner's
Capital
Website
Expenses
+19.20
+19.20
+9.03
+9.03
NO
ENTRY
+60
+60
+500
+500
What accounts should LawnKare use for loans?
Your parents want to support you in your efforts to start a business so they lend you $1,500 on May 3rd. The loan is due on April 30, 2023, two years from now. Your parents have provided the loan interest-free (meaning you don't have to make interest payments).
Is this an event or a transaction? It's a transaction because it is measurable ($1,500) and realized (the business received the cash already). What did LawnKare get? LawnKare received cash of $1,500. The cash is owned, has future benefit for the business since LawnKare can buy things with it, and the transaction was realized (already happened in the past). Assets increase by $1,500, again using the Cash account.
What did LawnKare give away? The business gave away an IOU, a promise to pay your parents cash on April 30, 2023, in the future. This is a liability: owed, due in the future, and the result of a past transaction (receiving the loan). What account should we use? Can we use Accounts Payable again? No
, because Accounts Payable is used when you purchase something (goods or services) from a supplier
who will send you an invoice or statement. Accounts Payable are also short term, meaning they will be paid in the upcoming year (next 12 months). Short term liabilities are called current liabilities. They are always settled sometime during the upcoming year (12-
month period). 16 | CH3
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The account used to record this loan is called Loan Payable
. This account is used when a business has an obligation to pay a debt in the future using
cash. If the debt is due beyond the upcoming year (12 months), like this one is, it is a long-term liability. If the debt is due within the upcoming year
(12 months) it is a current liability.
Assets
= Liabilities
+ Equity
Owner's
Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
Cash
Prepaid
Expense
Business
Licence
Accounts
Payable
Loan
Payable
Owner's
Capital
Website
Expenses
+19.20
+19.20
+9.03
+9.03
NO
ENTRY
+60
+60
+500
+500
+1,500
+1,500
What accounts should LawnKare use for the cost of website development?
Your friend, who has a website design business, designs your website for $300. The website is designed to allow customers to book lawn care appointments and pay using PayPal. You pay your friend cash for the design of your website and expect to continue to use this website for the next 3 years.
What did LawnKare get? The business got a website designed, something owned which will be used in the future to help run the business (because it allows for the booking of appointments and payments by customers) and is due to a past event. Assets increase by $300.
Like the business licence, the costs of developing a website are capitalized
, meaning the cost is recorded as an asset because it has future benefit for the company. The cost of website development is also an intangible asset because it is not a physical good but a legal right. This long-lived 17 | CH3
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intangible asset is called a technology asset
. Technology assets include website development and some software purchases. We'll record the website development costs in a long-term asset account called Website Design
. What did LawnKare give up? LawnKare gave away cash, which we already know is an asset. In this case the asset will decrease because, now that $300 has been given to website supplier, that cash is no longer owned by the business and therefore no longer has any future benefit. The account Cash, an asset, decreases by $300. 18 | CH3
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Let's record this in the expanded accounting equation using these account names.
Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
Cash
Prepaid
Expense
Business
Licence
Website
Design
Accounts
Payable
Loan
Payable
Owner's
Capital
Website
Expenses
+19.20
+19.20
+9.03
+9.03
NO
ENTRY
+60
+60
+500
+500
+1,500
+1,500
-300
+300
Does LawnKare require insurance?
General liability insurance protects your business against lawsuits from customers if you damage their property while you are providing lawn care services. In addition, you will be covered for any bodily injuries that you may cause, both to yourself and your customers. Considering your age (20 years old) and the fact that this is a new business, it is likely that the insurance coverage will be expensive, between $800 and $1,000 for the year. Sometimes, if you pay the full amount immediately, the insurance company will give you a discount, between 3% and 10%. You decide to get insurance coverage because it protects both you and your customers. You use your family's insurance company and get coverage for 6 months, which costs you $400 plus 8% provincial sales tax. (Note that insurance premiums are exempt from the 5% federal portion of the HST;
however, you do have to pay the 8% provincial sales tax.) Your father pays the full amount by cheque and gets a 5% discount on the premiums before sales tax is applied. You immediately pay your father the cash from the business.
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What did LawnKare get? The business got insurance coverage that will last 6 months, protecting the business into the future and due to a past business activity. Note you get the 5% discount before paying the provincial sales tax so you multiply the $400 by 95% first, to reflect the discount. You then multiply the amount by 1.08 to add in the provincial sales tax. Assets increase by $410.40 ($400 * 0.95 * 1.08). The account you would use to record this asset is Prepaid Insurance. Similar to the more general Prepaid Expense account, this account meets the definition of an asset. This means that it is owned (the business has a legal right to insurance coverage), has future benefit, and is due to a past activity. As the business uses up
the insurance coverage the asset will decrease in value (1/6 every month) and insurance expense will increase (remember that the definition of expense is something used, consumed, or incurred to generate revenue). What did LawnKare give up? LawnKare gave away cash, which we already know is an asset. In this case the asset, cash, will decrease because you paid $410.40 to your father. The cash is no longer owned by the business and therefore no longer has any future benefit. The account Cash, an asset, decreases by $410.40. Let's record this in the expanded accounting equation using these account names.
How does LawnKare record the cost of equipment?
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Your father has 3 lawn mowers, two blowers, and two trimmers (he's a bit of a packrat, never throwing anything out). You would like to buy the Toro Timemaster® Mower, available at Home Depot for $1,099 plus HST, but you don’t know if your business will be profitable. You decide to wait to see if your business is profitable in the future. For now, your father is willing to rent you his lawn mower, blower, and trimmer at a cost of $5 per lawn. You are responsible for purchasing all the gas but your father will also include the use of his extra five-liter gas can.
Is this an event or a transaction? This is an event; although it is measurable ($5 per lawn) it has not been realized (you have not mowed anyone's lawn yet so you have not borrowed the equipment from your father). No entry is required but you must enter NO ENTRY into your worksheet.
How can LawnKare build the business?
As noted in Chapter 2 for Walk UR Dog, to build a business you need to advertise. Using your old laptop and printer from high school you design a simple flyer that clearly states your name (you are going to advertise in your neighbourhood, where lots of families know you) and what services you provide. You include your cell phone number (text preferred) and the fact that customers can book an appointment through your website at any time. You get 250 copies made at the local UPS Store ($0.07 per copy plus HST), paying by credit card. That afternoon you deliver all the flyers. If someone is home, you knock on the door and offer your services. When no one is home you leave the flyer in the mailbox.
What did LawnKare get? Recall from Chapter 2 that advertising cannot be recorded as an asset because it does not meet all three characteristics of an asset. Therefore, there is no effect on the assets. Assets: no effect.
What did LawnKare give away? Flyers, but what does that mean? It's unclear. Let's move on to the enhancing questions.
What did LawnKare earn? Nothing, since it didn't do anything for a customer yet.
What did LawnKare use, consume, or incur? LawnKare used up all the flyers by delivering them to homes in the neighbourhood. The flyers were used to help generate future revenues: expenses increase by $19.78 (0.07 * 250 * 1.13).
What account should we use? Remember that expense accounts are specific to each business but should be named something which helps stakeholders (like you, the owner) assess the business. In order to know what advertising is costing you over time you name the expense account Advertising Expenses
. This will allow you to track the total cost of advertising and compare it to the number of customers who contact you. This information will allow you to decide, in the future, if delivering flyers is helping your business to generate revenue.
What does LawnKare owe? As with the domain name and webhosting service, LawnKare gave away an IOU, a promise to pay the credit card company cash in the future. We again use Accounts Payable to record this business activity.
21 | CH3
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Let's record this in the expanded accounting equation using these account names.
22 | CH3
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How does LawnKare record the provision of a service?
