CSEC PRINCIPLES OF ACCOUNTS

HANDOUT # 2

SEPTEMBER 20, 2019

MBI HIGH
SPANISH TOWN
Review of Handout 1

Exercise a
Exercise B

Exercise C
 PRACTICE QUESTIONS & CASES

SHORT ANSWER QUESTIONS, EXERCISES AND PROBLEMS

• Define the Accounting Cycle.

• Identify internal and external users of financial information?
• What is general purpose of financial statements?
• How a corporation differ from a partnership in context of the ownership?
• Describe the Limited-Liability Company?
• What is the role of ethics in accounting?

Exercises
Exercise A Match the descriptions in Column B with the appropriate terms in Column A.
Column A Column B

1. Corporation. a. An unincorporated business owned by an individual.

2. Merchandising company. b. The form of organization used by most large businesses.

3. Partnership. c. Buys raw materials and converts them into finished products.

4. Manufacturing company. d. Buys goods in their finished form and sells them to

5. Service company. customers in that same form.

6. Single proprietorship. e. An unincorporated business with more than one owner.

f. Performs services for a fee.

Write answers to the following questions:
Who is responsible for preparing the financial statements?
Of what importance is the internal audit?
What is the role of the audit committee?
Why are no officers or employees on the audit committee?
What is the responsibility of the external independent auditor?
Does the independent auditor have absolute assurance that the financial statements are
free of material misstatement?

To achieve basic objectives and implement fundamental qualities GAAP has

basic principles, and four basic constraints.

Principles

• Historical cost principle requires companies to account and report based on

acquisition costs rather than fair market value for most assets and liabilities. This
principle provides information that is reliable (removing opportunity to provide
subjective and potentially biased market values), but not very relevant.
• Going concern principle means the reporting assumption is that the company
will continue indefinitely.
• Monetary Measurement Concept refers to all transactions are recording in
monetary units. In the case of the US, all transactions would be recorded in US
dollars.
• Revenue recognition principle holds that companies may not record revenue
until (1) it is realized or realizable and (2) when it is earned. It does not matter if
cash has been received or paid. This is the essence of accrual basis accounting.
• Matching principle. Expenses have to be matched with revenues as long as it is
reasonable to do so. Expenses are recognized not when the work is performed, or
when a product is produced, but when the work has been done or the product has
been delivered. Only if no connection with revenue can be established, cost may
be charged as expenses to the current period (e.g. office salaries and other
administrative expenses).
• Full disclosure principle. Amount and kinds of information disclosed should be
decided based on trade-off analysis as a larger amount of information costs more
to prepare and use. Information disclosed should be enough to make a judgment
while keeping costs reasonable.
Constraints

• Objectivity constraint: the company financial statements provided by the

accountants should be based on objective evidence.
• Materiality constraint: the significance of an item should be considered when it is
reported. An item is considered significant when it would affect the decision of a
reasonable individual.
 • Consistency constraint: It means that the company uses the same accounting
principles and methods from period to period.
• Conservatism constraint: when choosing between two solutions, the one which
has the less favorable outcome is the solution which should be chosen (see
convention of conservatism).

Account Types

We have 5 basic categories for accounts:

• Asset: Something a business has or owns

• Liability: Something we owe to a non-owner
• Equity: Something we owe to the owners or the value of the investment to the
owner
• Revenue: Value of the goods we have sold or the services we have performed
• Expenses: Costs of doing business

2.3 The Basic Accounting Equation

ASSETS = LIABILITIES + EQUITY

Exercise E
COMPLETE THE EXERCISES 1- 12 ON PAGE 39 IN TEXT BOOK {CARLONG
PRINCIPLES OF ACCOUNTS FOR CSEC}

2.4 Financial Statements

Financial statements are how companies communicate their story. Thanks to GAAP,
there are four basic financial statements everyone must prepare . Together they
represent the profitability and strength of a company. The financial statement that
reflects a company’s profitability is the income statement. The statement of retained
earnings – also called statement of owners equity shows the change in retained
earnings between the beginning and end of a period (e.g. a month or a year).
The balance sheet reflects a company’s solvency and financial
position. The statement of cash flows shows the cash inflows and outflows for a
company over a period of time.

