Assessment Questions

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1 learning outcomes 1 Describe the purpose of accounting 2 Describe the balance sheet and the income statement 3 Define an accounting period 4 Explain how the accounting equation works 5 Explain accrual-based accounting 6 Explain how to account for debt and assets 7 Explain how to account for prepaid expenses 8 Distinguish between capital and revenue 9 Demonstrate how double entries are recorded in T-accounts Access ameengage.com for integrated resources including tutorials, practice exercises, the digital textbook and more. Assessment Questions AS-1 ( 1 ) Define accounting and describe the purpose of accounting. Accounting is a system to identify, measure and communicate all the financial activities of an individual or a business. The purpose of accounting is to allow interested users to make informed judgments based on accurately recorded information. AS-2 ( 2 ) What is net worth? Net Worth = Assets - Liabilities. If all assets are cashed out to pay off outstanding liabilities, the remaining cash will represent net worth. AS-3 ( 2 ) In simple terms, what are assets and liabilities? Assets are what you own and liabilities are what you owe. 1

2 AS-4 ( 2 ) What are revenues and expenses? Revenues are increases in net worth caused by providing goods or services. In your personal life, one way revenue is earned is by working and earning a salary. Expenses are a decrease in net worth due to the costs of day-to-day activities. In your personal life, expenses can include items such as rent or food. AS-5 ( 2 ) Explain the role of the balance sheet. The balance sheet is a permanent document that is used to record what you own (assets) and what you owe (liabilities) on a specific date. The balance sheet provides a snapshot of your financial position. The difference between the value of what you own and what you owe represents your net worth. AS-6 ( 2 ) Explain the role of the income statement. The income statement is primarily used as a temporary record of transactions relating to revenue and expenses. The purpose of this statement is to determine the change in net worth over a specific period of time. AS-7 ( 3 ) What are some advantages of using monthly accounting periods in your personal balance sheet? The advantages include tracking regular monthly living expenses (e.g. rent, cell phone), frequently assessing realistic expectations, and controlling errors effectively. 2

3 Chapter 1 AS-8 ( 4 ) What is the accounting equation? Assets = Liabilities + Net Worth AS-9 ( 8 ) What is the equation for calculating ending net worth for a period? Ending Net Worth = Beginning Net Worth + Capital + Surplus (Deficit) AS-10 ( 2 ) Define surplus and deficit. Surplus is the amount by which revenues exceed expenses for the period. Deficit is the amount by which expenses exceed revenues for the period. The amount is taken from the personal income statement. A surplus increases net worth and a deficit decreases net worth. AS-11 ( 4 ) What is a T-account? A T-account is used to record accounting transactions for individual items. This form allows you to record the double entries for each transaction on opposite sides (increase or decrease) of each account. AS-12 ( 5 ) Explain accrual-based accounting. Revenue (which causes an increase in net worth) and expenses (which cause a decrease in net worth) should be recognized in the time period in which they occur, regardless of when the cash payment is received or made. 3

4 AS-13 ( 5 ) Briefly describe the cash-based method of accounting. Under the cash-based method of accounting, revenue and expenses are recorded only when the cash is received or paid. AS-14 ( 6 ) True or False: When you borrow money, you have more cash but your net worth decreases. False. Borrowing money does not change your net worth. AS-15 ( 6 ) True or False: When you pay off a loan, your cash decreases and your net worth increases. False. Repaying debt does not change your net worth. AS-16 ( 6 ) True or False: Buying an asset has no impact on net worth. True. AS-17 ( 7 ) What is a prepaid expense? A prepaid expense occurs when you pay cash for an expense before it is incurred. AS-18 ( 7 ) When an expense is initially prepaid, which accounts increase or decrease? Cash decreases and prepaid expenses increases. 4

5 Chapter 1 AS-19 ( 7 ) When does an expense need to be recorded under accrual-based accounting? What are the three possible timings the payment can be made for an expense? Under accrual-based accounting, expenses are always recorded when they are incurred regardless of when the cash payment is made. 1. Pay before and recognize the expense when it is incurred (prepaid expense). 2. Pay as the expense is incurred (cash). 3. Pay after the expense is incurred (unpaid account). AS-20 ( 8 ) What is capital? Capital is an increase to net worth other than revenue (such as winning the lottery or receiving a gift). 5