When you were handing out flyers two neighbours ask you to quote on their lawns immediately. Based on the size of your family's lawn (which you have been mowing for free since you were 10 years old!) you quote one customer $20 and the other $25. Both ask you to mow their lawn – your first customers! On May 6th LawnKare buys gas and single stroke engine oil from the local gas station for $14.80 (including all taxes), paying by credit card. You then
mow the lawns of both of your customers, receiving $45 cash ($20 + $25). You use up half the gas and the oil while mowing the lawns. When you get home, you pay your father $10 for the rental of the equipment.
Let's break what happened on May 6th into several transactions so we don't miss recording any of the activities.
For the gas and oil, LawnKare got an asset (has future benefit) but used half of the asset up by the end of the day. Therefore, Prepaid Expense increased by $7.40 because half of the gas and oil is available for future use by the business. LawnKare paid by credit card so Accounts Payable increase by $14.80 as this amount is owed in the future. The remainder of the gas and oil was used to generate revenue, an expense. You use an expense account called Oil & Gas Expenses to track the usage against your revenues in the future. This will help you determine if this business is profitable. For the services LawnKare has provided to customers LawnKare received cash, an asset. The Cash account increases by $45. LawnKare gave away a service, which answers the question: What did LawnKare earn? You provided (past tense) a service to your customers so you have earned revenue.
Revenues increase by $45. You use the account Service Revenue to record revenues the business earns from the sale of services. By deducting expenses from your revenues you’ll be able to track your profitability over time.
For the equipment rental, LawnKare incurred a cost to generate revenue, which is an expense. Since you'll want to know if renting equipment is a good idea over the long term you track the cost of equipment rental in an expense account called Rent Expense. LawnKare paid your father using cash so the Cash account, an asset, decreases by $10.
Tracking the information now requires a larger worksheet with additional columns and rows. This has been provided for you a few pages further down. Note that the worksheet includes all the past transactions and also the transactions that will occur on the next few pages.
23 | CH3
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What should LawnKare record if a customer can't pay immediately?
On May 8 LawnKare mows and trims the lawns of two new customers for $30 and $25 respectively. Unfortunately, the customers are not home when you finish. You leave a bill (also called an invoice) in their mailboxes asking for payment to be dropped off at your home. You use up the remainder of your gas and oil. When you get home, you pay your father $10 for the rental of the equipment.
Again, let's break what happened on May 8 into several transactions so you don't miss recording any of the activities.
For the gas and oil, LawnKare used up the remainder of the gas and oil to generate revenue, so you use the expense account Oil & Gas Expenses again: expenses increased $7.40. In addition, Prepaid Expense decreases by the same amount ($7.40) because the asset no longer has any future benefit as it is now used up. For the services LawnKare has provided to customers LawnKare received no cash. Was this an event or a transaction? The amount is measurable ($55) and realized (LawnKare did its job, provided the service) so it MUST be a transaction and LawnKare MUST record it, even though no cash was received. What did LawnKare get from the customers if not cash? LawnKare got a legal right to collect cash from the customers in the future, which
businesses record in an account called Accounts Receivable. Accounts receivable is an asset account because it is owned (legal right), has future benefit (will result in a future cash inflow), and is due to a past transaction (the sale already happened and you finished the job). What did LawnKare give away? LawnKare gave away (provided, which is past tense) a service to the customers so it has earned revenue. Revenues increase by $55. Again, you use the account Service Revenue to record revenues the business earns from the sale of services. Note something important: recording revenues has nothing to do with cash
. Businesses record revenues when they have done their job, provided the service or delivered the goods, regardless of whether they were paid or not. The collection of cash is a separate issue, dealt with by recording the asset called Accounts Receivable. It is important that you clearly understand that performance of your obligation to the customer is what causes revenues to increase. It is NOT the cash that leads to the revenue but the EARNING of revenue by doing your job (or the business doing its job!) You have probably noticed by now that the same rule applies to expenses – we record an expense when we have received the service, and often the other side of the entry is Accounts Payable as the cash will be paid later.
Remember the idea of the exchange of goods/services for cash? The transaction must be recorded by both parties when either one
has performed. Here, LawnKare has performed by mowing those two lawns. The customers, however, have not yet performed their part because they have not yet paid. But since one party (LawnKare) has performed, the transaction must be recorded, and on LawnKare’s side, revenue is recognized as well as 24 | CH3
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the accounts receivable. (The customers who haven’t yet paid have their own accounts payable – to LawnKare!, and their own corresponding expenses.)
One last thing and then you’re finished with this transaction. For the equipment rental, LawnKare again incurred a cost to generate revenue, which you record in the account called Rent Expense. LawnKare paid your father using cash so the Cash account, an asset, decreases by $10.
Again, these transactions have been recorded in the larger worksheet provided for you below.
What should you record when a customer pays in advance?
One of your customers would like a contract: you mow and trim his lawn for the whole summer. He travels extensively and does not want to worry
about booking an appointment or paying you. You agree to check his lawn on a weekly basis and, when necessary, mow and trim the lawn. Since this customer entertains frequently when he is home, he wants to be sure that his lawn is always in perfect condition. The contract is from May 15th to September 15th. You estimate you will mow and trim the lawn once a week during the spring and once every two weeks during the summer. You estimate you will mow and trim his lawn 12 times during that period. You give him a discount of 5% because he is paying in advance. The standard charge, considering the size of his lawn, is $35 before the discount. To calculate: 12 * $35 = $420 but you have to take off the discount: $420 * 95% = $399. The customer gives you a cheque for $399.
What did LawnKare get? A cheque, which is equivalent to (same as) cash. It is an asset because LawnKare owns the cash it will get when you deposit the cheque in LawnKare’s bank account. In addition, cash has future benefit to the business and it is due to a past activity. The Cash account increases by $399. What did LawnKare give away? It gave away a promise to provide a service in the future. When you promise to do something for someone in the future it is a liability (owed). This is a liability account called Deferred Revenue. Remember the definition of liabilities; owed and will be settled in the future through the giving up of cash, goods, or services. LawnKare has given the customer a promise to mow and trim their lawn until September 15 so this meets the definition of a liability. Even though this account, Deferred Revenue
, uses the word revenue it does not belong in the revenue element because it has not been earned
. You can only earn revenue when you have done your job, In this case you must defer, or delay, recognizing revenue until you have completed the service or delivered the goods (notice the past tense!). Since LawnKare has not done anything for the customer yet, it owes a liability, a service in the future. The account, Deferred Revenue, increases by $399. (Deferred Revenue is sometimes called Unearned Revenue.)
Again, these transactions have been recorded in the larger worksheet provided for you below.
25 | CH3
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Note that some columns are blank. These are provided for future accounts that the business may require to record transactions.
Assets
= Liabilities
+ Equity
Owner's
Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
Cash
Accounts
Receivable
Prepaid
Expense
Prepaid
Insurance
Business
Licence
Website
Design
Accounts
Payable
Deferred
Revenue
Loan
Payable
Owner's
Capital
Service
Revenue
Website
Expenses
Advertising
Expenses
Gas & Oil
Expenses
Rent
Expenses
19.20
19.20
9.03
9.03
N/A
60
60
500
500
1,500
1,500
-300
300
-410.40
410.40
N/A
19.78
19.78
7.40
14.80
7.40
45
45
-10
10
-7.40
7.40
55
55
-10
10
399
399
1,713.6
0
55
19.20
410.40
60
300
122.81
399
1,500
500
100
9.03
19.78
14.80
20
26 | CH3
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Check your understanding (CYU3-4)
It is important to become familiar with all of the common account names and which element they belong in. For each of the following transactions provide the account names that would be affected, the
indicator (+ / -) IF THE EXPANDED ACCOUNTING EQUATION WAS USED and the element the account belongs in.
