Transaction 6 An unpaid account of $50 is a liability or account payable to be paid by the firm and was incurred to meet running expenses for the period.
Financial Reporting and Analysis 13 Transaction 7 A fare of $25 payable by a client is an asset or account receivable to be collected and represents revenue for the period in which the service was provided. Transaction 8 J Peter has made drawings for the purpose of meeting private expenses. The cash withdrawal of $500 represents a decrease in equity. It is treated as an amount withdrawn in anticipation of profit for a sole proprietor such as this. For a corporation, this would be known as a dividend. Accrual accounting versus cash accounting In the ‘J Peter’s’ illustration we have adopted accrual accounting rather than the cash basis of accounting. As the treatment of transactions 6 and 7 show, accrual accounting involves recording (recognising) revenue and expenses even if they do not constitute a cash inflow or cash outflow during the period. The alternative is to record just cash in and cash out, and some small businesses use such a cash-based approach. However, in providing information useful for decision-making, especially to those external to the entity, reporting just cash receipts and payments is inadequate because often the timing of the cash flow is in a different accounting period to the substance of the transaction. Hence, even though the accrual basis of accounting introduces complexity and provides opportunity for the ‘management’ of earnings and other numbers, it is mandated by accounting standards because of the rich information it can provide. The distinction between accrual and cash accounting is a very important concept to be grasped from this simple example. The accruals basis of accounting will be discussed further, later in this topic; and is also discussed later in this study guide. Additionally, it is important to note that no ‘rules’ exist in relation to the use of the number of columns in the statement of comprehensive income or statement of financial position. The objective of columnar formatting is clarity; in that regard, different columnar formatting can be used, as long as clarity is not compromised. For the period ending 31 January 20XX, J Peter has operated the taxicab as a fare-paying business. This means that we can determine the profit (or loss) of these operations for the corresponding period. Figure 1.2 below, shows the statement of comprehensive income of ‘J Peter’s Taxicabs’ for the corresponding period. Figure 1.2: J Peter’s Taxicabs Statement of comprehensive income for the month ending 31 January 20XX Item Amount Revenue Fares $1,225 Expenses Operating expenses $650 Net profit for the period $575
TOPIC 1 14 We have determined that the wealth of the firm increased by $575 due to profitable trading. However, a sum of $500 cash was withdrawn. Thus, the overall increase in the wealth of the firm was only $75. This is shown in Figure 1.3 below, in the statement of financial position as at the close of business on 31 January 20XX.