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Capturing Economics Events

A ledger is an important tool in business accounting, because it is a place, where all groups of accounts (cash, accounts payable and capital stock) are kept. When making entries in a T-account, receipts are entered in the debit side, while payments are recorded in the credit column. In order to find the balance of a transaction, the difference between the debit and credit entries is computed. The assets of a business are made up of both liabilities and equities. All transactions that a business conducts are initially recorded in a journal according to the actual accounting system.

By posting journal entries in the ledger accounts, accountants are able to update the ledgers, which is the key requirement in accounting. All variables have different effects on owner’s equity and liability. Income either increases an asset or decreases a liability, thus net income always increases the owner’s equity. This is particularly the case because revenue increases the owner’s equity, while expenses decrease owner’s equity.

Accruals and Deferrals

Whenever expenses or revenue affect more than a single accounting period, adjustment to entries must be done to accommodate it. The adjustment entails a change in an expense or revenue account, as well as a 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 an expense, and reduces the balance of asset account.

The concept of depreciation is explained as the fact 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 and it is not factual, e.g. 50 months for a $2,500 lawn mower or 60 months for a $15,000 truck. To reach the book value, an accountant subtracts the accumulated depreciation from the cost of the asset.  

In case the 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 the liability account. At the end of the current period, an accountant must recognize all unpaid expenses and uncollected revenue. It is also needed to recognize expense incurred and record liability for future settlement, and recognize revenue earned but not recorded yet and record it as a 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 into the market. A 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 fully 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 the break-even point. 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 Company to produce and sell the large number of units so as to attain or improve the break-even point. As such, there is the need for the company to raise the equity base so as to support the working capital required 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, increase equity to finance an ambitious operation, or outsource and market. 

Code: Sample20

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