5004 Aiou end term assesments by srassignments.com

Question No # 1

The elements of financial statements are the general groupings of line items contained
within the statements. These elements are as follows:
 Assets. These are items of economic benefit that are expected to yield benefits in future
periods. Examples are accounts receivable, inventory, and fixed assets.
 Liabilities. These are legally binding obligations payable to another entity or individual.
Examples are accounts payable, taxes payable, and wages payable.
 Equity. This is the amount invested in a business by its owners, plus any remaining retained
 Revenue. This is an increase in assets or decrease in liabilities caused by the provision of
services or products to customers. It is a quantification of the gross activity generated by a
business. Examples are product sales and service sales.
 Expenses. This is the reduction in value of an asset as it is used to generate revenue.
Examples are interest expense, compensation expense, and utilities expense.
Of these elements, assets, liabilities, and equity are included in the balance sheet. Revenues
and expenses are included in the income statement. Changes in these elements are noted in
the statement of cash flows.
Have you ever been to the circus and watched the high wire act? It amazes me how those men
and women manage to walk across that thin wire stretched way above the ground. What also
amazes me is that the thing they use to keep their balance is just a long pole. It’s hard to believe,
but did you know that an accountant and a tightrope walker have the same goal? It’s true. They
both work hard to keep something balanced. Where the tightrope walker uses the pole to
maintain balance, the accountant uses a basic mathematical equation that is called the accounting
The accounting equation, written as Assets = Liabilities + Owner’s Equity, shows the relationship
between the three major types of accounts found in the accounting world. When used correctly, it
is a reliable tool in maintaining balance in company accounts.
Understanding the Parts


In order to understand the accounting equation, you have to understand its three parts. First are
the assets. Assets are anything that a company owns. Good examples of assets are cash, land,
buildings, equipment, and supplies. Money that is owed to a company by its customers, which is
known as accounts receivable, is also an asset.
Liabilities are what a company owes. Things such as utility bills, land payments, employee
salaries, and insurance – those are all examples of liabilities.
The last component of the accounting equation is owner’s equity. Owner’s equity is the amount
of money that a company owner has personally invested in the company. Initial start-up cost of a
company that comes from the owner’s own pocket – that’s a good example of owner’s equity.
How it Works
Now that you understand the parts of the accounting equation, let’s talk about how it works.
Ed owns a small dairy. Production has been good these last few years, so Ed decided to open up
a country store to sell some of his homemade dairy products. He borrows $25,000 from the bank
to build the store. Once built, the store has a value of $40,000. Ed also has to hire an employee to
help him work the store. The employee’s salary is $15,000 a year. In order to make the cheese,
ice cream, and sweet cream that he plans on selling in the store, Ed purchases equipment. He
makes the $10,000 equipment purchase with money that he takes from his own savings account.
So, what are Ed’s assets, his liabilities, and his owner’s equity valued at? Are his accounts
Now, let’s take a look at the accounting elements.
Assets refer to resources owned and controlled by the entity as a result of past transactions and
events, from which future economic benefits are expected to flow to the entity. In simple terms,

assets are properties or rights owned by the business. They may be classified as current or non-

A. Current assets – Assets are considered current if they are held for the purpose of being traded,
expected to be realized or consumed within twelve months after the end of the period or its
normal operating cycle (whichever is longer), or if it is cash. Examples of current asset accounts