6 Application Questions Group A AP-1A ( 2 ) April Rose had the following financial data for the year ended December 31, 2016 Cash $6,000 Jewellery 10,000 Automobile 18,000 House 256,000 Bank Loan 45,000 Credit Card 5,000 Mortgage 140,000 Required a) Calculate April Rose s total assets. Cash $6,000 Jewellery 10,000 Automobile 18,000 House 256,000 Total Assets $290,000 b) Calculate April Rose s total liabilities. Bank Loan $45,000 Credit Card 5,000 Mortgage 140,000 Total Liabilities $190,000 AP-2A ( 2 4 ) Consider the following information for Julius Troy Cash $12,000 Jewellery 18,000 Automobile 22,000 House 161,000 Credit Card 5,000 Bank Loan 10,000 Mortgage 125,000 6

7 Chapter 1 Required a) Calculate Julius Troy s total assets. Cash $12,000 Jewellery 18,000 Automobile 22,000 House 161,000 Total Assets $213,000 b) Calculate Julius Troy s total liabilities. Credit Card $5,000 Bank Loan 10,000 Mortgage 125,000 Total Liabilities $140,000 c) Calculate Julius Troy s net worth. Total Assets $213,000 Less Total Liabilities 140,000 Net Worth $73,000 AP-3A ( 6 ) Darryl purchased a new laptop on January 1, 2016 worth $2,000. He paid the entire amount using cash. He also purchased a new cell phone worth $300 on account. How will these transactions affect Darryl s net worth? Net worth will remain unaffected. AP-4A ( ) The following information was taken from the personal records of Juliet Lahm on April 30, 2016 Cash $3,000 Jewellery 2,000 House 190,000 Mortgage 80,000 Net Worth 115,000 7

8 Transactions for the month of May Earned monthly salary of $5, Paid $1,200 cash for utilities. 3. Purchased an automobile worth $10,000 on account. 4. Paid $600 cash for food expenses. 5. Paid $400 cash for gas. Required a) Complete the Cash T-account to determine the ending balance of cash. INCREASE DECREASE + CASH - Opening Bal. 3, , , TOTAL: $5,850 b) Complete the personal income statement to determine the surplus or deficit for the period. Personal Income Statement For the Month Ended May 31, 2016 Revenue $5,050 Expenses Utilities Expense $1,200 Food Expense 600 Gasoline Expense 400 Total Expenses $2,200 Surplus (Deficit) $2,850 c) What is Juliet Lahm s net worth on May 31? Net Worth, Beginning $115,000 Add Surplus $2,850 Net Worth, Ending $117,850 8

9 Chapter 1 AP-5A ( 2 4 ) A person has the following information with regard to his own balance sheet, but the liability section is missing. Cash $35,000 Automobile 58,000 House 100,000 Net Worth 55,000 Required Determine the total amount of liabilities. Assets - Liabilities = Net Worth Assets - Net Worth = Liabilities ($35, , ,000) - ($55,000) = $138,000 AP-6A ( 4 ) Calculate the missing amounts in the following table. Scenario 1 Scenario 2 Total Assets $123,000 $148,000 Total Liabilities $29,000 $34,000 Net Worth $94,000 $114,000 AP-7A ( 4 ) As of December 31, 2015, Maria Green had total assets of $40,000, and total liabilities of $15,000. As of December 31, 2016, Maria s total assets and liabilities increased to $50,000 and $30,000, respectively. How has Maria s net worth changed since the end of 2015? Net Worth has decreased by $5,000 Dec 31, 2015 Dec 31, 2016 Total Assets $40,000 $50,000 Total Liabilities $15,000 $30,000 Net Worth $25,000 $20,000 9

10 AP-8A ( ) The following information pertains to Ken White s personal financial transactions Transactions for the month of January 2016 Opening Balances as at January 1, 2016 Cash $9,000 Contents of Home 6,000 Automobile 29,000 House 156,000 Unpaid Accounts 5,500 Bank Loan 60,000 Net Worth 134, Paid maintenance expense for the month of January with $120 cash. 2. Purchased new furniture worth $2,500 with cash. 3. Paid credit card liability of $5,500 (Unpaid Accounts) in full. 4. Paid telephone, electricity and water bill for January with $1,200 cash. 5. Purchased $2,000 of groceries and goods for personal consumption with cash. 6. Deposited $4,040 salary earned during the month. Required a) Using the information provided, record the opening balances in the T-accounts. b) Record the transactions for the month of January in the T-accounts. 10