There are several accounting activities that happen before financial statements are
prepared. Financial statements are prepared in the following order:
 1. Income Statement
2. Statement of Retained Earnings – also called Statement of Owners’ Equity
3. The Balance Sheet
4. The Statement of Cash Flows

Remember the transaction analysis we were working on for Metro Courier? Let’s use
those numbers to prepare the financial statements for Metro Courier Inc. The final
balances for January were:

Cash Asset $ 66,800

Accounts Receivable Asset $ 5,000

Supplies Asset $ 500

Prepaid rent Asset $ 1,800

Equipment Asset $ 5,500

Truck Asset $ 8,500

Accounts Payable Liability $ 200

Common Stock Equity $ 30,000

Retained Earnings Equity $0

Service Revenue Revenue $ 60,000

Salary Expense Expense $ 900

Utilities Expense Expense $ 1,200

Income Statement

The income statement, sometimes called an earnings statement or profit and loss
statement, reports the profitability of a business organization for a stated period of
time. In accounting, we measure profitability for a period, such as a month or year, by
comparing the revenues earned with the expenses incurred to produce these
revenues. This is the first financial statement prepared as you will need the information
from this statement for the remaining statements. The income statement contains:
 • Revenues are the inflows of cash resulting from the sale of products or the
rendering of services to customers. We measure revenues by the prices agreed
on in the exchanges in which a business delivers goods or renders services.
• Expenses are the costs incurred to produce revenues. Expenses are costs of
doing business (typically identified as accounts ending in the word “expense”).
• REVENUES – EXPENSES = NET INCOME. Net income is often called
the earnings of the company. When expenses exceed revenues, the business has
a net loss.

Metro Courier Inc.

Income Statement

Month Ended January 31

Revenue:

Service Revenue $ 60,000

Total Revenues $ 60,000

Expenses:

Salary Expense 900

Utility Expense 1, 200

Total Expenses 2,100

Net Income ($60,000 – 2,100) $ 57,900

• The net income from the income statement will be used in the Statement of
Equity.

Statement of Retained Earnings (or Owner’s Equity)

The statement of retained earnings, explains the changes in retained earnings

between two balance sheet dates. We start with beginning retained earnings (in our
example, the business began in January so we start with a zero balance) and add any
net income (or subtract net loss) from the income statement. Next, we subtract any
dividends declared (or any owner withdrawals in a partnership or sole-proprietor) to get
the Ending balance in Retained Earnings (or capital for non-corporations)

Metro Courier Inc.

Statement of Retained Earnings

Month Ended January 31

Beginning Retained Earnings, Jan 1 $ 0

Net income from month (from income statement) 57,900

Total increase $ 57,900

Dividends (or withdrawals for non-corporations) – $0

Ending Retained Earnings, January 31 $ 57,900

The Ending balance we calculated for retained earnings (or capital) is reported on the
balance sheet.

Balance Sheet

The balance sheet, lists the company’s assets, liabilities, and equity (including dollar
amounts) as of a specific moment in time. That specific moment is the close of business
on the date of the balance sheet. Notice how the heading of the balance sheet differs
from the headings on the income statement and statement of retained earnings. A
balance sheet is like a photograph; it captures the financial position of a company at a
particular point in time. The other two statements are for a period of time. As you study
about the assets, liabilities, and stockholders’ equity contained in a balance sheet, you
will understand why this financial statement provides information about the solvency of
the business.
 Metro Courier Inc.

Balance Sheet

January 31

Assets Liabilities and Equity

Cash $ 66,800 Accounts Payable 200

Accounts Receivable 5,000 Total Liabilities 200

Supplies 500

Prepaid Rent 1,800 Common Stock 30,000

Equipment 5,500 Retained Earnings 57,900

Truck 8,500 Total Equity 87,900

Total Assets $ 88,100 Total Liabilities + Equity $ 88,100

Remember in the transaction analysis, our final accounting equation was: Assets
$88,100 (Cash $66,800 + Accounts Receivable $5,000 + Supplies $500 + Prepaid Rent
$1,800 + Equipment $5,500 + Truck $8,500) = Liabilities $200 + Equity $87,900
(Common Stock $30,000 + Net Income $57,900 from revenue of $60,000 – salary
expense $900 – utility expense $1,200). The balance sheet is the same equation in an
easier to read format.

