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ACCT1501

AccountingandFinancialManagement1A

Session22016
Week2
Measuring&EvaluatingFinancialPositionandPerformance
DrHelenKang
SchoolofAccounting
helen.kang@unsw.edu.au

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Consultations

DontforgettousetheGlossary!(TCGp.734)
YouwillbeintroducedtomanykeyAccountingterms;itislike
learninganewlanguage
Youshouldrefertotheglossaryasoftenasneededuntilyou
gettoknowallthenewterms

Practiceusingtheglossary lookupthenewtermseachweek
andtrytoexplaintheminyourtermsorthinkofanexample
toexplainit.(Tip:Define,explain,andthinkofanexample!)

Topic2Outline
Learningobjectives
RecapofTopic1
Topic2:MeasuringandEvaluatingFinancialPosition&
Performance

EssentialreadingforWeek2:
TCGChapter2plusAppendix

Topic2:DesiredLearningOutcomes(LO)
1. Understandtheterms,format,andfunctionoftheBalance
Sheet&identifyitscomponents(A,L,OE)
2. Describetherelationshipbetweenthebalancesheetandthe
incomestatement(viaRetainedProfits)
3. Understandtheterms,format,andfunctionoftheIncome
Statement&identifyitscomponents(R,E)
4. Understandthedifferencesbetweencashprofitandaccrual
profit
5. Understandtheimplicationsofthedecisiontorecord
expenditureasanassetorasanexpense
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RecapofTopic1
Accounting recordkeepingandreportingofanenterprises
performanceandpositioninmonetaryterms
Theprimaryofobjectiveoffinancialreportingistoprovide
usefulinformationfordecisionmaking

Particularlytoexternalusers e.g.?

Theaccountingprocesssupportstheproductionof3key
financialstatements:

BalanceSheet,IncomeStatement,&StatementofCashFlows

RecapofTopic1
Balancesheet
Financialpositionofanenterpriseataparticularpointintime.
Whataretheentitysresourcesandhowweretheyfinanced?

Incomestatement
Financialperformanceofanenterpriseoveraperiodoftime.
Hastheentityuseditsresourcesefficientlyandeffectively?

Cashflowstatement:

Cashinflowsandoutflows

Notestothefinancialstatements(additionaldetail)
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RecapofTopic1
Recalltheaccountingequation:
Assets
=
Resources

Liabilities+Equity
Sources

Thisassistswithdoubleentrybookkeeping:i.e.therearealways
twoaspectsofatransaction

E.g.Buyingajuicerforthejuicebarbusiness,usingcredit

RecapofTopic1
Accrualaccounting:recognisingrevenuesandexpenseswhen
aneconomicallymeaningfuleventoccurs

Oftenthisdoesnotaffectcashatthetime
Profit=Revenue Expenses
Profitsincreaseequity,andlossesdecreaseit!

Assets=
Resources

Liabilities+Equity

profits

Sources
losses

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Topic2:Outline
1.BalanceSheet overview
1.1.Assets
1.2Liabilities
1.3Equity

2.ConnectingtheIncomeStatementandBalanceSheet
3.IncomeStatement overview
3.1Revenues
3.2Expenses

4.Accrualvs.CashProfit
5.Capitalisevs.expense

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1.TheBalanceSheet

LO1

Astatementthatsummarisesthefinancialpositionofanenterprise
ataparticularpointintime
Whataretheresources(Assets)oftheenterprise?
Watwerethesources:i.e.howweretheyfinanced?(DebtorEquity)
Pointintime e.g.asatJune30,2016

Providesinformationabout
Financialstructure(mixofdebt/equity)
Liquidity easeofconvertingassetstocashinnormalcourseof
business(shorttermfocus)
Solvency abilitytopaydebtswhentheyfalldue(longertermfocus)

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WhatisonaBalanceSheet?

LO1

ABalanceSheetwillalwayshavethefollowingidentifying
information:

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Nameofthereportingentity
Typeoffinancialstatement BalanceSheet
Date whatpointintimeitrefersto
Currencyused $m,$AUD

WhatisonaBalanceSheet?