11 Chapter 1 PERSONAL BALANCE SHEET As at January 31, 2016 PERSONAL INCOME STATEMENT For the Month Ended Jan. 31, 2016 ASSETS LIABILITIES DECREASE INCREASE INCREASE DECREASE DECREASE INCREASE - REVENUE + + CASH - - UNPAID ACCOUNTS + 6. $4,040 Opening $9,000 $5,500 Opening 6. $4, ,500 $4,040 $1, , , ,200 Less EXPENSES 5. 2,000 INCREASE DECREASE + ENTERTAINMENT EXPENSE - INCREASE DECREASE + contents of home - $0 INCREASE DECREASE Opening $6,000 + FOOD EXPENSE - 2. $2,500 DECREASE INCREASE 5. $2,000 - BANK LOAN + $60,000 Opening $2,000 INCREASE DECREASE $8,500 + INTEREST EXPENSE - INCREASE DECREASE + automobile - Opening $29,000 INCREASE DECREASE + MAINTENANCE EXPENSE - 1. $120 $60,000 $120 $29,000 Net Worth INCREASE DECREASE DECREASE INCREASE + Utilities EXPENSE - INCREASE DECREASE - NET WORTH + 4. $1,200 + house - $134,500 Opening Opening $156,000 $1,200 $156,000 $134,500 TOTAL ASSETS $195,220 Total Revenue $4,040 } TOTAL LIABILITES 60,000 $195,220 LESS TOTAL EXPENSES 3,320 Net Worth 135,220 SURPLUS (DEFICIT) $720 11

12 AP-9A ( ) Alan Marshall is preparing his balance sheet and income statement for the month ended April 30, Use the following information to help him prepare his financial statements. Transactions for the month of April Opening Balances as at April 1, 2016 Cash $5,000 Contents of Home 1,000 Automobile 4,000 House 280,000 Unpaid Accounts 10,000 Auto Loan 30,000 Net Worth 250, Purchased new furniture worth $2,000 for home using credit card. 2. Paid credit card bill with $3,000 cash. 3. Paid utility bills of $800 for the month of April using credit card. 4. Purchased groceries and food for $2,500 using cash. 5. Made a principal payment of $1,250 for the auto loan. 6. Paid April s rent of $1,500 with cash. 7. Deposited $4,050 salary earned during the month. Required a) Using the information provided, record the opening balances in the T-accounts. b) Record the transactions for the month of April in the T-accounts. 12

13 Chapter 1 PERSONAL BALANCE SHEET As at April 30, 2016 PERSONAL INCOME STATEMENT For the Month Ended April 30, 2016 ASSETS LIABILITIES DECREASE INCREASE INCREASE DECREASE DECREASE INCREASE - REVENUE + + CASH - - UNPAID ACCOUNTS + 7. $4,050 Opening $5,000 $10,000 Opening 7. $4, $3, $3, ,000 $4,050 $ $2, , ,500 Less EXPENSES INCREASE DECREASE + ENTERTAINMENT EXPENSE - INCREASE DECREASE + contents of home - $9,800 INCREASE DECREASE Opening $1,000 + FOOD EXPENSE - 1. $2,000 DECREASE INCREASE 4. $2,500 - AUTO LOAN + $30,000 Opening $2, $1,250 INCREASE DECREASE $3,000 + INTEREST EXPENSE - INCREASE DECREASE + automobile - Opening $4,000 INCREASE DECREASE + MAINTENANCE EXPENSE - $28,750 $4,000 net worth INCREASE DECREASE DECREASE INCREASE + RENT EXPENSE - INCREASE DECREASE - NET WORTH + 6. $1,500 + house - $250,000 Opening Opening $280,000 $1,500 INCREASE DECREASE + Utilities EXPENSE - 3. $800 $280,000 $250,000 $800 TOTAL ASSETS $287,800 Total Revenue $4,050 } TOTAL LIABILITES 38,550 $287,800 LESS TOTAL EXPENSES 4,800 Net Worth 249,250 SURPLUS (DEFICIT) ($750) 13

14 AP-10A ( 2 3 ) John Black is a senior administrator at a market research firm, and recently received a salary increase from $3,500 per month to $4,000 per month. He feels richer and would like to know the increase in his net worth. However, he has never prepared a personal balance sheet or an income statement that would help him understand his net worth. John gathered the following information to help him understand his financial position. September 30, 2016 October 31, 2016 November 30, 2016 Cash $1,000 $2,150 $4,050 House 120, , ,000 Bank Loan Salary 3,500 3,500 4,000 Entertainment Expense Food Expense 1,500 1,200 1,100 Insurance Expense Utilities Expense Miscellaneous Expense Required Prepare John Black s income statement for the three months. John Black Personal Income Statement For the Month Ending September 30, 2016 October 31, 2016 November 30, 2016 Total Revenue $3,500 $3,500 $4,000 $11,000 Expenses Entertainment Expense ,100 Food Expense 1,500 1,200 1,100 3,800 Insurance Expense Utilities Expense Miscellaneous Expense Total Expenses $2,225 $2,300 $2,050 $6,575 Surplus (Deficit) $1,275 $1,200 $1,950 $4,425 14