  1. Cash and Cash Equivalents – bills, coins, funds for current purposes, checks, cash in bank,


  1. Receivables – Accounts Receivable (receivable from customers), Notes Receivable
    (receivables supported by promissory notes), Rent Receivable, Interest Receivable, Due from
    Employees (or Advances to Employees), and other claims
    • Allowance for Doubtful Accounts – This is a valuation account which shows the estimated
    uncollectible amount of accounts receivable. It is a contra-asset account and is presented as a
    deduction to the related asset – accounts receivable.
  2. Inventories – assets held for sale in the ordinary course of business
  3. Prepaid expenses – expenses paid in advance, such as, Prepaid Rent, Prepaid Insurance,
    Prepaid Advertising, and Office Supplies
    B. Non-current assets – Assets that do not meet the criteria to be classified as current. Hence,
    they are long-term in nature – useful for a period longer that 12 months or the company’s normal
    operating cycle. Examples of non-current asset accounts include:
  4. Long-term investments – investments for long-term purposes such as investment in stocks,
    bonds, and properties; and funds set up for long-term purposes
  5. Land – land area owned for business operations (not for sale)
  6. Building – such as office building, factory, warehouse, or store
  7. Equipment – Machinery, Furniture and Fixtures (shelves, tables, chairs, etc.), Office
    Equipment, Computer Equipment, Delivery Equipment, and others
    • Accumulated Depreciation – This is a valuation account which represents the decrease in
    value of a fixed asset due to continued use, wear & tear, passage of time, and obsolescence. It
    is a contra-asset account and is presented as a deduction to the related fixed asset.
  8. Intangibles – long-term assets with no physical substance, such as goodwill, patent,
    copyright, trademark, etc.
  9. Other long-term assets

Liabilities are economic obligations or payables of the business.
Company assets come from 2 major sources – borrowings from lenders or creditors, and
contributions by the owners. The first refers to liabilities; the second to capital.


Liabilities represent claims by other parties aside from the owners against the assets of a
Like assets, liabilities may be classified as either current or non-current.
A. Current liabilities – A liability is considered current if it is due within 12 months after the end
of the balance sheet date. In other words, they are expected to be paid in the next year.
If the company’s normal operating cycle is longer than 12 months, a liability is considered
current if it is due within the operating cycle.
Current liabilities include:

  1. Trade and other payables – such as Accounts Payable, Notes Payable, Interest Payable, Rent
    Payable, Accrued Expenses, etc.
  2. Current provisions – estimated short-term liabilities that are probable and can be measured
  3. Short-term borrowings – financing arrangements, credit arrangements or loans that are short-
    term in nature
  4. Current-portion of a long-term liability – the portion of a long-term borrowing that is
    currently due.
    Example: For long-term loans that are to be paid in annual installments, the portion to be paid
    next year is considered current liability; the rest, non-current.
  5. Current tax liabilities – taxes for the period and are currently payable
    B. Non-current liabilities – Liabilities are considered non-current if they are not currently
    payable, i.e. they are not due within the next 12 months after the end of the accounting period or
    the company’s normal operating cycle, whichever is shorter.
    In other words, non-current liabilities are those that do not meet the criteria to be considered
    current. Hah! Make sense? Non-current liabilities include:
  6. Long-term notes, bonds, and mortgage payables;
  7. Deferred tax liabilities; and
  8. Other long-term obligations



Also known as net assets or equity, capital refers to what is left to the owners after all liabilities
are settled. Simply stated, capital is equal to total assets minus total liabilities. Capital is affected
by the following:

  1. Initial and additional contributions of owner/s (investments),
  2. Withdrawals made by owner/s (dividends for corporations),
  3. Income, and
  4. Expenses.
    Owner contributions and income increase capital. Withdrawals and expenses decrease it.
    The terms used to refer to a company’s capital portion varies according to the form of ownership.
    In a sole proprietorship business, the capital is called Owner’s Equity or Owner’s Capital; in
    partnerships, it is called Partners’ Equity or Partners’ Capital; and in corporations, Stockholders’
    In addition to the three elements mentioned above, there are two items that are also considered as
    key elements in accounting. They are income and expense. Nonetheless, these items are
    ultimately included as part of capital.
    Income refers to an increase in economic benefit during the accounting period in the form of an
    increase in asset or a decrease in liability that results in increase in equity, other than contribution
    from owners.
    Income encompasses revenues and gains.
    Revenues refer to the amounts earned from the company’s ordinary course of business such
    as professional fees or service revenue for service companies and sales for merchandising and
    manufacturing concerns.
    Gains come from other activities, such as gain on sale of equipment, gain on sale of short-term
    investments, and other gains.
    Income is measured every period and is ultimately included in the capital account. Examples of
    income accounts are: Service Revenue, Professional Fees, Rent Income, Commission Income,
    Interest Income, Royalty Income, and Sales.