LO1

Assets

Resources theywillbenefitthecompanythisyear(current)orin
futureyears(noncurrent)
e.g.,cash,property,equipment,inventory

Liabilities

Whatthecompanyowes
e.g.,accountspayable,loanpayable

Equity

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Whatbelongstotheowners,theresiduali.e.whatisleftafter
liabilitiesaretakencareofe.g.,sharecapital,retainedprofits

THEAccountingEquation
Assets

LO1
Liabilities

Equity

Resources(whatwehavetoearnincome)
Source:Whatweowe
Source:Whatownerscontributed,
plusanyprofitsthathaveaccumulated

Remember:theaccountingequationalwaysbalances!
Reliesontheaccountingentityassumption
Theentityistheenterprise/businessforwhichtheaccountingisbeing
done thefinancialstatementsarefortheentityonly
Activitiesoftheentityareseparatefromthoseoftheowners

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BalanceSheet sidebysideformat

LO1

ABCLtd
Balancesheet
AsatJune302016
Assets
$m
Currentassets
Cash
$50
Accounts
$75
receivable
Inventory
$120
$245
Noncurrentassets
Land
$100
$250
Equipment(net)
$150

TOTAL
$495

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Liabilities
$m
Currentliabilities
Bankoverdraft
$30
Accountspayable
$73 $103
Noncurrentliabilities
Loan
Shareholdersequity
Sharecapital
Retainedprofits

$87
$130
$175

$305
$495

WhatisonaBalanceSheet?

LO1

AASB101PresentationofFinancialStatementsrequiresataminimumthatthese
itemsbeshownonthefaceoftheBalanceSheet

Assets

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Liabilities

Cashandcashequivalents
Tradeandotherpayables
Tradeandotherreceivables
Interestbearingliabilities
Inventories
Taxliabilities
Biologicalassets
Provisions
Investmentsaccountedfor
ShareholdersEquity
usingtheequitymethod
Contributedequity/Issuedcapital
Otherfinancialassets
Reserves
Taxassets
Retainedprofits
Property,plantandequipment
Minorityinterest/Outsideequity
Investmentproperty
Intangibleassets

ComponentsofaBalanceSheet

LO1

Notallassets(andliabilities)arereportedonthebalance
sheet
Tobereportedonabalancesheet,theymustmeet
recognitioncriteria:
a)
b)

Itisprobable thatanyfutureeconomicbenefitassociatedwith
theitemwillflowtoorfromtheentity,and
Theitemhasacostorvaluethatcanbemeasuredreliably

Moreonthislater
Nowontodefinitions

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1.1WhatisanAsset?

LO1

Definition:
Aresourcethatiscontrolled (notnecessarilyowned)byan
entityasaresultofpastevents,andfromwhichfuture
economicbenefitsareexpectedtoflowtotheentity.

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Whathappensifdefinitioncriteriaarentmet?

ThreeEssentialCharacteristicsofAssets

LO1

1. Futureeconomicbenefits

Assetsareusedtoprovidegoodsorserviceswiththeobjectiveof
generatingnetcashflows

Considerfutureeconomicbenefitofcash,receivables,
investments,inventory,prepayments,propertyplantand
equipment.

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ThreeEssentialCharacteristicsofAssets

LO1

2. Controlledbyanentity

Relatestothecapacityofanentitytobenefitfromtheassetin
pursuingitsobjectivesandtodenyorregulatetheaccessof
others

3. Asaresultofpastevents

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Meansthatthetransactionorothereventgivingtheentity
controloverthefutureeconomicbenefitsmusthaveoccurred,
e.g.paidcashorcredit

ExamplesofAssets JuiceBarBusiness

LO1

WhatassetsmightourJuiceBarBusinesshave?

Juicer!
Others?

Anyassetsthatcannotberecognisedonbalancesheet?

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Slide18recognitioncriteria

ExamplesofAssets
Ouremployeesareourgreatestassets
Definitioncriteria

Futurebenefits
Control
Pastevent

Recognitioncriteria

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Probable
Reliablemeasurement

LO1

ExamplesofAssets Components
CurrentAssets(CA)

Expecttorealisethebenefitsinthenext12months

NoncurrentAssets(NCA)

Realisebenefitsoveralongerperiod

A
CA+NCA

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OE

LO1

ExamplesofAssets(andlotsofnewterms)
CurrentorNoncurrent?
Cash&cashequivalents
Accountsreceivable
Machinery
Inventory
Prepayments(<12monthsvs.>12months)
Investments
Motorvehicles
Buildings
Intangibleassetse.g.,licences
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LO1

1.2WhatisaLiability?