Trans #
Description
Account name and
indicator
Account name and
indicator
1
Provided services to a customer on account (for credit – they will pay later).
2
Paid cash for a 1-year insurance policy.
3
Paid an employee for the work they have completed.
4
Received payment from a customer for
services which had already been billed (invoiced) last month.
5
Purchased equipment in exchange for cash. The equipment will be used in the future.
6
Purchased office supplies on account.
7
Borrowed money from the bank.
8
Paid for a cell phone used during last month.
9
Received cash in advance from a customer. You will provide the services next month.
10
Paid interest on a bank loan that has been outstanding for a month.
11
Hired a new employee who will start next month.
12
You have not paid income taxes yet but you earned revenue so you owe them. Your tax rate is 17% of your profit.
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CYU3-4, continued
Did you use a positive indicator for the expenses or a negative? Explain your choice.
How would your answers change if you were recording these transactions into the basic accounting equation? What would change and why?
What questions can be answered by looking at the business’s accounts?
Remember that, in Chapter 2, the information available from the basic accounting equation was limited because there were no details. You also learned that, although the expanded accounting equation provides more information (for instance, total revenues and expenses so that you can calculate profit) there is still limited information available for stakeholders to make informed decisions. By using accounts, which subdivide the elements, you are provided with additional details.
In order to see this, let’s look at a list of the accounts and their ending balances from LawnKare divided into the different elements.
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Cash
1,713.60
Accounts Receivable
55.00
Prepaid Expense
19.20
Prepaid Insurance
410.40
Business License
60.00
Website Design
300.00
Total Assets
$2,558.20
Accounts Payable
122.81
Unearned Revenue
399.00
Loan Payable
1,500.00
Total Liabilities
$2,021.81
Owner's Capital
500.00
$500.00
Service Revenue
100.00
$100.00
Website Expenses
9.03
Advertising Expenses
19.78
Gas & Oil Expenses
14.80
Rent Expenses
20.00
Total Expenses
$63.61
Assets:
Liabilities:
Equity:
Revenue:
Expenses:
What can you, the owner, tell from the above information? Here are a few examples.
Assets: The cash position of the company is good. There is enough cash, for instance, to pay off the Accounts Payable ($122.81) and the Loan Payable ($1,500). The business has only one Account Receivable ($55) which is low. The remainder of the assets will never be converted into cash. Instead, the other assets are made up of things that the business will use over time to help you run the business. Examples include Prepaid Expenses and the Website Design. These assets have value but it is also good to know what the assets are made up of: accounts that will turn into cash in the future or will be used/consumed to aid running the business in the future. Liabilities: The total liabilities are high in comparison to the total assets. However, one of the liabilities does not need to be repaid in cash (Deferred Revenue will be settled by providing a service to customers
in the future). Even with the high liabilities that need to be paid ($122.81 + $1,500), there is enough cash in the business to pay the debts if you wanted to.
Equity: Shows how much you invested in the business to get it started.
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Revenue: Shows that you have not, as yet, started to generate much revenue (only $100).
Expenses: You have a total of $63.61 of expenses against only $100 of revenues. These expenses seem high in comparison to your revenue but that is likely because you have not, as yet, expanded your business. The expenses are all reasonable considering your business to date.
Profit: $100 – 63.61 = $36.39, which is pretty good, all things considered. You kept over 33% of your revenue. Many businesses have profit which is less than 10% of their revenue. That means that, in a business with revenues of $100, they would have expenses of $90. Your expenses are only $63.61, leaving you with profit that is 36.39% of your revenue. Well done!
As you can see, stakeholders can tell a lot more about a business when you use accounts to subdivide the elements. This provides better information for decision-making. For instance, you know you can’t afford to buy that Toro Timemaster® Mower right now with cash from the business. In fact, you know you have very low revenue. Looking at the accounts you know that you have to build your business first,
likely by advertising again.
Accounts and their balances give you information that is not available from either the basic accounting equation or expanded accounting equation.
Putting it all together!
The overall objective of GAAP is to provide financial information about a business that is useful to stakeholders for decision-making. By using the elements in Chapter 2 you discovered that recording information allows you to better understand your business so you can make decisions. You also discovered that information recorded using only the accounting equation, even the expanded accounting equation, is not enough for decision-making. By using accounts, which further subdivides the elements, you are better able to determine things like your cash position at the end of the year or how much you owe in loans. This provides better information for you to make decisions as you move forward with your business.
Going forward!
Stakeholders, including owners, need to see the accounting information in a format that can be easily understood. Using the account names, businesses can record transactions and create the financial statements. Financial statements
tell a business's story, what it does and how well it does it. They provide a business’s financial performance (income statement), its current financial position (balance sheet), and its cash flows (statement of cash flows). Both internal and external stakeholders can use the
financial statements to analyze a business and answer questions, which allow them to make decisions and meet their objectives. In Chapter 4 you will be introduced to the financial statements.
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What do I need to know for a super quiz, midterm or final exam?
A.
Recognize the difference between events and transactions.
B.
Analyze and record transactions using the critical and enhancing questions.
C.
Record all transactions using account names.
D.
Determine which accounts belong in which elements and sub-elements.
E.
Review the total of all the accounts and analyze the business’s position at the end of the period. For instance, do they have enough cash to pay off their loans or purchase supplies?
Watch out for
....
You need to be able to use the critical and enhancing questions to better analyze business transactions. You then need to decide on the appropriate account names. You might be tempted to make up names but, remember, there are some standard names that are always used (cash, accounts receivable, accounts payable are just a few). You need to ensure you practise recording transactions. The critical thinking is in the analysis of each transaction using the critical and enhancing questions. Key is ensuring you get the practice you need to become proficient at analyzing transactions.
31 | CH3
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In Class Demo Questions
ICDQ3-1
Without looking at the textbook DEFINE each of the following accounts. When defining the accounts, be
SURE you tie the definition of the account into the definition of the element it belongs in. Do this without repeating the element's definition word for word. Why would you do this? Because you can only use an account name when you know what the account is used for. That understanding is shown through your knowledge of the definition of the account.
An example has been provided for you.
Question: Define the account inventory.
Answer: The product on your shelves that you bought from a supplier which you will sell to customers in the future. Inventory is an asset.
Tie into the definition of assets: owned (product on your shelves), with future benefit (sell to customers in the future), due to a past transaction (bought from a supplier).
Account Name:
Definition
Accounts payable
Accounts receivable
Prepaid expense
Service revenue
Deferred Revenue
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ICDQ3-2
You start a consulting business in June of 2021. Record the following transactions in the expanded accounting equation using account names.
1. You make a cash contribution to your business, $3,500.
2. You set up a business bank account at Scotiabank. They will charge you $15 at the end of every month.
3. Borrow $4,000 cash from the bank.
4. Purchase supplies for your business, $600, plus HST, using a business credit card.
5. Paid your landlord rent for the month, $1,700 cash.
6. Purchased a 1-year liability insurance policy for $2,400, plus 8% sales tax, paying cash.
7. Paid $200, plus HST, for business cards from Staples, using your business credit card.
8. Provided services to your customers worth $2,670. you receive cash of $2,100. The other customer has promised to pay next month.
9. At the end of the month you count your supplies and you have $390 remaining.
10. You use up 1 month of your insurance coverage.
11. The bank withdraws $27 from the business bank account to pay the interest on the loan. 12. The bank also withdraws the monthly fee for the bank account.
