CSEC PRINCIPLES OF ACCOUNTS

HANDOUT # 1

Islam commands authority over the totality of a Muslim's being, not accepting any distinction
between the sacred and the secular. Economics, politics, religious and social affairs—even
accounting—fall under the jurisdiction of the divine law of Islam—the shari'a.

In fact, accounting in the broad sense is central to Islam, since accountability to God and the
community for all activities is paramount to a Muslim's faith. Based on the shari'a, Islam has
formulated a comprehensive ethic governing how business should be run, how accounting
ought to be undertaken, and how banking and finance is to be arranged.

SEPTEMBER 6, 2019
MBI HIGH
SPANISH TOWN
1.1 Introduction: What is Accounting
LEARNING OBJECTIVES

By the end of this lesson, you will be able to:

• Define accounting
• Describe the evolution of accounting
• Identify reasons for the study of accounting.
• List various types of accounting activities
• Identify users of accounting information.
• Explain the importance of Ethics in business and accounting

Why do we need financial information?

Each business needs financial information to be able to answer the following questions:

• How much cash does the business need?

• What is the business’ profit or loss?
• How much should the business sell?
• What is the cost of goods sold?
• What are the business’ expenses?
• Do customers owe money to the business?

Consider these questions:

• What is Accounting?
• What is Business?
• Who are the three people that want to know the story of your business?
• What language of Accounting does the government use?
• What language of Accounting do Investors use?
• What language of Accounting do internal users employ?

Every business organization that has economic resources, such as money, machinery,
and buildings, uses accounting information. For this reason, accounting is called the
language of business. Accounting also serves as the language providing financial
information about not-for-profit organizations such as governments, churches, charities,
fraternities, and hospitals.

Financial accounting information appears in financial statements that are intended

primarily for external use (although management also uses them for certain internal
decisions). Stockholders and creditors are two of the outside parties who need financial
accounting information.

Managerial accounting information is for internal use and provides special information
for the managers of a company. The information managers use may range from broad,
long-range planning data to detailed explanations of why actual costs varied from cost
estimates. Management accountants in a company prepare the financial statements.

Exercise a
1.2 Accounting Defined
We understand, from the prior video, that accounting is “the language of business”.

The American Accounting Association defines accounting as:

the process of identifying, measuring, and communicating economic

information to permit informed judgments and decisions by the users of the
information.

Accounting, then, is a measurement and communication process used to report on the

activities of profit-seeking business organizations.

Users of accounting information are separated into two groups, internal and external.
Internal users are the people within a business organization who use accounting
information. External users are people outside the business entity that use accounting
information.

Accounting is often confused with bookkeeping. Bookkeeping is a mechanical

process that records the routine economic activities of a business. Accounting includes
bookkeeping but goes well beyond it in scope.

As you move through this course, keep in mind an important concept – accounting
has the OPPOSITE mindset of a bank account. A bank account is something you
own but something the bank owes you.

IMPORTANT POINTS TO REMEMBER

• Accounting is a process of recording, organizing, summarizing, and analyzing

financial information. Financial information is presented to owners, investors,
managers, and other interested parties.
• Accounting systems help to gather all financial data and create periodic reports
called financial statements.
 Exercise B

1.3 Users of Accounting Information

The accounting process provides financial data for a broad range of individuals whose
objectives in studying the data vary widely. Three primary users of accounting
information identified, Internal users, External users, and Government/ Tax Office.