Expenses are decreases in economic benefit during the accounting period in the form of a
decrease in asset or an increase in liability that result in decrease in equity, other than distribution
to owners.
Expenses include ordinary expenses such as Cost of Sales, Advertising Expense, Rent Expense,
Salaries Expense, Income Tax, Repairs Expense, etc.; and losses such as Loss from Fire,
Typhoon Loss, and Loss from Theft. Like income, expenses are also measured every period and
then closed as part of capital.
Net income refers to all income minus all expenses.
And we’ve come to the end of this lesson. We have covered all the elements of accounting. For a
recap: assets are properties owned by a business; liabilities are obligations to other parties;
and, capital refers to the portion of the assets available to the owners of the business after all
liabilities are settled.

Question No # 2

An information system is a formal process for collecting data, processing the data into
information, and distributing that information to users. The purpose of an accounting information
system (AIS) is to collect, store, and process financial and accounting data and produce
informational reports that managers or other interested parties can use to make business
decisions. Although an AIS can be a manual system, today most accounting information systems
are computer-based.
Functions of an Accounting Information System
Accounting information systems have three basic functions:

  1. The first function of an AIS is the efficient and effective collection and storage of data
    concerning an organization’s financial activities, including getting the transaction data
    from source documents, recording the transactions in journals, and posting data from
    journals to ledgers.
  2. The second function of an AIS is to supply information useful for making decisions,
    including producing managerial reports and financial statements.


  1. The third function of an AIS is to make sure controls are in place to accurately record and
    process data.
    Parts of an Accounting Information System
    An accounting information system typically has six basic parts:
  2. People who use the system, including accountants, managers, and business analysts
  3. Procedure and instructions are the ways that data are collected, stored, retrieved, and
  4. Data including all the information that goes into an AIS
  5. Software consists of computer programs used for processing data
  6. Information technology infrastructure includes all the hardware used to operate the AIS
  7. Internal controls are the security measures used to protect data
    The Reliability of Accounting Information Systems
    Because an AIS stores and provides such valuable business information, reliability is vitally
    important. The American Institute of CPAs (AICPA) and Canadian Institute of Chartered
    Accountants (CICA) have identified five basic principles important to AIS reliability:
  8. Security – Access to the system and its data is controlled and limited only to those
  9. Confidentiality – The protection of sensitive information from unauthorized disclosure.
  10. Privacy – The collection, use, and disclosure of personal information about customers is
    done in an appropriate manner.
  11. Processing integrity – The accurate, complete, and timely processing of data done with
    proper authorization.
  12. Availability – The system is available to meet operational and contractual obligations.
    Accounting Information System Jobs
    Students can pursue bachelor’s, master’s, and doctorate degrees in accounting information
    systems. These degrees generally provide students with both accounting knowledge and an
    understanding of the technology involved in setting up an AIS. This prepares accounting
    program graduates to work with the information technology, information systems, and people
    needed to set up and maintain an AIS.
    Accounting information system specialist jobs are available in corporations, accounting firms,
    consulting firms, non-profit organizations, and government agencies.


An AIS must have a database structure to store information, such as structured query language
(SQL), which is a computer language commonly used for databases. SQL allows the data that’s
in the AIS to be manipulated and retrieved for reporting purposes. The AIS will also need
various input screens for the different types of system users and data entry, as well as different
output formats to meet the needs of different users and various types of information.
The data contained in an AIS is all of the financial information pertinent to the organization’s
business practices. Any business data that impacts the company’s finances should go into an AIS.
The type of data included in an AIS depends on the nature of the business, but it may consist of
the following:
 Sales orders
 Customer billing statements
 Sales analysis reports
 Purchase requisitions
 Vendor invoices
 Check registers
 General ledger
 Inventory data
 Payroll information
 Timekeeping
 Tax information
The data can be used to prepare accounting statements and financial reports, including accounts
receivable aging, depreciation or amortization schedules, a trial balance, and a profit and loss

statement. Having all of this data in one place—in the AIS—facilitates a business’s record-
keeping, reporting, analysis, auditing, and decision-making activities. For the data to be useful, it

must be complete, accurate, and relevant.
On the other hand, examples of data that would not go into an AIS include memos,
correspondence, presentations, and manuals. These documents might have a tangential
relationship to the company’s finances, but, excluding the standard footnotes, they are not really
part of the company’s financial record-keeping.