13. You have used up half of your business cards, which you charge to your Supplies Expense account.
14. You pay the outstanding balance on your credit card.
Required:
Record all the transactions using the critical and enhancing questions as well as account names into the expanded accounting equation. NOTE: you are required to come up with the account names for this business. Some of the names may be standard ones (Cash, Accounts Receivable) but others you may be required to create an account that suits this business. 33 | CH3
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Assets =
Liabilities
+ Equity
Owner's
Capital
+ Retained Earnings
Profit - Dividends
Revenue
- Expenses
34 | CH3
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ICDQ3-3
Ankita starts up All4U, a home-based business that provides salon services to her customers. She travels
to their home and provides manicures, pedicures, polish, sculptured nails, European facials and body waxing, all in the comfort of your own home. Ankita uses her own car to travel to and from her client's homes. The following transactions took place during Ankita's first month of business.
1. Ankita contributes $3,000 of her own cash to start the business. 2. Ankita's parents lend her an additional $2,000. They will not charge interest.
3. Ankita registers her business name, All4U, at Service Ontario for $60 using a credit card.
4. Ankita opens a business bank account, which allows her 50 transactions a month, at Royal Bank. The bank will charge her $16 on the last day of every month. She also signs up for a business VISA®. This credit card has no annual fees.
5. Ankita purchases all the necessary supplies for her business online using the business credit card. The invoice is for $500, plus HST. Because her order is over $250 the shipping is free.
6. Ankita purchases a 1-year insurance policy, just in case either she or a client is hurt. She is charged $1,800, plus 8% sales tax, for the policy and pays cash.
7. Ankita designs and orders 1,000 flyers to advertise her business to Mississauga neighbourhoods from Staples®. She pays $200.00, plus HST, for the services using the business credit card.
8. Ankita posts a free ad on Kijiji® Mississauga titled "Esthetician and Manicurist - All4U!" Every evening
she renews the ad so it is always listed first.
9. Ankita delivers 500 of the flyers to homes in Mississauga. 10. By the end of the month Ankita has provided $1,590 of services to various clients in exchange for cash.
11. Ankita counts her supplies at the end of the month and discovers that $378 of supplies are remaining.
12. Online Ankita sees that the bank has charged the business account for the monthly service fee. 13. Ankita has been tracking her mileage and sees that, for the last month, 50% of her travel was related to business. Total vehicle expenses paid for the month are $190 (including taxes). Ankita withdraws the correct amount from the business bank account.
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14. Ankita used her personal phone for business 50% of the time. The total monthly charge for her phone is $92 (all taxes included). She pays the business portion from the business bank account using cash.
15. Ankita has used up 1 month of her insurance policy.
16. Ankita's credit card statement has arrived and she pays the outstanding balance.
Required:
Record all the transactions using the critical and enhancing questions as well as account names. NOTE: you are required to come up with the account names for this business. Some of the names may be standard ones (Cash, Accounts Receivable) but others you may be required to create an account that suits this business. 36 | CH3
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Assets =
Liabilities
+ Equity
Owner's
Capital
+ Retained Earnings
Profit
Revenue
- Expenses
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ICDQ3-4
Darren Gretzky (no relation to you-know-who) is a registered massage therapist (RMT). For a number of
years, he has worked for a spa in Oakville but he has decided start his own business. To differentiate his business Darren will travel to his clients’ homes to provide full massage treatments. He knows that providing in-home massage treatments will set him apart from his competitors and help him build a client base. Luckily Darren already has a portable massage table that he received as a gift from his parents when he graduated. Darren will use his own car to travel to and from his client's homes. The following business activities took place during May of 2021. 1. Darren contributes $500 cash to start the business. 2. Darren's parents lend him an additional $500 to help him out. They will not be charging him interest.
3. Darren registers his business name, DG Massage, at Service Ontario for $60 using a credit card.
4. Darren opens a business bank account at the Bank of Montreal®. A fee of $10 per month, will be charged to the account at the end of every month. He also signs up for a MasterCard® in his business name. 5. Darren purchases a $188 table warmer from Massage Essentials in Edmonton, Alberta. He pays shipping of $12 and HST. Note that HST is paid on the total amount of the invoice, including shipping costs. He pays using the business credit card. 6. Darren purchases supplies for $90 (including taxes) from Massage Supply Depot for cash. 7. Darren already has an excellent selection of relaxing music on his iPhone 5S. Using the business credit card, he purchases a Bose SoundDock XT Speaker Dock for $300, plus HST, from Best Buy. 8. Darren posts a free ad on Kijiji Oakville with the title "IN HOME FULL BODY MASSAGE by MALE RMT". Every morning he renews the ad so that it is always at the top of the day's listings.
9. Darren has decided to advertise by delivering flyers to Oakville neighbourhoods where some of his previous spa clients live. He goes to Staples and they help him design a tasteful flyer. He uses a credit card to pay the $161.95, plus HST, for the service, which includes 500 copies of the flyer. 10. Darren delivers all of his flyers to homes in Oakville.
11. Darren will charge clients as follows: $70 for a 60-minute massage, $100 for a 90-minute massage and $120 for a 120-minute massage. He will provide an official receipt for insurance purposes. He is permitted to do so because he is an RMT - Registered Massage Therapist.
12. Darren will use his own car and he can deduct the business portion of all his car expenses (gas, oil, insurance, license and registration, and maintenance and repairs)
4
. To help him track his business usage Darren purchases MileIQ, an iPhone app which tracks mileage, for $61.95 plus HST, using the business credit card. 38 | CH3
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13. By the end of May Darren has provided the following services in exchange for cash:
Service
# Provided
60-minute massage
14
90-minute massage
9
120-minute massage
5
14. Darren determines that, by the end of May, he has used up about 50% of his supplies he purchased in Transaction #6. 15. Online Darren sees that BMO® has charged the business account the monthly service fee. 16. MileIQ shows Darren that he has travelled 725 kilometers over the last month. A total of 435 kilometers was for business purposes. Total vehicle expenses for the month are $285.00, which Darren paid personally so he needs the business to reimburse him. 17. Darren is using his cell phone 50% for business. Total monthly charge for his phone is $80 (including
taxes), which Darren paid personally so he needs the business to reimburse him. 18. It is now May 31. Darren's credit card statement has arrived but he will not pay for his business purchases until June 5th.
Required:
Record all the transactions using the critical and enhancing questions as well as account names in the expanded accounting equation. NOTE: you are required to come up with the account names for this business. Some of the names may be standard ones (Cash, Accounts Receivable) but others you may be required to create an account that suits this business. The chart has been provided for you on the next page. Once you have finished the chart answer the questions that follow.
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Assets =
Liabilities
+ Equity
Owner's
Capital
+ Retained Earnings
Profit -
Dividends
Revenue
- Expenses
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Similar to what was done in the chapter, list all the accounts’ ending balance from your chart, dividing them by element. What are Darren’s assets made up of? Are the majority of the assets ones that will be converted into cash or are they things that the business will use or consume in the future? Which type of asset is better
and why do you think this?
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What are Darren’s liabilities? Does Darren have the required cash to pay his liabilities immediately if he needed to? Why is having enough cash to pay your liabilities important to a business?
How profitable was Darren's business in May? Why do you think a business like Darren's might be profitable? Given that Darren just started his business can you predict his profits for the upcoming 11 months?
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Can Darren afford to withdraw money from the business? After all, he needs to live! At the same time, Darren might want to keep the money in the business. Why would it be important for a new business to
keep money in the business?
What do you think might be some key success factors for a business like Darren's? What factors could cause the business to fail? Do you know of any factors that might limit Darren's business when considering the long term?
43 | CH3
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Practice Questions
PQ3-1
Why should you use the Critical and Enhancing Questions when analyzing business activities?
PQ3-2
You start a consulting business on May 1 and had the below-noted transactions during the month. Analyze the transactions using the critical and enhancing questions and record the business activities using accounts. The chart is provided on the next page. Ensure the totals at the bottom of the chart equal! Note: the credit card you use is a business credit card that is used exclusively for business purchases.