Internal Users

Accounting supplies managers and owners with significant financial data that is useful
for decision making. This type of accounting in generally referred to as managerial
accounting.
Some of the ways internal users employ accounting information include the following:

• Assessing how management has discharged its responsibility for protecting and
managing the company’s resources
• Shaping decisions about when to borrow or invest company resources

External Users

Typically called financial accounting, the record of a business’ financial history for use
by external entities is used for many purposes. The external users of accounting
information fall into six groups; each has different interests in the company and wants
answers to unique questions. The groups and some of their possible questions are:

• Owners and prospective owners. Has the company earned satisfactory income on its
total investment? Should an investment be made in this company? Should the present
investment be increased, decreased, or retained at the same level?
• Creditors and lenders. Should a loan be granted to the company? Will the company be
able to pay its debts as they become due?
• Employees and their unions. Does the company have the ability to pay increased
wages? Is the company financially able to provide long-term employment for its
workforce?
• Customers. Does the company offer useful products at fair prices? Will the company
survive long enough to honor its product warranties?
• General public. Is the company providing useful products and gainful employment for
citizens without causing serious environmental problems?

Some of the ways external users employ accounting information include the following:

• Stockholders have the right to know how a company is managing its investments
• Banks or lending institutions may use accounting information to guide decisions such as
whether to lend or how much to lend a business

Financial statements used by external entities are prepared using generally accepted
accounting principles, or GAAP.

IMPORTANT POINTS TO REMEMBER

• Internal users are people within a business organization who use financial information.
Examples of internal users are owners, managers, and employees.
• External users are people outside the business entity (organization) who use accounting
information. Examples of external users are suppliers, banks, customers, investors,
potential investors, and tax authorities.
1.4 Types of Businesses
A business entity is any business organization, such as a hardware or grocery store,
that exists as an economic unit. For accounting purposes, each business entity has an
existence separate from its owner(s), creditors, employees, customers, and other
businesses. This separate existence of the business organization is known as
the business entity concept.

• A single proprietorship/sole trader is an unincorporated business owned by an

individual and often managed by that same person. Single proprietors include physicians,
lawyers, electricians, and other people in business for themselves. Both proprietorships
and partnerships do not pay taxes on profits at the business level. The only taxes
paid are at the personal level—this occurs when proprietors and partners pay taxes on
their share of their company’s income. On the other hand, a business owner is personally
liable for all debts of his or her company. If you’re a sole proprietorship and the debts of
your business exceed its assets, creditors can seize your personal assets to cover the
proprietorship’s outstanding business debt.

• A partnership is an unincorporated business owned by two or more persons associated

as partners. Often the same persons who own the business also manage the business.
Many small retail establishments and professional practices, such as dentists, physicians,
attorneys, and many Accounting firms, are partnerships.

• A corporation/company is a business incorporated under the laws of a state and owned

by a few stockholders or thousands of stockholders. Almost all large businesses and
many small businesses are incorporated. The corporation is unique in that it is a separate
legal business entity. The owners of the corporation are stockholders, or shareholders.
Stockholders do not directly manage the corporation. They elect a board of directors to
represent their interests.

• A cooperative is an association of members who come together voluntarily to achieve a

common aim. They contribute capital and share profits and losses

• Also NFPOs (Not-for-profit organizations)

Important Points to Remember

• Business entity is any business organization, such as super market, or accounting firm,
that exists as an economic unit.
• The three most common types of business entities: Sole-proprietorship, Partnership, and
Corporation. From the accounting perspective and its purpose these types of business
are considered separate entities from their owners. The corporation is only one
considered as a separate legal entity.

Exercise C
1.5 Ethics in Accounting
ETHICAL BEHAVIOR OF ACCOUNTANTS

Most of those who write about ethics do not make a clear distinction between ethics and
morality. The question of what is “right” or “morally correct” or “ethically correct” or
“morally desirable” in any situation is variously phrased, but all of the words and
phrases are after the same thing: what act is “better” in a moral or ethical sense than
some other act?

People often speak about the ethics or morality of individuals and also about the
morality or ethics of businesses. For example, if we conclude that WorldCom or Enron
acted “unethically” in certain respects, then we are making judgments that their
collective actions are morally deficient.

Why Should a Business or Accountant Be Ethical?

The usual answer is that good ethics is good business. In the long run, businesses that
pay attention to ethics do better; they are viewed more favorably by customers. But this
is a difficult claim to measure scientifically, because “the long run” is an indistinct period
of time and because there are as yet no generally accepted criteria by which ethical
excellence can be measured. In addition, life is still lived in the short run, and there are
many occasions when something short of perfect conduct is a lot more profitable.