LO1

Definition:

Aliabilityisapresentobligationoftheentityarisingfrompast
events,thesettlementofwhichisexpectedtoresultinan
outflowfromtheentityofresourcesembodyingeconomic
benefits.

Whathappensifthedefinitioncriteriaarenotmet?

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TwoEssentialCharacteristicsofaLiability

LO1

1. Apresentobligationexistsandtheobligationinvolves
settlementinthefuture
2. Ithasadversefinancialconsequencesfortheentityinthat
theentityisobligatedtosacrifice economicbenefitstoone
ormoreotherentities

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ExamplesofLiabilities JuiceBarBusiness
WhatliabilitiesmightourJuiceBarBusinesshave?
Wagesexpense

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Youeitherpayincashor

LO1

ExamplesofLiabilities

LO1

Liabilitiesalsohavetobeclassifiedascurrentornoncurrent

Currentliabilitiesarethosethatwillbepaidoffwithinoneyear
ofthebalancesheetdate.
Noncurrentliabilitieswillremainliabilitiesforatleastthenext
year.

Reasonforthisdistinction(forbothassetsandliabilities):
Tohelpthefinancialstatementuserassessshortterm
financialposition.

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ExamplesofLiabilities CLorNCL?
Accountspayable
Overdrafts
Loans

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(duein<12monthsvs.>12months)

Unearnedrevenue
Taxespayable
Dividendspayable
Wagespayable
Provisionforwarranty

LO1

WorkingCapital CAandCL

LO1

Calculatedbysubtractingcurrentliabilitiesfromcurrentassets

Workingcapital=CA CL
Lowornegativeworkingcapitalisanindicationofshortterm
financialdifficulties

IfyoudivideCAbyCL=
HOWEVER

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Interpretationdependsonthecircumstancesofeachcase

1.3WhatisEquity?

LO1

Theresidualinterestintheassetsoftheentityafterdeducting
allitsliabilities

A=L+OE
A L=OE
Alsoreferredtoasnetassets

Whatwe contribute
Commoncomponents:

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Sharecapital
Retainedprofits

2.ConnectingtheBS&IncomeStatement

LO2

EquityisthelinkbetweentheBalanceSheet&Income
Statement
RecallthatcommoncomponentsofEquityare:

Sharecapital
Retainedprofits

Letsnowconsidermeasuringchangesinownerwealth(i.e.,
changesinnetassets)

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TransactionsthatAffectOwnersEquity
OWNERSEQUITYINCREASES

LO2

OWNERSEQUITYDECREASES

OwnerWithdrawals
fromtheBusiness

OwnerInvestments
intheBusiness

OwnersEquity

Revenues

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Expenses

AcloserlookatOwners(shareholders)Equity LO2
HowisOwnersEquityaffectedbythefollowing?
Contributionsbyowners(shareholders)
Profit

Revenues
Expenses

Distributionstoowners

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Dividends

2.ConnectingtheBS&IncomeStatement

LO2

Retainedprofit
Whenacompanyearnsaprofit,thatprofitcanbedistributedto
shareholdersasdividendsorkeptinthebusinesstogrowthebusiness
TheprofitthatiskeptiscalledRetainedProfit

TheRetainedProfitAccountisthelinkbetweenthebalancesheet
andincomestatement
OpeningRetainedprofit
Plus
Less
=

Profit(Revenues Expenses)forthisperiod
Distributions(Dividends)
ClosingRetainedProfit

Remember:DividendsareNOTANEXPENSE!
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TheAccountingEquationexpandedevenfurther!