1. You invested $2,500 of cash into a business.
2. You borrowed $2,500 from your parents. The loan must be repaid by July 1.
3. Registered a business name with Service Ontario, $60, using a credit card. You will pay the credit card at the end of this month.
4. Purchased office supplies for $400, plus HST, using a credit card. 5. Paid cash for 500 business cards from Staples for $60. 6. Received cash from customers for consulting services provided, $930.
7. Attended a one-day conference to network and paid the conference fee of $500, plus HST, using the credit card.
8. Used up half of the business cards during the conference.
9. At the end of the month you had $375 of office supplies remaining.
10. Paid the credit card for all business expenses using cash.
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PQ3-2, continued.
Trans. #
Assets
Liabilities
Equity
Owner's
capital
Retained earnings
Profit
Dividends
Revenue
Expenses
Trans. 1
Trans. 2
Trans. 3
Trans. 4
Trans. 5
Trans. 6
Trans. 7
Trans. 8
Trans. 9
Trans. 10
Total:
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PQ3-3
Why is equipment an asset?
PQ3-4
At the beginning of the year a business has assets of $94,000 and equity of $42,000. During the year the business had expenses of $89,560, paid dividends of $2,000, and earned revenues of $114,230. In addition, the assets increased by $19,200. What are total liabilities at the end of the year? Be sure to show your work!
Liabilities are (insert your amount) $
Calculations (show your work):
What is the most likely reason for the change in liabilities during the year?
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PQ3-5
In Chapter 2 you recorded the transactions for Walk UR Dog using the basic and expanded accounting equation but not the account names. This time, AND WITHOUT LOOKING AT CHAPTER 2, analyze the business activities using the critical and enhancing questions. Then record the business activities using the expanded accounting equation and
insert account names. The chart is provided for you.
1.
Start the business by contributing $100 of your own money to the business.
2.
Walk UR Dog purchases a package of 120 Top Paw® Citrus Scented Poop Bags from Pet Smart for $23.39 plus HST (13%), a total of $26.45. The business pays cash for the bags.
3.
Sandra, a neighbour, hires you to immediately walk her dog, Bella. Sandra pays you $15 cash
when you return.
4.
During the walk Bella required the use of 4 poop bags. The bags cost $0.22 each (120 bags for $26.45 = $0.22 each). In order to earn revenue of $15 the business used 4 X $0.22 = $0.88 worth of poop bags.
5.
To prepare for customers who purchase play time you go to your local Pet Valu and purchase a selection of dog toys: six toys are $60.95, including HST (13%).
6.
For Walk UR Dog to build the business you need to advertise. Your mother has agreed to let you use her computer, printer, and paper so you create a flyer to advertise the services of Walk UR Dog and print up 500 copies. You spend the afternoon delivering the flyers around the neighbourhood. Your mother charges you $0.07 per sheet, for a total of $35.00. You check the cash position of Walk UR Dog: $100.00 - 26.45 + 15.00 - 60.95 = $27.60. Unfortunately Walk UR Dog does not have enough money to pay your mother immediately. She agrees that you can owe her until the business has grown and she won't charge you interest (thanks Mom!)
7.
Your best friend contributes $100.00 cash to the business. 8.
Seven customers have their dogs walked once a day for 4 weeks at $15.00 per walk. This service is only provided on weekdays. Every day you and your friend collect the cash from your customers. 9.
Two customers have their dogs walked twice a day for 4 weeks at $15.00 per walk. This service is only provided on weekdays. Cash is collected at the end of every day. 10.
Three customers have their dogs walked once a day followed by play time for 15 minutes for
4 weeks at $20.00 per walk/play time. This service is only provided on weekdays. Again, cash
is collected at the end of every day. 11.
You and your friend are shocked at the number of poop bags you use: approximately 145 bags per week! The remaining Top Paw® Citrus Scented Poop Bags are used up quickly. In order to save money, you both agree that the business should purchase 1,000 Bark+® Dog Waste Poop Bags from amazon.ca for a total cost of $48.55 including HST. Your mother pays
for it and you will repay her at the end of the month, when the credit card bill arrives. By the
end of the month there are only 428 of the 1,000 bags left. 12.
You repay your mother for the $35.00 loan.
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13.
During the month two of the toys are destroyed by one of the walk/play dogs. You and your friend decide to replace them with better toys that will last longer at a cost of $11.99 each plus HST (13%) for a total cost of $27.10, paying cash. The remaining toys are in good shape and you will continue to use them in the future. 14.
Your mother's credit card bill arrives and you pay her the amount owed for the Bark+® Dog Waste Poop Bags. 15.
Dog waste has become an issue. Neither family wants the waste in their garbage cans. You discuss this with your business partner and decide to buy a garbage can that seals well, locks, and has wheels. The simplehuman® 40 Liter Slim Plastic Step Can in Black from amazon.ca costs $50.00 plus $6.99 shipping and HST (13%), for a total cost of $64.40. Your mother gladly pays for it on her credit card and, at the end of the month, you still owe her as
the charge has not, as yet, come through on her credit card. All dog waste is deposited in the special garbage can and you put it out every week for pick up at your house. 16.
After the first week of business you and your friend decide to open a joint bank account so there are better controls over cash. After looking into chequing accounts at the local TD Bank® you agree on a plan with unlimited transactions for $14.95 per month. By the end of the 4 weeks you have received your bank statement and see that they have charged you the
monthly fee and withdrawn it from the bank account. 17.
At the end of the period you estimate that you will have to pay income taxes of 17% on the income you made in the business. (HINT: calculate your income before income tax first, then multiply that amount by 17%. That is the amount of the payable and the expense!) Round your calculation to the nearest dollar.
The chart is provided for you on the next page. Note that totals at the bottom of each column have been given to you as a check of your work. If you do
not end up with the same totals, then you know you have gone wrong somewhere along the way!
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PQ3-5, continued Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
Trans. #
Cash
Poop Bag
Supplies
Toys
Office
Supplies
Equipment
Accounts
Payable
Income Tax
Payable
Service
Revenue
Poop Bag
Expense
Dog Toy
Expense
Advertising
Expense
Bank
Charges
Income Tax Expense
Tota
l
4502
20.78
67.73
0
64.40
64.40
746
200
4,515
54.22
20.32
35
14.95
746
This question continues on the next page. You may print this chart out and complete it by hand if you need larger spaces.
49 | CH3
+
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PQ3-5, continued
Why is it important to record the income taxes that will have to be paid at the end of the year, even though you have not, as yet, filed any tax returns? (HINT: consider the definition of the element liabilities and expenses.)
PQ3-6
Draw the flowchart which demonstrates the interconnection between the financial reporting elements.
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PQ3-7
The following question comes from the Practice Questions in Chapter 2. WITHOUT LOOKING AT THE SOLUTION IN CHAPTER 2 analyze the business activities using the critical and enhancing questions. Record the business activities using the expanded accounting equation and
account names. Kelly Clark has been working at Staples® as head cashier. She has for years heard her mother complain about the cleaning service she uses. Kelly knows she can do a better job so she has decided to start her own cleaning business. This business does not require a lot of start-up money because she will be using the cleaning equipment in the houses she cleans (e.g., vacuum). All she needs are cleaning supplies and a uniform. Kelly will use her own car to travel to and from her clients’ homes. The following business activities took place during February of 2021. 1.
Kelly starts the business on February 1, 2021 by contributing $1,000 cash. Her parents loan her an additional $1,000 to help her start the business. The loan will have to be paid back in 6 months.
2.
Kelly uses a credit card to register her business name, Kelly Cleaning Services, with Service Ontario, $60. 3.
Kelly has a personal bank account but she decides to open a bank account for the business at the local branch of the Bank of Montreal. She chooses the BMO Biz Basic™ Plan for $6.00 a month which allows her 7 transactions per month, to be charged at the end of every month. 4.