Several accounting organizations have codes of ethics governing the behavior of their
members. It is important to maintain ethical behavior both personally and professionally
in business, therefore many business firms have also developed codes of ethics for
their employees to follow.

Ethical behavior involves more than merely making sure you are not violating a code of
ethics. Most of us sense what is right and wrong. Yet get-rich-quick opportunities can
tempt many of us. Almost any day, newspaper headlines reveal public officials and
business leaders who did not do the right thing. Greed won out over their sense of right
and wrong. These individuals followed slogans such as: “Get yours while the getting is
good”; “Do unto others before they do unto you”; and “You have done wrong only if you
get caught”. More appropriate slogans might be: “If it seems too good to be true, it
usually is”; “There are no free lunches”; and the golden rule, “Do unto others as you
would have them do unto you”.

An accountant’s most valuable asset is an honest reputation. Those who take the high
road of ethical behavior receive praise and honor; they are sought out for their advice
and services. They also like themselves and what they represent. Occasionally,
accountants do take the low road and suffer the consequences

PRACTICE QUESTIONS & CASES

SHORT ANSWER QUESTIONS, EXERCISES AND PROBLEMS

Comprehensive Review Questions

• Why do we need financial information?
• What is accounting?
 • What is Business?
• Who are the three people that want to know the story of your business?
• Describe the difference between Financial and Managerial Accounting.
• 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.

Beyond the numbers—critical thinking

Business decision case A Upon graduation from high school, Jim Crane went to work
for a builder of houses and small apartment buildings. During the next six years, Crane
earned a reputation as an excellent employee—hardworking, dedicated, and
dependable—in the light construction industry. He could handle almost any job requiring
carpentry, electrical, or plumbing skills.
Crane then decided to go into business for himself under the name Jim’s Fix-It Shop,
Inc. He invested cash, some power tools, and a used truck in his business. He
completed many repair and remodeling jobs for homeowners and apartment owners.
The demand for his services was so large that he had more work than he could handle.
He operated out of his garage, which he had converted into a shop, adding several new
pieces of power woodworking equipment.
Now, two years after going into business for himself, Crane must decide whether to
continue in his own business or to accept a position as construction supervisor for a
home builder. He has been offered an annual salary of $50,000 and a package of fringe
benefits (medical and hospitalization insurance, pension contribution, vacation and sick
pay, and life insurance) worth approximately $8,000 per year. The offer is attractive to
Crane. But he dislikes giving up his business since he has thoroughly enjoyed being his
own boss, even though it has led to an average workweek well in excess of the
standard 40 hours
Suppose Crane comes to you for assistance in gathering the information needed to help
him make a decision. He brings along the accounting records that have been
maintained for his business by an experienced accountant. Using logic and your own
life experiences, indicate the nature of the information Jim needs if he is to make an
informed decision. Pay particular attention to the information likely to be found in his
business accounting records. Does the accounting information available enter directly
into the decision?
Write a memorandum to Jim describing the information he will need to make an
informed decision. The memo’s headings should include Date, To, From, and
Subject. (See the format in Group Project E below.)

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 what extent does the independent auditor examine evidence?
Ethics case- writing experience D Refer to “An ethical perspective: State university”.
Write a short essay discussing the alternatives James Stevens could pursue and the
likely outcomes of those alternatives. Which of the alternatives you have discussed
would you recommend?

Group project E In teams of two or three students, interview a businessperson in your

community. Ask how that person uses accounting information in making business
decisions and obtain specific examples. Each team should write a memorandum to the
instructor summarizing the results of the interview. Information contained in the memo
should include:
Date:
To:
From:
Subject:
Content of the memo must include the name and title of the person interviewed, name
of the company, date of the interview, examples of the use of accounting information for
decision making, and any other pertinent information.
Group project F With a team composed of one or two other students, conceive of a
business that you would like to form after graduation. Then describe approximately 15–
20 transactions that the business might undertake in its first month of operations.
Prepare a summary of transactions showing how each transaction affects the
accounting equation. Identify each asset, liability, and stockholders’ equity item in your
summary of transactions. For instance, instead of grouping all assets in one number,
show cash, accounts receivable, and so on in your accounting equation.