Question NO # 3

Financial leverage is the extent to which fixed-income securities and preferred stock are used in
a company’s capital structure. Financial leverage has value due to the interest tax shield that is
afforded by the U.S. corporate income tax law. The use of financial leverage also has value when
the assets that are purchased with the debt capital earn more than the cost of the debt that was
used to finance them. Under both of these circumstances, the use of financial leverage increases
the company’s profits. With that said, if the company does not have sufficient taxable income to
shield, or if its operating profits are below a critical value, financial leverage will reduce equity
value and thus reduce the value of the company.

Given the importance of a company’s capital structure, the first step in the capital decision-
making process is for the management of a company to decide how much external capital it will

need to raise to operate its business. Once this amount is determined, management needs to
examine the financial markets to determine the terms in which the company can raise capital.
This step is crucial to the process because the market environment may curtail the ability of the
company to issue debt securities or common stock at an attractive level or cost. With that said,
once these questions have been answered, the management of a company can design the
appropriate capital structure policy and construct a package of financial instruments that need to
be sold to investors. By following this systematic process, management’s financing decision
should be implemented according to its long-run strategic plan, and how it wants to grow the
company over time.
The use of financial leverage varies greatly by industry and by the business sector. There are
many industry sectors in which companies operate with a high degree of financial leverage.
Retail stores, airlines, grocery stores, utility companies, and banking institutions are classic
examples. Unfortunately, the excessive use of financial leverage by many companies in these
sectors has played a paramount role in forcing a lot of them to file for Chapter 11 bankruptcy.
Examples include R.H. Macy (1992), Trans World Airlines (2001), Great Atlantic & Pacific Tea
Co. (A&P) (2010), and Midwest Generation (2012). Moreover, excessive use of financial
leverage was the primary culprit that led to the U.S. financial crisis between 2007 and 2009.
The demise of Lehman Brothers (2008) and a host of other highly levered financial institutions
are prime examples of the negative ramifications that are associated with the use of highly
levered capital structures.


Perhaps the best way to illustrate the positive impact of financial leverage on a company’s
financial performance is by providing a simple example. The Return on Equity (ROE) is a
popular fundamental used in measuring the profitability of a business as it compares the profit
that a company generates in a fiscal year with the money shareholders have invested. After all,
the goal of every business is to maximize shareholder wealth, and the ROE is the metric of return
on shareholder’s investment.
In the table below, an income statement for Company ABC has been generated assuming a
capital structure that consists of 100 percent equity capital. The capital raised was $50 million.
Since only equity was issued to raise this amount, the total value of equity is also $50 million.
Under this type of structure, the company’s ROE is projected to fall between the range of 15.6
and 23.4 percent, depending on the level of the company’s pre-tax earnings.

In comparison, when Company ABC’s capital structure is re-engineered to consist of 50 percent
debt capital and 50 percent equity capital, the company’s ROE increases dramatically to a range
that falls between 27.3 and 42.9 percent.


As you can see from the table below, financial leverage can be used to make the performance of
a company look dramatically better than what can be achieved by solely relying on the use of
equity capital financing.

Since the management of most companies relies heavily on ROE to measure performance, it is
vital to understand the components of ROE to better understand what the metric conveys.
A popular methodology for calculating ROE is the utilization of the DuPont Model. In its most
simplistic form, the DuPont Model establishes a quantitative relationship between net
income and equity, where a higher multiple reflects stronger performance. However, the DuPont
Model also expands upon the general ROE calculation to include three of its parts. These parts
include the company’s profit margin, asset turnover, and equity multiplier. Accordingly, this
expanded DuPont formula for ROE is as follows:


Based on this equation, the DuPont Model illustrates that a company’s ROE can only be
improved by increasing the company’s profitability, by increasing its operating efficiency or by
increasing its financial leverage.

