BAF3M1 - Chapter 5 (Expanded Ledger: Revenue, Expenses, Drawing) Review

December 10, 2020 BAF3M1 - Chapter 5 (Expanded Ledger: Revenue, Expenses, Drawing) Review Section 5.1 1. The new accounts in the equity section of the ledger are revenues, expenses, and drawings. 2. The main purpose of the new accounts in the ledger is to provide essential information about the progress of the business. 3. A ledger with only one equity account cannot answer the question, “How much profit or loss was made during a financial period?” 4. In the expanded ledger, the procedure for preparing a trial balance does not change. You still transfer the final balance of each account to the correct side of the trial balance and total each column. 5. Three things an income statement does is to show a business’s revenue during a given period, its expenses during a given period, and its profit or loss during a given period. 6. The two equity accounts that are not included on the income statement are Capital and Drawings. 7. The date on an income statement covers a period, such as a month or a year, while the date on a balance sheet is for one day. 8. The “bottom line” is the net income or loss shown at the bottom of the income statement. 9. Revenue is an increase in equity resulting from the sale of goods or services. 10. An expense is a decrease in equity resulting from the costs of operating the business. 11. The purpose of an expense is to produce revenue or to help with revenue-making activities. 12. Net income is the difference between total revenues and total expenses when revenues are more than expenses. 13. Owners are very interested in income statements because they use income statements to determine the company’s profits, examine financial trends, set goals for the company, and make business decisions. 14. Bankers are interested in seeing the income statement of a business that has a loan with them to see whether the business can repay the loan. 15. Investors want to provide a business with cash because they can earn a profit on their money if the business is successful. 16. A business must provide an income statement to the government as part of its annual income tax return, which helps the government calculate the amount of income tax the business owes. 17. Drawings are not included in the income statement because they are not always directly related to earning revenue or to supporting revenue-making activities. 18. A chart of accounts is a list of the ledger accounts and their account numbers in ledger order. 19. This text uses a three-digit account numbering system. Assets are numbered in the 100s. Liabilities are numbered in the 200s. Capital and Drawings are numbered in the 300s. Revenues are numbered in the 400s. Expenses are numbered in the 500s. December 10, 2020 20. An asset account normally has a debit balance. A liability account normally has a credit balance. A Revenue account normally has a credit balance. An Expense account normally has a debit balance. The Drawings account normally has a debit balance. The Capital account normally has a credit balance. 21. The Capital account will normally contain the beginning equity figure and new investments from the owner. Section 5.2 1. From their normal account balances, two conclusions you can make about equity transactions are that revenues are normally credited and expenses and drawings are normally debited. 2. You can be reasonably certain that revenue accounts will have a credit balance at the end of the year because debits to a revenue account are rare. Once a sale amount is recorded in the account, it usually remains there until year-end. 3. You might want to debit a revenue account when recording a sales return. 4. The revenue recognition principle requires a transaction to be recorded in the accounts of a business at the time the transaction is completed. 5. Before sending an invoice to a customer, the seller must fulfill its obligations to provide the promised goods or services. 6. The IFRS allows a seller to record a sale without having delivered the goods so long as it is probable that delivery will be made; the item is on hand, identified, and ready for delivery; the buyer is aware of delayed delivery, and the usual payment terms apply. 7. When purchasing advertising on credit, equity decreases from the debit to the Advertising Expense account even though no assets have left the business. This is due to the creditor having an increased claim on the business’s assets. The owner’s claim on those assets has less priority than the creditors’, so the owner’s claim must decrease. 8. The fiscal period is the period over which earnings are measured. 9. The student’s statement is accurate in the sense that expenses are expired costs—they have no future value or role. They have “given up their lives.” Additionally, the mission of these expired costs was to produce revenue or support revenue-making activities. When they are subtracted from, or matched against, the revenues they produced or supported, net income or loss is revealed. Section 5.3 1. The two major financial statements learned so far are the balance sheet and the income statement. 2. The equity equation for a profit situation is Beginning Capital + Net Income – Drawings = Ending Capital. December 10, 2020 3. The equity equation for a loss situation is Beginning Capital – Net Loss – Drawings = Ending Capital. 4. You will find the beginning equity figure in the Capital account. 5. Changes to equity are recorded in the Revenue, Expense, and Drawings accounts. Occasionally, changes will be entered directly into the Capital account, such as an additional investment by the owner (debit Bank, credit Capital). 6. Drawings do not affect the calculation of net income. Drawings affect the calculation of the ending capital on the balance sheet. 7. If Drawings are greater than net income, there will be an overall decrease in equity. 8. The statement is most often true. A net loss represents a decrease in equity from normal business operations. Therefore, in most cases, equity would decrease with a net loss, even if drawings are zero. 9. Equity could increase if there was a net loss if the owner invested additional funds in the business. Chapter 5 - Further Thought 1. The owner would calculate the net income by carefully inspecting the Capital account and adding all the revenues earned less all the expenses incurred. Calculating the change in equity from one year to another would only give a rough indication of net income because other equity items like drawings and additional investments would affect the result. 