Group project G With a team of one or two other students and using library sources,
write a paper on the Institute of Chartered Accountants of Jamaica, their services to
members, and their activities. Be careful to cite sources for your information. Direct
quotes should be labeled as such and should be single-spaced and indented if relatively
long or in quote marks and not indented if relatively short. To quote without giving the
source is plagiarism and should be avoided at all costs.

Using the Internet—A view of the real world

Visit the following website for Nokia:
http://www.nokia.com
Write a short paper describing company information, products and services, and
support available for their products.
Visit the following website for Ford Motor Company:
http://www.ford.com
When the web page appears, search for Investor Information and then locate the Ford
Motor Company Annual Report. Based on your investigation, write a short paper
describing the general content of the annual report.

Introduction: Accounting Principles and Practices

LEARNING OBJECTIVES

By the end of this section, you will be able to:

• Explain the meaning of the term Generally Accepted Accounting Principles
(GAAP).
• Define assets, liabilities, and owner’s equity.
• Describe the causes of change in owners’ equity, specifically: Owner investments,
Owner withdrawals, Net income, Net loss
• Explain the effect of various transactions on the accounting equation.
2.1 GAAP – Generally Accepted Accounting Principles
Financial accounting information is historical in nature, reporting on what has happened
in the past. To facilitate comparisons between companies, this information must
conform to certain accounting standards or principles called generally accepted
accounting principles (GAAP).

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.
• Time period principle (periodicity). This concepts refers to an organization
being subdivided into time periods for easy reporting. Examples of time periods
include monthly, quarterly and annually.
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).

2.2 Account Types

Account Types

Transactions can be summarized into similar group or accounts. A company compiles a

list of accounts to make the chart of accounts.

The video explained that accounts are like file folders. What are some things a
company might have? A company might have cash or a checking account, invoices
for money we will receive from customers later, bills we have to pay, and we might own
property like land, building or equipment. 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

Let’s look at each one individually. We will look at the broad picture of each category as
you will learn the details later in the course.

Assets: Assets are something you own or have and they are resources you expect to
gain a benefit from in the future. Depending on the nature of the business there are
many things that can be classified as assets.

Some examples of assets are:

• Cash (refers to the business cash available but can also be a checking or savings
account)
• Prepaid expenses (any expenses the business pays in advance)
• Accounts receivable (amount we will receive from customers at a later date)
• Inventory (items we intend to sell later)
• Equipment (value of equipment purchased)
• Building (value of building purchased)
• Land (value of land purchased)
Liabilities: Liabilities are something that business owes to a non-owner (debt and
business obligations). Liabilities can easily be identified as the account will most often
end in the word “payable” since it is something we must pay someone in the future.

Some examples of liabilities are:

• Accounts Payable (bills the company must pay)

• Wages Payable (obligations to employees for work performed),
• Payroll Taxes Payable (obligations paid on a monthly or quarterly to state, local or
federal agencies)
• Mortgage Payable (for example mortgage on business property)

Equity: Equity accounts represent the value of the owner’s investment in the
company. The Equity accounts are different based on the type of company.

1. For sole-proprietorship and partnership, a Capital account is used to record the

investment of the owners and income earned by the company. A Withdrawal (or
drawing) account is used when the owner takes money out for personal use.
2. For corporations, a Common Stock/Ordinary Share Capital account is used to
record the investment of the owners.