A =

CA+NCA =CL+NCL

OE

+ (SC +

RP)

CA+NCA =CL+NCL +SC+(RP(beginning)+Profit D)


CA+NCA =CL+NCL +SC+(RP(beginning)+(R E) D)
Where:
A
=
CA =
NCA =
L
=
CL =
NCL =
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Assets
CurrentAssets
NoncurrentAssets
Liabilities
CurrentLiabilities
NoncurrentLiabilities

OE
SC
RP
R
E
D

=
=
=
=
=
=

Ownersequity
Sharecapital
Retainedprofit
Revenue
Expenses
Dividend(declared)

2.ConnectingtheBS&IncomeStatement
BalanceSheet
Cash
Otherassets
Totalassets
Liabilities
Sharecapital`
Retainedprofits
Totalliabilitiesand
shareholdersequity

RetainedProfitsNote
2015balance
+Netprofit

Dividends
2016balance

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2015
1,400
114,000
115,400
51,400
40,000
24,000

2016
2,000
118,000
120,000
53,000
40,000
27,000

115,400

LO2

CashFlowStatement
Fromoperatingactivities
Frominvestingactivities
Fromfinancingactivities
Totalnetcashflows
Openingbalance
Closingbalance

2016
2,500
(2,300)
400
600
1,400
2,000

IncomeStatement
Revenues
Expenses*
Netprofit

2016
21,000
15,000
6,000

120,000

24,000
6,000
30,000
3,000
27,000

2.ConnectingtheBS&IncomeStatement

LO2

Incomestatementaccountsaretemporaryaccounts
Balancesheetaccountsarepermanentaccounts
Incomestatementaccountsareclosedandtheirbalances
transferredtotheretainedprofitsaccount(onthebalancesheet)at
theendofeachaccountingperiod
Theretainedprofitsaccountprovidesthelinkbetweentheincome
statementandthebalancesheet

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Example1

LO2

Contributionsbyowners issuedsharesfor$300,000cash

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+OE

Example2

LO2

Companyreceives$3,000interestonbankdeposit

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+OE

Example3

LO2

Companypays$3,000interestonabankloan

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+OE

RevisionQuestion1
Whichofthefollowingstatementsaboutabalancesheetis
true?
1. Abalancesheetpresentsthefinancialperformanceofa
companyforaperiodoftime
2. Abalancesheetpresentsthefinancialpositionatapointin
time
3. Abalancesheetshowsallitemsmeetingthedefinitionof
assetsandliabilities
4. Abalancesheetincludesnamesofthecompanys
shareholders
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RevisionQuestion2
Basedonthefollowinginformation,calculateOwners
Equity(OE)
A=L+OE
Cash
Inventory
Equipment
Accountspayable
Taxespayable
Bankloan

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10000
30000
200000
50000
40000
100000

Wherearewenow?
1.BalanceSheet overview
1.1.Assets
1.2Liabilities
1.3Equity

2.ConnectingtheIncomeStatementandBalanceSheet
3.IncomeStatement overview
3.1Revenues
3.2Expenses

4.Accrualvs.CashProfit
5.Capitalisevs.expense

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3.IncomeStatement

LO3

Showstheresultsofbusinessoperationsoveraspecifictime
period

Relatestotheaccountingperiodassumption
Reportsrevenuesearned,lessanyexpensesincurred
Providesameasureoforganisationalefficiency
Calculatestheprofitthatmaybeavailabletoshareholders

Remember:Accrualprofitisnotthesameascashprofit!

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3.1Revenue

LO3

Revenueisgrossinflowsofeconomicbenefitsduringthe
periodarisingintheordinaryactivitiesofanentitywhen
thoseinflowsresultinincreasesinequityotherthanthose
relatingtocontributionsfromequityparticipants.
(AASB118,para7)

Revenuerepresentsanincreaseinthewealthofthebusiness

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Itisrecognisedwhenitisconsideredtobeearned requiresa
triggerpoint
E.g.:whengoods/serviceshavebeenprovidedtocustomers
Receiptofcashisnotnecessary!