2. Equity represents the owner’s claim on assets. Since equity is on the right side of the accounting equation, it increases on the credit side and decreases on the debit. By nature, expense accounts decrease equity and therefore are recorded with debits. When expenses go up, equity goes down so an increase in an expense must be recorded as a debit. 3. There are usually only one or two revenue accounts because, in most cases, a business’s revenue comes from only one or two sources. There are many expense accounts because there are many different types of costs incurred when running a business. 4. A banker would be interested in the net income or loss on the income statement, which would show the profitability of the business. A banker would also be interested in the assets and liabilities on the balance sheet, which shows how much debt is owed by the business compared to the value of its assets. These things will show the banker if the business can honour its debts to the bank. 5. A company has to produce an annual statement because the government requires all businesses to file income tax statements every year. 6. To determine the equity amount from the ledger, you could subtract the total of the liability accounts from the total of the asset account (Assets − Liabilities = Equity). Or you could add the capital and revenue accounts and then subtract the drawings and expense accounts (Capital + Revenues – Drawings – Expenses = Equity). 7. ○ A medical office would have a revenue account called Fees Earned. December 10, 2020 ○ A loan company would have a revenue account called Interest Revenue. ○ A photography company could have a revenue account called Photo Shoots Revenue or Photo Enhancements Revenue. ○ A real estate company would have a revenue account called Commissions Earned. ○ A hair salon could have a revenue account called Hair Cut Fees, or Colouring Fees, or Permanents. ○ 8. A dry cleaning company would have a revenue account called Cleaning Revenue. A business could be quite profitable and yet have a cash shortage because the owner takes out more money than the company earns in revenue. Or, the business could spend much of its profits on new equipment or other assets. 9. The Bank account could have a credit balance if a company withdraws more than the actual bank balance. This is allowed if the company has overdraft protection. A credit balance in a Bank account is an exceptional balance. 10. Businesses prefer to purchase on credit because it leaves them with cash for other expenses, they can inspect the goods before paying, and they can withhold payment if the goods are unsatisfactory or damaged. 11. It is as important to control the expenses of a business as it is to increase the revenues because expenses decrease the net income of a business. A business can earn a large revenue and still not make a profit if its expenses are too high. 12. No, you cannot be sure who has the better earnings because you do not know how long each person took to earn the money. If John took longer to earn the money or it was the same period, then Gary earned more. But if Gary took longer to earn the money, John might have earned more. 13. To make a larger profit, the revenue must be greater or the expenses must be lower or both. Bonanza Burger could sell cheaper burgers than Giant Burger and make a larger profit because they sell more burgers per week, resulting in greater revenue. Or Bonanza Burger could have a better deal with their suppliers so they pay less for their ingredients, resulting in a lower per burger cost, which means they earn more profit on each burger sold. Another possibility is that Bonanza Burger pays less rent or lower wages, resulting in lower overall expenses. December 10, 2020 BAF3M1 - Chapter 7 (Postings) Review Sections 7.1 1. The two important books in the accounting process are the journal and the ledger. 2. The simple account that shows debit amounts on one side and credit amounts on the other is called a T-account. 3. The account that is more useful and convenient than the T-account is the balance column account. 4. The balance column account is considered useful because it has three separate money columns for debits, credits, and balance. There are also columns for the date, to indicate if the balance is a debit or credit, and to record the journal page from where the amount originated. 5. To open a new account, assign the account an identification number and an appropriate account title that describes the purpose of the account. Then place the account in the proper order with the other accounts in the ledger. 6. Accounting entries are first recorded in the journal. 7. Posting is the process of transferring information from the journal to the ledger. 8. The five steps in posting that are performed in the ledger are as follows. Step 1: Record the date on the next unused line in the account. Step 2: In the posting reference (P.R.) column of the account, write “J” and then the general journal page number where the transaction is recorded. Step 3: Record the amount. Debit amounts are entered in the debit columns of the accounts. Credit amounts are entered in the credit columns of the accounts. Step 4: Calculate the new balance. Indicate whether this balance is a debit or credit in the Dr/Cr column. Step 5: Enter the new account balance you calculated in Step 4 in the balance column. 9. The one-step in posting that is performed in the journal is to write the ledger account number that received the posting in the posting reference (P.R.) column on the same line as the amount posted. 10. Cross-referencing is the process of recording the journal page number in the account and the account number in the journal. 11. There are three reasons for cross-referencing. One, cross-referencing allows entries in the journal to be traced to the accounts where they have been posted. Two, it allows entries in accounts to be easily traced back to their source in the general journal. Three, if the posting process is interrupted, cross-referencing makes it easy to tell where to begin again since journal amounts that have been posted will have the account number entered. 12. Forwarding is the process of continuing an account in a new account form by carrying forward the date and the balance from the completed page. 13. The first four steps in the accounting cycle are as follows. Step 1: Transactions occur and source documents are generated. Step 2: Use the source documents to journalize the accounting entries. Step 3: Post the journal entries to the ledger. Step 4: Take off a trial balance.