Revenues represent the value of the goods or services provided. Thanks to the
revenue recognition principle, we record revenue when we actually do the work by
performing a service or delivering a product. Examples of revenue accounts include:

• Service Revenue (revenue from completing a service, could be specific like

plumbing service revenue, accounting service revenue, photography service
revenue, etc.)
• Sales Revenue (value of products you sell)
• Interest Revenue (value of interest earned on investments or bank accounts)

Expenses are costs to the company and reflect the outflow of money. These expenses
represent the all costs of doing business and are used in order to generate the
revenue. Examples of expenses accounts include (notice how most expense accounts
end in the word “expense”):

• Cost of Goods Sold (what we paid for inventory we have sold)

• Utilities Expense (cost of utilities)
• Wages Expense (cost of employee’s earnings)
• Rent Expense (cost of renting office space or equipment)
 • Supplies Expense (cost of supplies used)

Below is an example of a chart of accounts for Metro Courier, Inc. which is a

corporation. Notice how the chart is listed in the order of Assets, Liabilities,
Equity, Revenue and Expense.

Metro Courier Inc.

Chart of Accounts

Account Name Account Type

Cash Asset

Accounts Receivable Asset

Prepaid Rent Asset

Inventory Asset

Office Equipment Asset

Building Asset

Accounts Payable Liability

Sales Tax Payable Liability

Common Stock Equity

Retained Earnings Equity

Service Revenue Revenue

Interest Revenue Revenue

Rent Expense Expense

Supplies Expense Expense

Wages Expense Expense

Insurance Expense Expense

You can create your own master chart of accounts for use in this course and build on it
as we go along. You should be able to complete the account type column and some of
the account descriptions

Answer the following questions about the types of accounts that used to record
business activities.

Exercise D
2.3 The Basic Accounting Equation
In the previous section we described specific types of accounts that business activities
fall into, namely:

1. Assets (what it owns)

2. Liabilities (what it owes to others)
3. Equity (the difference between assets and liabilities or what it owes to the owners)

These are the building blocks of the basic accounting equation. The accounting
equation is:

ASSETS = LIABILITIES + EQUITY

For Example:

A sole proprietorship business owes $12,000 and you, the owner personally invested
$100,000 of your own cash into the business. The assets owned by the business will
then be calculated as:
$12,000 (what it owes) + $100,000 (what you invested) = $112,000 (what the company
has in assets)

Assets = Liabilities + Equity

112,000 = 12,000 100,000

In a sole-proprietorship, equity is actually Owner’s Equity. If the business in question is

a corporation, equity will be held by stockholders, which uses stockholder’s equity but
the basic equation is the same:

ASSETS = LIABILITIES + EQUITY

For Example:

A business owes $35,000 and stockholders (investors) have invested $115,000 by

buying stock in the company. The assets owned by the business will then be calculated
as:

$35, 000 (what it owes) + $115,000 (what stockholders invested) = $150,000 (what the
company has in assets)

Assets = Liabilities + Equity

150,000 = 35,000 115,000

Since each transaction affecting a business entity must be recorded in the accounting
records based on a detailed account (remember, file folders and the chart of accounts
from the previous section), analyzing a transaction before actually recording it is an
important part of financial accounting. An error in transaction analysis could result in
incorrect financial statements.

To further illustrate the analysis of transactions and their effects on the basic accounting
equation, we will analyze the activities of Metro Courier, Inc., a fictitious
corporation. Refer to the chart of accounts illustrated in the previous section.

1. Owners invested cash

Metro Courier, Inc., was organized as a corporation on January 1, the company issued
shares (10,000 shares at $3 each) of common stock for $30,000 cash to Ron Chaney,
his wife, and their son. The $30,000 cash was deposited in the new business account.

Transaction analysis:
 • The new corporation received $30,000 cash in exchange for ownership in common stock
(10,000 shares at $3 each).
• We want to increase the asset Cash and increase the equity Common Stock.

Assets Equity

Transaction Cash Common Stock

1. Owner invested cash + 30,000 + 30,000

Let’s check the accounting equation: Assets $30,000 = Liabilities $0 + Equity $30,000

2. Purchased equipment for cash

Metro paid $ 5,500 cash for equipment (two computers).