Kelly purchases 2 pants and 4 shirts. She has the shirts embossed with her name. Total charge from Entropy Inc. is $189.00 plus HST. In addition, she purchases comfortable running shoes which she will only wear inside for $98.00 plus HST from Payless Shoes. She pays for all her purchases with a credit card. 5.
Using a credit card Kelly purchases a selection of cleaning supplies from TSS Sanitation Supplies Limited in Mississauga for $489.00 plus HST. 6.
Using a free website service, Yola (www.yola.com) Kelly produces a website where clients can get an immediate quote based on the number of bedrooms and bathrooms. In addition,
clients can book an appointment too. The website shows Kelly's availability for the upcoming 6 weeks. Kelly knows that convenience is important to the clients she wants to attract: young professionals. 7.
Kelly reviews house prices in Oakville using www.realtor.ca for areas with house prices greater than $600,000. She develops a flyer and goes to the UPS Store to print off 600 copies for $0.07 each plus HST. She pays with a credit card. 8.
Kelly delivers all of her flyers to homes in Oakville. 51 | CH3
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9.
Kelly will charge $25 per hour for her services, with a minimum time of 2 hours. She will leave a receipt on the kitchen counter at the end of every service call. PQ3-7, continued
10.
Kelly will use her own car and she can deduct the business portion of all her car expenses (gas, oil, insurance, license and registration, and maintenance and repairs). To help her track her business usage Kelly purchases MileIQ, an iPhone app which tracks mileage, for $59.99 plus HST, using a credit card. 11.
By the end of February Kelly has provided the following services in exchange for cash:
Week
# of homes
# of hours (in total for the week)
1
2
8
2
7
21
3
8
32
4
11
33
12.
Kelly determines that, by the end of May, she has used up about 15% of her cleaning supplies. Online she sees that BMO has charged her the monthly service fee. 13.
MileIQ tells Kelly she has travelled a total of 1,428 kilometres during the month with 1,113 for business purposes. Her total car expenses for the month, both business and personal, were $192.00, paid in cash. 14.
Kelly now uses her cell phone 40% for business. Her phone plan costs $100 per month, plus HST, which was paid in cash. 15.
Kelly pays for all the business expenses charged to her credit card from her business bank account.
16.
At the end of the period Kelly estimates that she will have to pay income taxes of 25% on the income she makes in the business. (HINT: calculate income before income tax first, then multiply that amount by 25%. That is the amount of the payable and the expense!) Round your calculation to the nearest dollar.
The chart is provided for you on the next page. Note that totals at the bottom of each column have been given to you as a check of your work. If you do not end up with the same totals, then you know you have gone wrong somewhere along the way!
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PQ3-7, continued Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
Profit
Dividend
Revenue
Expenses
Trans. #
Cash
Prepaid
Advertising
Cleaning
Supplies
Uniform
Supplies
Licence
Software
Accounts
Payable
Loan
Payable
Income Tax
Payable
Service
Revenue
Advertising
Expense
Cleaning
Supplies
Expense
Car
Expense
Bank
Charges
Telephone Expense
Income Tax Expense
Tota
l
3097.02
0
469.68
324.31
60
67.79
0
1,000
505
1000
2,350
47.46
82.89
149.65
6
45.20
505
You may print this chart out and complete it by hand if you need larger spaces.
53 | CH3
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PQ3-8
What is the definition of the element "revenue"? Provide an example of revenue for a business such as Bank of Montreal (BMO®).
PQ3-9
Wages paid to employees for work completed would be categorized as which financial reporting element? Be sure to explain WHY you place it into this element.
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PQ3-10
The following information is provided for you. Calculate dividends for the period.
Owner's Capital, end of period
85,000
Profit for the period
19,500
Total assets, end of period
192,000
Retained earnings, beginning of the period
22,000
Total liabilities, end of period
69,500
Dividends are (insert your amount) $
Calculations (show your work)
PQ3-11
What is the difference between an internal stakeholder and an external stakeholder? 55 | CH3
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PQ3-12
Definite the account called accounts receivable. What element does it belong in and why?
PQ3-13
You are a lawyer who practices law under the business name Shalini DiVinto, Lawyer. During the month you had the following transactions.
Trans. #
Description
Amount
1.
Contributions you made to start your business.
20,000
2.
You set up a business bank account. The monthly charge will be $15 per month, charged on the last day of the month. -
3.
You paid cash for 3 months of rent in advance. 3,750
4.
You purchased office supplies using your credit card. 485
5.
You paid cash for a one-year insurance policy. 2,100
6.
You registered your business licence with Services Ontario, paying by credit card.
60
7.
You pay cash to your friend to design a website to advertise your services.
1,000
8.
You pay for one month of web services to the website provider, using your credit card.
20
9.
You advertise in the Mississauga News for one month and pay using your credit card.
2,260
10.
You advertise in the local Sheridan News, paying cash for a full-page advertisement.
500
11.
You receive an advance payment from a customer for work to be performed next month.
1,200
12.
You provide services to customers for the month. Customers pay you in cash.
4,350
13.
One of your customers has not, as yet, paid; however, you have provided all of the services to the customer already.
780
14.
You pay for the office utilities (electricity, etc.) for the month in cash.
172
Continued on the next page.
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15.
You pay for your business phone for the month. The amount is withdrawn from your business bank account.
192
16.
The bank withdraws the monthly charge from your bank account.
15
17.
By the end of this month you have used up one month of the rent.
?
18.
At the end of the month you had used one month of insurance coverage up.
?
19.
At the end of the month $175 of the supplies were still on hand and the remainder had been used up.
?
20.
You know you will have to pay income taxes on any income. Your income tax rate is going to be 25%.
?
1. Analyze the business activities using the critical and enhancing questions. Once analyzed record the business activities using the expanded accounting equation and
account names. The chart is provided for you on the next page. Note that totals at the bottom of each column have been given to you as a check of your work. If you do not end up with the same totals, then you know you have gone wrong somewhere along the way!
(Additional questions continue after the chart!)
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PQ3-13, continued
Trans.
Assets
Liabilities
Equity
Retained earnings
Owner's
Capital
Retained
Earnings
Profit
Revenue
Expenses
Cash
Accounts
Receivable
Office
Supplies
Prepaid
Rent
Prepaid
Insurance
Business
Licence
Website
Design
Accounts Payable
Deferred Revenue
Income Tax Payable
Owners` Capital
Service Revenue
Website
Advertising
Office Supplies
Utilities
Telephone
Insurance
Rent
Bank charges
Income Tax
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Totals:
17821
780
175
2500
1925
60
1000
2825
1200
59
20000
5130
20
2760
310
172
192
175
1250
15
59
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PQ3-13, continued
2. You would like to know how you have been doing over the last month. Using the totals from your chart, determine if you were profitable for the month of operations. Can you use this information to predict how you will do over the upcoming 12 months? If you were not profitable, do you feel that you should quit your business?
PQ3-14
Why is it important to have assumptions in accounting?
PQ3-15
Define the qualitative characteristic "timely" and provide an example of when this characteristic would be violated by a business.
59 | C H 3
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Solutions - Blast From The Past
BFTP3-1
Assets
Liabilities
Equity
Opening
287,750
189,500
98,250
During
60,550
19,700
20,000
Capital Contributions
324,600
Revenues
-296,750
Expenses
-7,000
Dividends
Closing
$348,300
209,200
139,100
BFTP3-2
Assets
Liabilities
Equity
Owner's Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
2,500
2,500
2,500
2,500
60
60
452
452
-60
+60
930
930
565
565
-30
30
-190
190
-1,077
-1,077
$5,145
2,500
2,500
930
785
$0
60 | C H 3
=
+
+
-
-
=
+
+
-
-
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BFTP3-2, continued
How profitable was the business? What was the main reason for this outcome?