ExamplesofRevenue

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SalesRevenue
InterestRevenue
RentRevenue
DividendsRevenue

LO3

JuiceBarExamplecontinued Revenue

LO3

HowmuchrevenuewouldJuiceBarrecordforthemonthof
July?
(a) Collected$1,000cashfromcustomersduringJulyfor
servicesprovidedduringJune
(b) Cashsalesof$4500duringJuly
(c) Providedacustomerwithjuicesworth$2,000oncredit inJuly,
moneytobecollectedinAugust
(d) Receivedadepositof$500inJuly(fromanothercustomer)for
juicestobeprovidedinAugust

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3.2Expenses

LO3

Expensesrepresentdecreasesintheentityswealth
Theyareincurredinordertoearnrevenue
Note:

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Expensesdonotincludepaymentsorreturnstoowners(i.e.
withdrawalsbysoletradersorpartners,or,dividendsto
shareholders)
Paymentstoownersareconsideredtobedistributionsofnet
profittoowners

Wealthdecreasesbecause:

LO3

Operatingcostshavetobepaid
Longtermassetswearout

Referredtoasdepreciationoramortisation
Noticethishasnodirecteffectoncash!

Assetsareusedup(e.g.prepayments,inventory)

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Againnotethattheusingupofprepaymentsandinventorydoes
notleadtoacashoutflow!

JuiceBarExamplecontinued Expenses

LO3

WhatexpensewouldJuiceBarrecordforthemonthofJuly?
(a)
(b)
(c)
(d)
(e)

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$1,000WagespaidduringJulythatrelatetoworkdoneinJuly
$250WagesincurredthatistobepaidinAugust
$200WagespaidinJulythatwereowingfromJune
JuiceBartookoutaloanfromthebankfor$10,000
$500,thecostofrentinJuly,tobepaidinAugust

JuiceBarExample Accrualvs.CashProfit
ForJuly:
Collected$1,000cashfromcustomers
duringJulyforservicesprovidedinJune
Cashsalesof$4500duringJuly
Providedacustomerwithjuicesworth
$2,000oncreditinJuly,moneytobe
collectedinAugust
Receivedadepositof$500inJuly(from
anothercustomer)forjuicestobeprovided
inAugust
Total
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LO4

Revenue

CashIn

$0

$1,000

$6,500

$6,000

JuiceBarExample Accrualvs.CashProfit
ForJuly:

$1,000WagespaidduringJulythatrelateto
workdoneinJuly

LO4

Expense

CashOut

$1,000

$1,000

$1,750

$1,200

$250WagesincurredthatistobepaidinAugust
$200WagespaidinJulythatwereowingfrom
June
JuiceBartookoutaloanfromthebankfor
$10,000
$500,thecostofrentinJuly,tobepaidin
August
Total

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JuiceBarExample Accrualvs.CashProfit
WhatwastheaccrualprofitforJuly?

$6,500 $1,750=$8,250

WhatwasthecashprofitforJuly?

$6,000 $1,200=$4,800

AccrualisbetterthanCashaccounting?

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LO4

ExamplesofCosts

LO5

Costoranexpenditure

EitheranAssetoranExpense

Aninterestingchoicethatcanmakeabigdifferencetoa
business!

Whenweclassifyacostasanassetwesaywecapitalise it
Ifacostisnotcapitalised,itisexpensed

A=L+OE

Thisdecisioncanbeaffectedbytheamountand/orforhow
longitwouldlast/definitionofanasset
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Classifyingacostasanasset(capitalise)orexpense
Has a cost
been incurred?

No

Unlikely to be an
accounting event

Yes

Is there a benefit
to the business?

No

Relates to the owner or


someone else and should
be charged appropriately

Yes

Has the benefit been


used in this period?
Yes

No

Is the amount considered


material?

No
Yes

Report as an expense

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Report it as an asset

Capitalisevs.Expense

LO5

WhichofthefollowingisJuiceBarlikelytocapitalise?

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Spent$10,000cashonnewequipment
Borrowed$5,000tobuymoreequipment
Spent$200,000tryingtodevelop ajuicewithgreatfatburning
properties(willneedgovernmentapprovalbeforeitcanbesold)
Paid12monthsrentinadvance$6,000
Spent$30onprinterink(willlast6months)

RevisionQuestion3
During2016,acompanymakescreditsalesof$500,000of
which$375,000iscollectedatyearend.Itpays$200,000in
expensesandowes$25,000forelectricityusedduring2016.
Whatisaccrualprofitfor2016?
Whatiscashprofit?

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Notes

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