Transaction analysis:

• The new corporation purchased new asset (equipment) for $5,500 and paid cash.
• We want to increase the asset Equipment and decrease the asset Cash since we paid
cash.

Assets Equity

Transaction Cash Equipment Common Stock

1. Owner invested cash + 30,000 +30,000

2. Purchased equipment for cash – 5,500 +5,500

Balance: 24,500 5,500 30,000

Let’s check the accounting equation: Assets $30,000 (Cash $24,500 + Equipment
$5,500) = Liabilities $0 + Equity $30,000

3. Purchased truck for cash

Metro paid $ 8,500 cash for a truck.

Transaction analysis:

• The new corporation purchased new asset (truck) for $8,500 and paid cash.
 • We want to increase the asset Truck and decrease the asset cash for $8,500.

Assets Equity

Transaction Cash Equipment Truck Common Stock

1. Owner invested cash +30,000 +30,000

2. Purchased equipment for cash – 5,500 +5,500

3. Purchased truck for cash -8,500 + 8,500

Balance: 16,000 5,500 8,500 30,000

Let’s check the accounting equation: Assets $30,000 (Cash $16,000 + Equipment
$5,500 + Truck $8,500) = Liabilities $0 + Equity $30,000

4. Purchased supplies on account.

Metro purchased supplies on account from Office Lux for $500.

Transaction analysis:

• The new corporation purchased new asset (supplies) for $500 but will pay for them later.
• We want to increase the asset Supplies and increase what we owe with the liability
Accounts Payable.

Assets = Liabilities + Equity

Accounts Common
Transaction Cash Supplies Equipment Truck
Payable Stock

1. Owner invested cash +30,000 +30,000

2. Purchased equipment
-5,500 +5,500
for cash

3. Purchased truck for +

-8,500
cash 8,500

4. Purchased supplies
+ 500 +500
on account.

Balance: 16,000 500 5,500 8,500 500 30,000

Let’s check the accounting equation: Assets $30,500 (Cash $16,000+ Supplies $500 +
Equipment $5,500 + Truck $8,500) = Liabilities $500 + Equity $30,000

5. Making a payment to creditor.

Metro issued a check to Office Lux for $300 previously purchased supplies on account.

Transaction analysis:

• The corporation paid $300 in cash and reduced what they owe to Office Lux.
• We want to decrease the liability Accounts Payable and decrease the asset cash
since we are not buying new supplies but paying for a previous purchase.

Assets = Liabilities + Equity

Accounts Common
Transaction Cash Supplies Equipment Truck
Payable Stock

1. Owner invested cash +30,000 +30,000

2. Purchased equipment for

-5,500 +5,500
cash

3. Purchased truck for cash -8,500 +8,500

4. Purchased supplies on
+500 +500
account.

5. Making a payment to
-300 -300
creditor.

Balance: 15,700 500 5,500 8,500 200 30,000

Let’s check the accounting equation: Assets $30,200 (Cash $15,700 + Supplies $500 +
Equipment $5,500 + Truck $8,500) = Liabilities $200 + Equity $30,000

6. Making a payment in advance.

Metro issued a check to Rent Commerce, Inc. for $1,800 to pay for office rent in
advance for the months of February and March.

Transaction analysis (to save space we will look at the effects of each of the remaining
transactions only):
 • The corporation prepaid the rent for next two months making an advanced
payment of $1,800 cash.
• We will increase an asset account called Prepaid Rent (since we are paying in
advance of using the rent) and decrease the asset cash.

Assets

Transaction Cash Prepaid Rent

Previous Balance $ 15,700

6. Making a payment in advance. -1,800 + 1,800

Balance: 13,900 1,800

The only account balances that changed from transaction 5 are Cash and Prepaid
Rent. All other account balances remain unchanged. The new accounting equation
would be: Assets $30,200 (Cash $13,900 + Supplies $500 + Prepaid Rent $1,800 +
Equipment $5,500 + Truck $8,500) = Liabilities $200 + Equity $30,000

7. Selling services for cash.

During the month of February, Metro Corporation earned a total of $50,000 in revenue
from clients who paid cash.