Question No # 4

The way you calculate the cost of your inventory can change the profit you show on your
financial statement. Learn how one method can show higher profits, while the other method can
give you tax benefits.
A Financial Statement
If you run your own company, then you will need to prepare regular financial statements so you
can see how your business is doing financially. Your financial statements are also required for
your taxes. We define financial statements as those records that show your purchases and sales
for a specified period of time. If you are doing your yearly taxes, then your financial statements
are those that show your purchases and expenses for the tax year.
Now, how much profit you show on your financial statement can actually be different depending
on the type of costing method you choose to valuate the cost of your inventory. We
define costing method as the method to determine the cost of your inventory. In this lesson, we’ll
look at the three different costing methods along with their impact on your financial statement.
Pretend that you are the owner of a shop specializing in fancy dishes. Your inventory consists of
lots of fancy dishes. Let’s see how the different costing methods can change how much profit you
show on your financial statement.
The first method is FIFO or first-in, first-out. With this method, you price inventory according to
the oldest purchase. So if you received inventory on Monday for $10 each, Tuesday for $12


each, and Wednesday for $13 each, this method assumes that the inventory you received on
Monday will sell before the inventory on Tuesday. Your inventory cost will go from $10, to $12,
to $13 as you sell your items from oldest to newest. Grocery stores generally use this costing
method as older items are sold before the newer items. This prevents food products from
expiring before being sold.
This method can actually increase the profit you show on your financial statement. How so?
Well, this method does not take into account inflation. Think about that. Say you purchased some
sets of fancy dishes for $20 per set last year. This year, that same set of dishes is now worth $25
each. Using the FIFO method, though, you would show that your inventory still costs $20 per
set. Your profit will look higher. For example, if you sell your dishes for $40 per set, at the
current value of $25 per set, you make a profit of $40 – $25 = $15; but on your financial
statement, you show a profit of $40 – $20 = $20, since you are using the value of the dishes from
last year when you purchased them.
The second costing method is LIFO or last-in, first-out. With this method, your inventory is
priced according to the most recent inventory purchase. So, using the same example of receiving
inventory on Monday for $10 each, Tuesday for $12 each, and Wednesday for $13 each, this
method will have your inventory costing $13, $12, and then $10 as you sell your products from
newest to oldest.
There are several accounting methods that will be encountered when recasting financial
statements of small businesses, as well as variations on these methods. This article provides an
introduction to the various methods. The subject’s entity type can also affect the accounting
method used for tax returns. This article also discusses the impact of entity type on tax returns
and tax return recasting. In addition to the accounting methods discussed below, other
accounting methods may encountered, including “income tax basis”, “modified cash basis”, or
“hybrid basis”.
In income tax basis accounting[1], the financial statements are prepared primarily using financial

information as it will appear on the income tax return. In modified cash basis accounting, long-
term assets and liabilities are accrued, while short-term income and expenses are kept on the cash

basis. Under a hybrid accounting method[2], companies will use the accrual accounting method
to satisfy tax requirements and the cash basis method for all other financial transactions.


Accounts receivable (A/R) and accounts payable (A/P) are the only items recorded using the
accrual method; A/P transactions relate to inventory, as required by the IRS. Financial
transaction like asset purchases, payroll or equity investments are recorded using the cash
method, reflecting transactions where cash changes hands.
In this article financial statement recasting, with regard to the income statement, refers primarily
to the analysis required to determine the client company’s Seller’s Discretionary Earnings
(SDE). Where SDE is defined as:
“…..net income before the primary owner’s compensation, other discretionary, non-operating, or
non-recurring income or expenses, depreciation, interest, and taxes” – ValuationResources.com
SDE = Earnings Before Tax + Add-backs
 Seller’s Discretionary Earnings are pre-tax
 Seller’s Discretionary Earnings are based on one owner
 Seller’s Discretionary Earnings must be verifiable
 Add-backs must be acceptable to Buyer and/or a Lender
If you are recasting financial statements for a client company, and you have questions regarding
the details of the accounting method used, with the owner’s approval, meet with the client’s
Accountant/CPA to make sure you understand the accounting method.
Accrual Basis Accounting
̈ Accrual Basis Accounting: Revenues are reported in the fiscal period in which they are
earned, regardless of when received, and expenses are deducted in the fiscal period in which they
are incurred, whether they are paid or not. In other words, using accrual basis accounting, you
record both revenues and expenses when they occur.
Cash Basis Accounting
̈ Cash Basis Accounting: Revenues are recorded when cash is actually received and expenses
are recorded when they are actually paid (no matter when they were invoiced).
 Cash basis balance sheets do not include accounts receivable, accounts payable, and
accrued expenses
The accrual basis of accounting generally is preferred for income statement and balance sheet
recasting because it more accurately matches revenue sources to the expenses incurred during the
accounting period.