The business was profitable but not by much (930- 785 = 145). You would have to look at your transactions to determine that the reason for this was the conference which cost $565.
The conference was quite expensive. Do you think it was worth it? Why or why not?
Since this is a new business it is difficult to determine if the conference was worth it. You did hand out 250 business cards so the value of the conference is that it might lead to customers, which would increase your revenues. However, it is not possible, right now, to determine if the conference will lead to future revenues, particularly because you don't have any past experience with conferences to help you determine that.
What is your financial position at the end of the period? Would you consider your financial position good? Why or why not?
Your financial position is 5,145 = 2,500 + 2,645. You had to calculate equity by taking the owner's capital, adding the revenues, and subtracting the expenses. It is difficult to determine if the financial position is good because you don't know what makes up your assets or the equity. For instance, if all of your assets were things such as office supplies and equipment but you had no cash, your financial position would not be very good. Those assets might result in your not having enough to pay off your loan when it comes due in a month.
You would like to know the breakdown of your assets and your expenses at the end of the month in order to help you make decisions regarding the future. Is this information easy to find when you record transactions using the expanded accounting equation?
Although using the expanded accounting equation allows you to calculate your profit (revenue and expense totals are available), it is not possible to determine the breakdown of each of the elements without doing manual calculations. For instance, you would have to do manual calculations to determine your cash position or to determine what type of expenses you incurred to generate your revenue. This information is critical to help you manage your business in the future, such as if you can pay down the loan when it comes due.
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BFTP3-3
K12 Inc. is a for-profit education company selling online schooling and curriculum in United States. Several years ago, the company released its annual report a month late due to issues with their accounting system
1
. Investors responded by selling off their shares on the stock exchange, causing the company's share price to decline sharply. What qualitative characteristic did K12 Inc. violate? Why would the delay in releasing financial information concern investors? What type of stakeholder are the investors?
K12 Inc. violated the qualitative characteristic timely. Information that is not provided quickly is older news and less useful for decision-making. The investors may have suspected that the company was delaying the financial results because the company was trying to hide bad news. Bad news would cause the share price to decline, so investors likely started to sell their shares immediately so as to avoid the loss of value that WOULD happen IF the news was bad. Unfortunately, the fact that investors were all selling their shares anyway caused the share price to decline sharply before any news was released. By selling the shares investors actually caused
the decline in price that they were afraid of!
Investors are the same as shareholders and they are external stakeholders of K12 Inc. financial information.
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Solutions - Check Your Understanding
CYU3-1
Consider what type of business you would start if given the opportunity. Develop a name for that business and do a search using one of the common domain name registration companies mentioned in #2, above. Is the name available? If so, which extension (.com, .ca, .org to name a few)? Which extension would you prefer and why? ·
Answers will vary re: names developed.
·
Generally, you should almost always use .com if it is available. This is because it is well known (familiar) and people, when typing into their web browser, have come to expect the use of .com above all other extensions.
How much would you be charged to rent the domain? ·
If you did a quick search on Google, you would know that you typically pay $10 - $20 a year but it does depend on the extension (with .com the higher priced domains).
CYU3-2
CYU3-3
Indicate which of the following business activities are events (not recorded) or transactions (recorded because they are measurable and realized).
Description
Event (E) or Transaction (T)
The business hires a new administrative assistant at $1,200 per week. He will start next month.
E
The business purchases a computer for $900.00 cash, plus HST.
T
The owner decides to relocate to a new office and pays $2,500 cash in advance to secure the space.
T
A new advertising company is hired to develop an ad for a new product. A fee of $32,000 is negotiated and will be paid in installments as the work is completed.
E
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CYU3-4
It is important to become familiar with all of the common account names and which element they belong in. For each of the following transactions provide the account names that would be affected, the
indicator (+ / -) IF THE EXPANDED ACCOUNTING EQUATION WAS USED and the element the account belongs in.
Trans #
Description
Account name,
element, and indicator
Account name,
element, and indicator
1
Provided services to a customer on account (for credit – they will pay later).
Accounts receivable,
Assets, +
Service revenue,
Revenue, +
2
Paid cash for a 1-year insurance policy.
Prepaid Insurance,
Assets, +
Cash, Assets, -
3
Paid an employee for the work they had completed.
Cash, Assets, -
Salary Expense,
Expenses, +
4
Received payment from a customer for
services which had already been billed (invoiced) last month.
Cash, Assets, +
Accounts Receivable,
Assets, -
5
Purchased equipment in exchange for cash. The equipment will be used in the future.
Equipment, Assets, +
Cash, Assets, -
6
Purchased office supplies on account.
Office Supplies, Assets,
+
Accounts Payable,
Liabilities, +
7
Borrowed money from the bank.
Cash, Assets, +
Note Payable,
Liabilities, +
8
Paid for a cell phone used during last month.
Cash, Assets, -
Telephone Expense,
Expenses, +
9
Received cash in advance from a customer. You will provide the services next month.
Cash, Assets, +
Deferred Revenue,
Liabilities, +
10
Paid interest on a bank loan that has been outstanding for a month.
Cash, Assets, -
Interest Expense,
Expenses, +
11
Hired a new employee who will start next month.
This is an event, not a
transaction!
12
You have not paid income taxes yet but you earned revenue so you owe them. Your tax rate is 17% of your profit.
Income Tax Payable,
Liabilities, +
Income Tax Expense,
Expenses, +
Did you use a positive indicator for the expenses or a negative? Explain your choice.
·
The indicator for expenses was a positive
·
This is because expenses are increasing (meaning the expenses are getting larger)
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·
When the expense is flows up into the expanded accounting equation the negative sign in front of the expense calculation (Revenues - Expenses = Profit) will result in a negative effect on profit,
retained earnings, and equity
How would your answers change if you were recording these transactions into the basic accounting equation? What would change and why?
·
All of the expense accounts would have a NEGATIVE indicator
·
That is because the effect of expenses is to increase the expense element, decrease profit, decrease retained earnings, and therefore decrease equity
·
For that reason, the effect on equity is negative
65 | C H 3
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SOLUTIONS - Practice Questions
PQ3-1
Why should you use the Critical and Enhancing Questions when analyzing business activities?
·
A set structure to analyze business activities helps you to think about each activity critically.
·
Business activities that involve an EXCHANGE between the business and an outside party, which are represented by the critical questions and clarified by the enhancing questions, must always be recorded in the accounting system of the business.
·
The questions help you to recognize when there is a transaction (must be recorded) and an event (not recorded).
PQ3-2
Trans. #
Assets
Liabilities
Equity
Owner's
capital
Retained earnings
Profit
Dividends
Revenue
Expenses
Cash
Business Licence
Office Supplies
Loan Payable
Accounts
Payable
Owner’s Capital
Service Revenue
Conference
Office Expenses
Trans. 1
2500
2500
Trans. 2
2500
2500
Trans. 3
60
60
Trans. 4
452
452
Trans. 5
-60
60
Trans. 6
930
930
Trans. 7
565
565
Trans. 8
-30
30
Trans. 9
-77
77
Trans. 10
-1077
-1077
Total:
4793
60
405
2500
0
2500
930
565
107
66 | C H 3
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PQ3-3
Why is equipment an asset?
·
It is owned by the business
·
It will benefit the business in the future (will be used to generate revenue).
·
It is due to a past purchase.
Because equipment matches the definition of the element asset, it is recorded as an asset.
PQ3-4
Liabilities are $48,530.
Assets
Liabilities
Equity
Opening
94,000
52,000
42,000
Change
19,200
-3,470
114,230 Revenue
-89,560 Expenses
-2,000 Dividends
Ending
113,200
48,530
64,670
Liabilities decreased during the year. They most likely decreased because the business paid down its
debt. Examples would be paying accounts payable or paying down a loan payable.