Statement of Cash Flows

The statement of cash flows shows the cash inflows and cash outflows from operating,
investing, and financing activities. Operating activities generally include the cash effects
of transactions and other events that enter into the determination of net income.
Management is interested in the cash inflows to the company and the cash outflows
from the company because these determine the company’s cash it has available to pay
its bills when due. We will examine the statement of cash flows in more detail later but
for now understand it is a required financial statement and is prepared last. The
statement of cash flows uses information from all previous financial statements.
 KEY POINTS

There are four financial statements produced by accountants, including

• The income statement reports the revenues and expenses of a company and
shows the profitability of that business organization for a stated period of
time. The net income (or loss) calculated is used in the statement of retained
earnings.
• The statement of retained earnings shows the change in retained earnings
between the beginning of the period (e.g. a month) and its end. The ending
retained earnings is used by the balance sheet.
• The balance sheet lists the assets, liabilities, and equity (including dollar amounts)
of a business organization at a specific moment in time and proves the accounting
equation.
• The statement of cash flows which shows the cash inflows and cash outflows for a
company for a stated period of time. The statement of cash flows uses
information from all previous financial statements.

2.5 Accounting in the Headlines

What impact do lower fuel costs and other

changes have on an airline’s net income?

American Airlines Group (AAL), the world’s biggest airline, has been reporting record
profits in recent quarters. United Continental Holdings and Southwest Airlines also
reported record profits.

Part of what has contributed to the record profits has been the decline in the cost of oil.
The price of oil has fallen during 2014; we are spending much less at the gas pump to
fill our cars. The airlines are also experiencing the effects of lower oil prices; the price
of jet fuel is down 18% since August 2014.

Increased revenues have also contributed to the high profits in the airline
industry. Overall, airfares are up 3% for 2014 according to Airlines for America, an
industry trade group. In addition, planes have been about 85% full in 2014, which is a
record high for the airline industry.

On the other hand, airlines spent more on fuel in 2014 than in 2010. Airlines also spent
more on labor due to higher renegotiated labor contracts.

Questions

Would each of the following changes INCREASE or DECREASE an airline’s net income
(consider each item independently)? What income statement account would be
impacted by each item?

1. The 3% increase in airfare (ticket prices)

2. The 18% decrease in the price of per gallon of jet fuel
3. The increase in the number of seats sold
4. The increase in the total spent on jet fuel
5. The increase in the cost of labor contracts

Glossary: Lesson 2
GLOSSARY

Accounting equation Assets = Liabilities + Equity.