If the client company uses cash basis accounting, one can make a couple of simple cash-to-
accrual adjustments to estimate the revenue and expense if the company had used accrual

The first adjustment is based on the increase/decrease in the subject’s accounts receivable from
the beginning of the year to the end of the year. The amount that accounts receivable increased is
added to the cash basis revenues to estimate the accrual basis revenue. If the accounts receivable
balance decreased, the amount of the decrease is subtracted from the cash basis revenue to
estimate the accrual basis revenue.

The second adjustment is based on the increase/decrease in the subject’s accounts payable from
the beginning of the year to the end of the year. The amount that accounts payable increased is
added to the cash basis cost of goods sold to estimate the accrual basis cost of goods sold. If the
accounts payable balance decreased, the amount of the decrease is subtracted from the cash basis
revenue to estimate the accrual basis revenue.
Construction-Related Accounting Methods
Construction-related accounting methods can be quite complicated. Therefore, a detailed
discussion of these methods is outside the scope of this article. However, business brokers and
other business consultants involved in pricing and/or selling such companies need to be familiar
with these methods. The following discussion is intended to provide a cursory description of
construction related accounting methods and the related terminology. It is recommended that
business brokers / business consultants work closely with their clients and/or their client’s
Accountants/CPAs when pricing such businesses to make sure that they correctly interpret the
subject’s financial information.
Most construction businesses use two different methods, one for their long-term contracts and
one overall method for everything else. A long-term contact being one that is not completed in
the same year it is started. A short-term contract is one that is started and completed within one
tax year.
Construction-related companies can use several different accounting methods[3], including:
̈ Cash Method
̈ Accrual Method
̈ Percentage of Completion Method


̈ Completed Contract Method
In the percentage of completion method, the contractor must allocate direct and indirect costs to
contracts in a manner as to recognize revenues and gross profit in the applicable periods of
construction, and not only in the period when the construction has been completed, as in the

completed contract method. The degree of completion of the construction, i.e., the percentage-of-
completion, is typically estimated by dividing the total construction costs incurred to date by the

total estimated costs of the contract, or job.
The referenced IRS article, also discusses several variations to these methods. There are special
IRS tax rules
that determine which accounting method(s) and/or variations of methods must be
used for construction companies. Factors that affect the allowed accounting method(s) include:
̈ The type of contracts the company has,
̈ The company’s contract completion status at the end of the tax year,
̈ The company’s average annual gross receipts
When the percentage of completion method is used, the accounting principle of full disclosure
requires the presentation of a work-in-process schedule in the company’s financial
statements. This schedule discloses the details of each contract stage of completion and
profitability to date as well as in the current period of reporting. The work-in-process schedule
will not show the backlog of contracted jobs that have not yet started.
Comparison of the subject’s backlog from year-to-year, including those contracts that have not
been started, is important information when listing a business.

  1. www.srassignments.com
  2. https://www.accountingverse.com/accounting-basics/elements-of-accounting.html
  3. https://iproject.com.ng/index.php/accounting/effective-accounting-information-
  4. https://www.researchgate.net/post/How_Capital_structure_of_firm_improved_by_financi
  5. https://study.com/academy/lesson/the-effects-of-financial-statements-on-costing-


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