67 | C H 3
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PQ3-5
Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
Profit
Dividends
Revenue
Expenses
Trans. #
Cash
Poop Bag
Supplies
Toys
Office
Supplies
Equipment
Accounts
Payable
Income Tax
Payable
Owners’
Capital
Service
Revenue
Poop Bag
Expense
Dog Toy
Expense
Advertising
Expense
Bank
Charges
Income Tax Expense
1
100
100
2
-26.45
26.45
3
15
15
4
-0.88
0.88
5
-60.95
60.95
6
35
35
7
100
100
8
2100
2100
9
1200
1200
10
1200
1200
11a
-25.57
25.57
11b
48.55
48.55
11c
-27.77
27.77
12
-35
-35
13a
-20.32
20.32
13b
-27.10
27.10
14
-48.55
-48.55
15
64.40
64.40
16
-14.95
14.95
17
746
746
Tota
l
4502
20.78
67.73
0
64.40
64.40
746
200
4,515
54.22
20.32
35
14.95
746
68 | C H 3
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PQ3-5, continued
Why is it important to record the income taxes that will have to be paid at the end of the year, even though you have not, as yet, filed any tax returns?
·
Although income taxes are not PAID until you file your tax return in the following year you INCUR the cost of income taxes every time you earn income (profit).
·
Liabilities are defined as owed, a future obligation which will be settled in cash, goods, or services, and due to a past transaction.
·
The taxes you will OWE next year meet the definition of a liability and therefore should be recorded.
·
In addition, expenses are defined as anything that is used, consumed, or incurred to help generate revenue.
·
The income taxes are incurred WHEN you generate revenue so they meet the definition of the element expense.
·
It is for these reasons (owed and incurred to help generate revenue) that both the income taxes payable and the income tax expense have to be recorded, even though there is not, as yet, any filing of the tax return.
·
Finally, it is important so that you and your partner can PLAN for the future. ·
If you do not recognize the income taxes you will owe at the end of the year you might think you
have that income (and therefore cash) available to you, which you do not as you will have to pay
those income taxes in the future.
·
You have to set aside the cash to pay the taxes in the future.
PQ3-6
Draw the flowchart which demonstrates the interconnection between the financial reporting elements.
70 | C H 3
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PQ3-7
Assets
Liabilities
Equity
Owner's
Capital
Retained Earnings
Profit
Dividend
Revenu
e
Expenses
Trans. #
Cash
Prepaid
Advertising
Cleaning
Supplies
Uniform
Supplies
Licence
Software
Accounts
Payable
Loan
Payable
Income Tax
Payable
Owner’s
capital
Service
Revenue
Advertising
Expense
Cleaning
Supplies
Expense
Car
Expense
Bank
Charges
Telephone Expense
Income Tax Expense
1
2000
1000
1000
2
60
60
3
NO
ENTRY
4
324.31
324.31
5
552.57
552.57
6
NO
ENTRY
7
47.46
47.46
8
-47.46
47.46
9
NO
ENTRY
10
67.79
67.79
11
2350
2350
12
-6
-82.89
82.89
6
13
-149.65
149.65
14
-45.20
45.20
15
-1052.13
-1052.13
16
505
505
Tot
.
3097.02
0
469.68
324.31
60
67.79
0
1,000
505
1000
2,350
47.46
82.89
149.65
6
45.20
505
71 | C H 3
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PQ3-8
What is the definition of the element "revenue"? Provide an example of revenue for a business such as Bank of Montreal (BMO®).
·
What the business earns through its day to day activities (what it DOES!).
·
Generated from providing a service or delivering a good (past tense - done your job!)
·
Example from BMO® would be Interest Revenue which is earned from lending out cash to customers or Fees Revenue which is earned from the fees BMO charges customers for the services it performs such as providing bank accounts for customers.
PQ3-9
Wages paid to employees for work completed would be categorized as which financial reporting element? Be sure to explain WHY you place it into this element.
·
Expenses
·
The services of employees are used to help generate revenue, which is the definition of the element expense
PQ3-10
Assets = Liabilities + Equity
192,000 = 69,500 + Equity = so Equity is $122,500
Equity = Owners' Capital + Retained earnings, ending
122,500 = 85,000 + Retained earnings, ending, so Retained earnings, ending is 37,500
Retained earnings, beginning, + Profit - Dividends = Retained earnings, ending
22,000 + 19,500 - Dividends = $37,500, so Dividends are $4,000
Dividends are $4,000 for the period.
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PQ3-11
What is the difference between an internal stakeholder and an external stakeholder? An internal stakeholder works for the business and has access to all its accounting information. For example, the president of the company, management, and employees. An external stakeholder is either affected by the business or can affect the business itself but only has access to the accounting information that the business decides to share. For example,
shareholders/owners, creditors (i.e. bank or suppliers), Canada Revenue Agency (CRA) and customers. PQ3-12
Definite the account called accounts receivable. What element does it belong in and why?
·
Accounts receivable represent the amount of cash that a business has a right to collect from its customers in the future.
·
It is an asset because it meets the definition of an asset: future benefit (right to collect cash), owned (legal right, so the company can sue customers for the cash if they don't pay), due to a past transaction (the company must have provided services to these customers in the past to record the accounts receivable)
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PQ3-13
Trans.
Assets
Liabilities
Equity
Retained earnings
Owner's
Capital
Retained
Earnings
Profit
Revenue
Expenses
Cash
Accounts
Receivable
Office
Supplies
Prepaid
Rent
Prepaid
Insurance
Business
Licence
Website
Design
Accounts Payable
Deferred Revenue
Income Tax Payable
Owners` Capital
Service Revenue
Website
Advertising
Office Supplies
Utilities
Telephone
Insurance
Rent
Bank charges
Income Tax
1
20000
20000
2
N/A
3
-3750
3750
4
485
485
5
-2100
2100
6
60
60
7
-1000
1000
8
20
20
9
2260
2260
10
-500
500
11
1200
1200
12
4350
4350
13
780
780
14
-172
172
15
-192
192
16
-15
15
17
-1250
1250
18
-310
310
19
-175
175
20
59
59
Totals:
17821
780
175
2500
1925
60
1000
2825
1200
59
20000
5130
20
2760
310
172
192
175
1250
15
59
74 | C H 3
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PQ3-13, continued
2. You would like to know how you have been doing over the last month. Using the totals from your chart, determine if you were profitable for the month of operations. Can you use this information to predict how you will do over the upcoming 11 months? If you were not profitable, do you feel that you should quit your business?
·
You were profitable but not by much: $177.01 is your income after income taxes are taken into account.
·
No, you cannot use this information to predict about the upcoming 11 months. This was your first month of operations and you don't know how you will do for the remainder of the year based on your first month of operations.
·
Even if you had been unprofitable you should not close your business after only one month. Most businesses take up to five years to become profitable and, if you go into your own business, you need to be prepared for the possibility that this may happen to you.
PQ3-14
Why is it important to have assumptions in accounting?
Assumptions are the guidelines used by the individuals and businesses who prepare financial information for external stakeholders. They provide assurance that the information provided is useful for decision-making. Note that students may also indicate that the information can be depended on because it is true and complete but the idea of being able to use it for decision-making is critical.
PQ3-15
Define the qualitative characteristic "timely" and provide an example of when this characteristic would be violated by a business.
Timely
Information is provided quickly (as old information is less useful).
Students may provide many different examples but one common one would be if a business does not provide financial information to external stakeholders within a reasonable amount of time. In current terms this is likely any information that is four or more months old, although students may say that even
a week is longer than necessary to be relevant for decision-making. This could generate a discussion about how much time needs to pass before information is no longer relevant and how that time period differs depending on the situation.
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