Accounts payable Amounts owed to suppliers for goods or services purchased on credit.
Accounts receivable Amounts due from customers for services already provided.
Assets Things of value owned by the business. Examples include cash, machines, and
buildings. To their owners, assets possess service potential or utility that can be measured and
expressed in money terms.
Balance sheet Financial statement that lists a company’s assets, liabilities, and stockholders’
equity (including dollar amounts) as of a specific moment in time. Also called a statement of
financial position.
Business entity concept (or accounting entity concept) The separate existence of the
business organization.
Capital stock The title given to an equity account showing the investment in a business
corporation by its stockholders.
Continuity See going-concern concept.
Corporation Business incorporated under the laws of one of the states and owned by a few
stockholders or by thousands of stockholders.
Cost Sacrifice made or the resources given up, measured in money terms, to acquire some
desired thing, such as a new truck (asset).
Dividend Payment (usually of cash) to the owners of a corporation; it is a distribution of income
to owners rather than an expense of doing business.
Entity A business unit that is deemed to have an existence separate and apart from its owners,
creditors, employees, customers, other interested parties, and other businesses, and for which
accounting records are maintained.
Equities Broadly speaking, all claims to, or interests in, assets; includes liabilities and
stockholders’ equity.
Equity ratio A ratio found by dividing stockholders’ equity by total equities (or total assets).
Exchange-price (or cost) concept (principle) The objective money prices determined in
the exchange process are used to record most assets.
Expenses Costs incurred to produce revenues, measured by the assets surrendered or
consumed in serving customers.
Going-concern (continuity) concept The assumption by the accountant that unless strong
evidence exists to the contrary, a business entity will continue operations into the indefinite
future.
Income statement Financial statement that shows the revenues and expenses and reports
the profitability of a business organization for a stated period of time. Sometimes called
an earnings statement.
Liabilities Debts owed by a business—or creditors’ equity. Examples: notes payable, accounts
payable.
Manufacturing companies Companies that buy materials, convert them into products, and
then sell the products to other companies or to final customers.
Merchandising companies Companies that purchase goods ready for sale and sell them to
customers.
Money measurement concept Recording and reporting economic activity in a common
monetary unit of measure such as the dollar.
Net income Amount by which the revenues of a period exceed the expenses of the same
period.
Net loss Amount by which the expenses of a period exceed the revenues of the same period.
Notes payable Amounts owed to parties who loan the company money after the owner signs
a written agreement (a note) for the company to repay each loan.
Partnership An unincorporated business owned by two or more persons associated as
partners.
Periodicity (time periods) concept An assumption that an entity’s life can be meaningfully
subdivided into time periods (such as months or years) for purposes of reporting its economic
activities.
Profitability Ability to generate income. The income statement reflects a company’s
profitability.
Retained earnings Accumulated net income less dividend distributions to stockholders.
Revenues Inflows of assets (such as cash) resulting from the sale of products or the rendering
of services to customers.
Service companies Companies (such as accounting firms, law firms, or dry cleaning
establishments) that perform services for a fee.
Single proprietorship An unincorporated business owned by an individual and often
managed by that individual.
Solvency Ability to pay debts as they become due. The balance sheet reflects a company’s
solvency.
Source document Any written or printed evidence of a business transaction that describes
the essential facts of that transaction, such as receipts for cash paid or received.
Statement of cash flows Financial statement showing cash inflows and outflows for a
company over a period of time.
Statement of retained earnings Financial statement used to explain the changes in
retained earnings that occurred between two balance sheet dates.
Stockholders’ equity The owners’ interest in a corporation.
Stockholders or shareholders Owners of a corporation; they buy shares of stock, which
are units of ownership, in the corporation.
Summary of transactions Teaching tool to show the effects of transactions on the
accounting equation.
Transaction A business activity or event that causes a measurable change in the items in the
accounting equation, Assets = Liabilities + Equity.

Exercises: Chapter 2

SHORT ANSWER QUESTIONS, EXERCISES AND PROBLEMS

Questions:
➢ Accounting has often been called the language of business. In what respects would you
agree with this description? How might you argue that this description is deficient?
➢ Define asset, liability, and stockholders’ equity.
➢ How do liabilities and stockholders’ equity differ? How are they similar?
➢ How do accounts payable and notes payable differ? How are they similar?
➢ Define revenues. How are revenues measured?
➢ Define expenses. How are expenses measured?
➢ What is a balance sheet? On what aspect of a business does the balance sheet provide
information?
➢ What is an income statement? On what aspect of a business does this statement provide
information?
➢ What information does the statement of retained earnings provide?
➢ Identify the three types of activities shown in a statement of cash flows.
➢ What is a transaction? What use does the accountant make of transactions? Why?
➢ What is the accounting equation? Why must it always balance?
➢ Give an example from your personal life that illustrates your use of accounting information in
reaching a decision.
➢ You have been elected to the governing board of your church. At the first meeting you
attend, mention is made of building a new church. What accounting information would the board
need in deciding whether or not to go ahead?
➢ A company purchased equipment for $2,000 cash. The vendor stated that the equipment
was worth $2,400. At what amount should the equipment be recorded?
➢ What is meant by money measurement?
➢ Of what significance is the exchange-price (or cost) concept? How is the cost to acquire an
asset determined?
➢ What effect does the going-concern (continuity) concept have on the amounts at which long-
term assets are carried on the balance sheet?
➢ Of what importance is the periodicity (time periods) concept to the preparation of financial
statements?
➢ Describe a transaction that would:
• Increase both an asset and capital stock.
• Increase both an asset and a liability.
• Increase one asset and decrease another asset.
• Decrease both a liability and an asset.
• Increase both an asset and retained earnings.
• Decrease both an asset and retained earnings.
• Increase a liability and decrease retained earnings.
• Decrease both an asset and retained earnings.
• Identify the causes of increases and decreases in stockholders’ equity
B) Accounting Exercises:
Exercise 1. Applying Basic Accounting Equation
Royals Palm, Inc. reports the following assets and liabilities. Compute the totals that would
appear in the corporation’s basic accounting equation (Assets = Liabilities + Stockholders’
Equity (Capital Stock)).

