: The Accounting Cycle: Capturing Economics Events
A ledger keeps all groups of accounts, which are cash, accounts payable and capital stock. Receipts and payments are entered in the debit and credit columns respectively. The difference between the debit and credit entries gives the balance. Liabilities and equities make up the assets. Transactions are initially recorded in a journal in an actual accounting system.
Ledger accounts are updated by posting journal entries in them. Income either increases an asset or decreases a liability, thus net income always increases the owner’s equity. This is especially the case because revenue increases the owner’s equity while expenses decrease owner’s equity.
Summary Chapter 4: The Accounting Cycle: Accruals and Deferrals
Whenever expenses or revenue affect more than a single accounting period, adjustment to entries is done. The adjustment entails a change in either an expense or revenue and liability or an asset. An asset is created by paying cash in advance of incurring expense. Therefore, adjusting an entry considers a portion of asset used as expense, and reduces balance of asset account.
The concept of depreciation argues that the usefulness or value of an asset is partially consumed during the systematic allocation of cost of a depreciable asset to expense. However, the useful life of an asset can only be estimated e.g. 50 months for a $2,500 lawn mower or 60 months for a $15,000 truck (Godwin & Alderman, 2010). Book value is attained by subtracting accumulated depreciation from cost. Where cash is collected in advance of earning revenue, a liability is created. Consequently, liabilities are converted to revenue by recognizing portion earned as revenue and thus reducing balance of liability account. At the end of a current period, you must recognize all unpaid expenses and uncollected revenue. You recognize expense incurred and record liability for future settlement, and recognize revenue earned but not recorded yet and record it as future receivable.
Summary Cape Electronics Company Case
The case relates to a 1970 plan of two Cape Engineer’s engineers to introduce a new product The six month profit for the company was computed with the exclusion of labor, equipment, depreciation, patent depreciation and overhead charges. This resulted in misleading ratios for the company because a company’s Income Statement cannot be valid until all costs have been duly charged.
The company’s break-even point (no profit/no loss) was computed as fixed costs divided by contribution per unit. This implies that 200 units were needed to achieve break-even. Total fixed costs for the company were $40,000 and contribution per unit was 200, thus 40,000/200 = 200. With proper strategy, it is possible for Cape Electronics to produce and sell the high number of units. There is need to raise the equity base so as to support the working capital needed to expand without risking a cash crisis for the company. The appropriate course of action would be to conduct a thorough market research to establish the potential of the company’s product, generate cash to pay the creditors, raise more equity to finance an ambitious operation, or outsource and market.
Reference:
Godwin, H. N., & Alderman, W. C. 2010. Financial ACCT 2010. Connecticut: Cengage Learning.