Transaction analysis:

• The corporation received $50,000 in cash for services provided to clients.

• We want to increase the asset Cash and increase the revenue account Service
Revenue.

Assets Revenues

Transaction Cash Service Revenue

Previous Balance $ 13,900

7. Selling services for cash . + 50,000 + 50,000

Balance: $ 63,900 $ 50,000

Wait a minute…the accounting equation is ASSETS = LIABILITIES + EQUITY and it

does not have revenue or expenses…where do they fit in? Revenue – Expenses
equals net income. Net Income is added to Equity at the end of the period. Assets
$80,200 (Cash $63,900 + Supplies $500 + Prepaid Rent $1,800 + Equipment $5,500 +
Truck $8,500)= Liabilities $200)+ Equity $80,000 (Common Stock $30,000 + Net
Income $50,000). Note: This does not mean revenue and expenses are equity
accounts!

8. Selling services on credit.

Metro Corporation earned a total of $10,000 in service revenue from clients who will pay
in 30 days.

Transaction analysis:

• Metro performed work and will receive the money in the future.
• We record this as an increase to the asset account Accounts Receivable and an
increase to service revenue.

Assets Revenues

Transaction Accounts Receivable Service Revenue

Previous Balance $ 50,000

8. Selling services on credit. + 10,000 + 10,000

Balance: $ 10,000 $ 60,000

Remember, all other account balances remain the same. The only changes are the
addition of Accounts Receivable and an increase in Revenue. Assets $90,200 (Cash
$63,900 + Accounts Receivable $10,000 + Supplies $500 + Prepaid Rent $1,800 +
Equipment $5,500 + Truck $8,500)= Liabilities $200 + Equity $90,000 (Common Stock
$30,000 + Net Income $60,000).

9. Collecting accounts receivable.

Metro Corporation collected a total of $5,000 on account from clients who owned money
for services previously billed.

Transaction analysis:

• Metro received $5,000 from customers for work we have already billed (not any
new work).
• We want to increase the asset Cash and decrease (what we will receive later from
customers) the asset Accounts Receivable.
 Assets

Transaction Cash Accounts Receivable

Previous Balance $ 63,900 $ 10,000

9. Collecting accounts receivable. + 5,000 – 5,000

Balance: $ 68,900 $ 5,000

Assets $90,200 (Cash $68,900 + Accounts Receivable $5,000 + Supplies $500 +

Prepaid Rent $1,800 + Equipment $5,500 + Truck $8,500)= Liabilities $200 + Equity
$90,000 (Common Stock $30,000 + Net Income $60,000).

10. Paying office salaries.

Metro Corporation paid a total of $900 for office salaries.

Transaction analysis:

• The corporation paid $900 to its employees.

• We will increase the expense account Salaries Expense and decrease the asset
account Cash.

Assets Expenses

Transaction Cash Salary Expense

Previous Balance $ 68,900

10. Paying Office Salaries. – 900 + 900

Balance: $ 68,000 $ 900

Remember, net income is calculated as Revenue – Expenses and is added to

Equity. The new accounting equation would show: Assets $89,300 (Cash $68,000 +
Accounts Receivable $5,000 + Supplies $500 + Prepaid Rent $1,800 + Equipment
$5,500 + Truck $8,500)= Liabilities $200 + Equity $89,100 (Common Stock $30,000 +
Net Income $59,100 from revenue of $60,000 – expenses $900).

11. Paying utility bill.

Metro Corporation paid a total of $1,200 for utility bill.

Transaction analysis:

• The corporation paid $1,200 in cash for utilities.

• We will increase the expense account Utility Expense and decrease the asset
Cash.

Assets Expense

Transaction Cash Utilities Expense

Previous Balance $ 68,000

11. Paying Utility Bill – 1,200 + 1,200

Balance: $ 66,800 $ 1,200

The final accounting equation would be: 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).

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