Cash………………………….$55,000
Accounts Payable……………25,000
Office Supplies………………. 1, 500
Loan Payable…………………..7,000
Accounts Receivable………….10,000
Answer:
 Assets = Liabilities + Stockholders’ Equity

Exercise 2. Applying Basic Accounting Equation

Dan and Den, Inc. reports the following assets and liabilities. Compute the totals that would
appear in the corporation’s basic accounting equation (Assets = Liabilities + Stockholders’
Equity (Capital Stock)).

Cash………………………….$37,000
Accounts Payable……………15,000
Supplies……………………….1, 800
Loan Payable…………………..9,000
Inventory……………………….12,000

Answer:

Assets = Liabilities + Stockholders’ Equity

Exercise 3. Complete missing amounts in fundamental accounting equation for

several businesses:

Assets = Liabilities + Stockholders’ Equity

578,000 152,000

25,000 180,500

127,000 17,000

269,000 45,000

850,000 675,000

250,000 657,450
Exercise 4. Perez Company had the following transactions during January:
1. Jan 1 Issued $100,000 in stock to owners in exchange for cash to start the business.
2. Jan 5 Borrowed $50,000 from the bank by signing a notes payable.
3. Jan 10 Purchase equipment by paying cash for $25,000.
3. Jan 15 Paid January rent of $2,400 for the office space (hint: since this is for January,
record as rent expense)
4. Jan 18 Performed services for customers and received cash immediately for $8,000.
5. Jan 20 Purchased $2,000 in supplies on account.
Prepare a transaction analysis for the January transactions. Remember to prove the accounting
equation at the end.

+ –
Assets = Liability + Equity
Revenue Expense

Accounts Notes Common Service Rent

Transaction Cash Supplies Equipment
Payable Payable Stock Revenue Expense

Jan 1 Issued
stock to owners

Jan 5 Borrowed
money from bank

Jan 10
Purchased
equipment with
cash

Jan 15 Paid
January rent

Jan 18
Performed
services

Jan 20
Purchased
supplies on
account

Balance:

Exercise 5. On December 31, Bryniuk’s Company, the accounting records

showed the following information:
 Cash 49,500

Accounts Receivable 125,000

Supplies 1,500

Prepaid Insurance 12,000

Equipment 70,000

Building 420,000

Land 111,500

Accounts Payable 80,000

Notes Payable 170,000

Common Stock 410,000

Retained Earnings 65,000

Dividends 20,000

Service Revenue 174,000

Interest Revenue 1,000

Salaries Expense 52,000

Advertising Expense 17,000

Insurance Expense 5,000

Utilities Expense 13,750

Interest Expense 2,750

Prepare the Income Statement for year ended December 31.

 Bryniuk’s Company

Income Statement

For Year Ended December 31

Revenues: .

Total Revenues

Expenses:

Total Expenses

Net Income

Exercise 6. Using the information from Exercise 5, prepare the Statement of

Retained Earnings for December 31.

Bryniuk’s Company

Statement of Retained Earnings

For Year Ended December 31

Beginning Retained Earnings $65,000

Add: Net Income

Subtract: Dividends

Ending Retained Earnings

Exercise 7. Using the information from Exercises 5 and 6, prepare the Balance
Sheet for December 31.

Bryniuk’s Company

Balance Sheet

December 31

Assets Liabilities and Equity

Total Liabilities

Total Equity

Total Assets Total Liabilities and Equity

Problem 1: Prepare the financial statements of RodCast Company using the

following information:

Accounts Payable 43,100.00

Accounts Receivable 85,000.00

Cash 55,320.00

Common Stock 125,000.00

Dividends 28,000.00

Machinery 70,000.00

Rent Expense 24,000.00

Retained Earnings 70,000.00

Salaries Expense 65,000.00

 Service Revenue 165,320.00

Supplies 2,350.00

Trucks 60,000.00

Utilities Expense 13,750.00

1. Classify each account by Account Type (Asset, Liability, Equity, Revenue or Expense) and
which financial statement (income statement, statement of retained earnings, or balance sheet)
it appears on.

Account Account Type Financial Statement

2. Prepare the Income Statement, Statement of Retained Earnings and Balance Sheet for the
month ended October 31.

Comprehensive Problems Example:

Larson’s Accounting Company has the following account balances: Cash, $5,000; Accounts
Receivable, $2,000; Prepaid Rent $1,500; Supplies, $850; Equipment, $6,000; Trucks, $15,000;
Accounts Payable, $2,500; Common Stock, $20,000; Retained Earnings $7,850. Business
transactions during December are presented as follows:
1. Company received cash from clients for services, $4,500
2. Larson paid to creditors $500,
3. Paid office rent for the month of December, $750,
4. Company billed client for accounting services on account, $5,200
5. Supplies were purchased on account, $650,
6. Company received cash from clients billed previously, $6,000
7. Larson received an invoice for office equipment repair services from Office Extra for
December (the invoice will be paid next month), $850,
8. Larson paid monthly salaries, $2,700,
9. Utilities expense were paid, $280,
10. Miscellaneous expense were paid, $350,
11. Dividends were paid, $550.
 Assets = Liabilities + Stockholders’ Eq

+
Retain
Accounts Prepaid Accounts Common
Cash Supplies Equipment Trucks ed
Receivable Rent Payable Stock
Earnin
gs

Previous
$5,000 $2,000 $1,500 $850 $6,000 $15,000 $2,500 $20,000 $7,850
Balances

1 4,500

2 -500 -500

3 -750

4 5,200

5 650 650

6 6,000 -6,000

7 850

8 -2,700

9 -280

10 -350

11 -550

Ending
$11,120 $1,200 $750 $1,500 $6,000 $15,000 $3,500 $20,000 $7,850
Balance:
Larson Company

Income Statement

Month Ended December 31, 2014

Fees earned $9,700

Expenses:

Rent Expense $750

Repair Expense 850

Wages Expense 2700

Utilities Expense 280

Miscellaneous expense 350

Total Expenses $4,930

Net Income ($9,700 – $4,930)= $4,770

Larson Company

Statement of Retained Earnings

Month Ended December 31

Larson Inc., Retained Earnings, December 31 $ 7,850

Net income for the month $4,770

Less Dividends – 550

Increase in Stockholders’ Equity + 4,220

Larson Inc., Retained Earnings, December 31 $12,070

 Larson Company

Balance Sheet

Month Ended December 31

Assets Liabilities

Cash $11,120 Accounts Payable $3,500

Accounts Receivable 1,200

Prepaid Rent 750 Stockholders’ Equity

Supplies 1,500 Common Stock 20,000

Equipment 6,000 Retained Earnings 12,070

Trucks 15,000

Total Assets $35,570 Total Liabilities and Stockholders’ Equity $35,570

Comprehensive Problem 1.
Cast 77 Service Company has the following account balances: Cash, $6,000; Accounts
Receivable, $7,000; Prepaid Rent, 1,900; Prepaid Insurance, $1,200 Supplies, $950;
Equipment, $7,000; Trucks, $10,000; Accounts Payable, $2,700;Common Stock $25,000;
Retained Earnings $6,350. Business transactions during December are presented as follows:
1. Company received cash from clients for services, $7,500
2. Cast 77 paid to creditors $600,
3. Paid office rent for the month of December, $950,
4. Company billed client for accounting services on account, $8,200
5. Supplies were purchased on account, $450,
6. Company received cash from clients billed previously, $4,200
7. Cast 77 received an invoice for services from Copy Plus for December (the
invoice will be paid next month), $550,
8. Cast 77 paid monthly salaries, $4,700,
9. Utilities expense were paid, $380,
10. Miscellaneous expense were paid, $250,
11. Paid for monthly insurance, $200
12. Dividends were paid, $750.
Required:
• Apply the basic accounting equation (create a spreadsheet, please see
comprehensive example) to complete a transaction analysis for each
transaction (hint: enter the balances provided first).
• Prepare income statement at the end of December 31.
• Prepare statement of retained earnings equity at the end of December 31.
• Prepare balance sheet at the end of December 31.