15 Chapter 1 AP-11A ( 3 8 ) Jeff Winger is working at a law firm. His salary recently increased and he would like to keep track of his net worth. Jeff has gathered the following information to help you track his net worth. Assume the opening net worth for June 30 is $0. June 30, 2016 July 31, 2016 August 31, 2016 Cash $2,500 $4,100 $6,300 Automobile 13,000 13,000 13,000 Credit Card Bills 1, Automobile Loan 12,000 11,500 11,000 Salary 4,300 4,900 4,900 Food Expense Entertainment Expense Rent Expense 1,300 1,300 1,300 Complete the table below. June 30, 2016 July 31, 2016 August 31, 2016 Opening Net Worth $0 $2,500 $4,800 Surplus (Deficit) $2,500 $2,300 $3,000 Closing Net Worth $2,500 $4,800 $7,800 Analysis After looking at the table you prepared for Jeff, he notices that his cash has not increased by as much as his net worth has. Why is this the case? Some transactions, such as purchasing assets or paying back debt, affect cash but not net worth. Jeff has not purchased any assets during the period. His credit card debt has decreased by $500 and his car loan has decreased by $1,000. Therefore he used $1,500 cash to pay back his debts which is why the increase in cash is $1,500 less than the increase in net worth. 15

16 AP-12A ( 2 4 ) Using the opening balances provided in the balance sheets below, enter the updated amounts for each transaction in the blank balance sheets labelled Answers. 1. Borrowed $4,000 from the bank. Opening Balances Assets Liabilities Cash $5,000 Unpaid Accounts $3,000 Investment 8,000 Bank Loan 0 Contents of Home 6,000 Automobile Loan 5,000 Automobile 20,000 Student Loan 6,000 House 280,000 Mortgage 250,000 Total Liabilities 264,000 Net Worth 55,000 Total Assets $319,000 Total Liabilities + Net Worth $319,000 Answers Assets Liabilities Cash $9,000 Unpaid Accounts $3,000 Investment 8,000 Bank Loan 4,000 Contents of Home 6,000 Automobile Loan 5,000 Automobile 20,000 Student Loan 6,000 House 280,000 Mortgage 250,000 Total Liabilities 268,000 Net Worth 55,000 Total Assets $323,000 Total Liabilities + Net Worth $323, Purchased $3,000 of investments in cash. Opening Balances Assets Liabilities Cash $7,000 Unpaid Accounts $3,000 Investment 8,000 Bank Loan 0 Contents of Home 6,000 Automobile Loan 5,000 Automobile 20,000 Student Loan 6,000 House 180,000 Mortgage 150,000 Total Liabilities 164,000 Net Worth 57,000 Total Assets $221,000 Total Liabilities + Net Worth $221,000 16

17 Chapter 1 Answers Assets Liabilities Cash $4,000 Unpaid Accounts $3,000 Investment 11,000 Bank Loan 0 Contents of Home 6,000 Automobile Loan 5,000 Automobile 20,000 Student Loan 6,000 House 180,000 Mortgage 150,000 Total Liabilities 164,000 Net Worth 57,000 Total Assets $221,000 Total Liabilities + Net Worth $221, Paid $1,000 to reduce an outstanding automobile loan (principal portion). Opening Balances Assets Liabilities Cash $3,000 Unpaid Accounts $3,000 Contents of Home 6,000 Bank Loan 0 Automobile 20,000 Automobile Loan 5,000 House 180,000 Student Loan 6,000 Mortgage 150,000 Total Liabilities 164,000 Net Worth 45,000 Total Assets $209,000 Total Liabilities + Net Worth $209,000 Answers Assets Liabilities Cash $2,000 Unpaid Accounts $3,000 Contents of Home 6,000 Bank Loan 0 Automobile 20,000 Automobile Loan 4,000 House 180,000 Student Loan 6,000 Mortgage 150,000 Total Liabilities 163,000 Net Worth 45,000 Total Assets $208,000 Total Liabilities + Net Worth $208,000 17

18 4. Bought a motorcycle for $6,000. Paid a $1,000 deposit with cash and borrowed $5,000 from the bank. Opening Balances Assets Liabilities Cash $2,000 Unpaid Accounts $3,000 Contents of Home 4,000 Bank Loan 1,000 Motorcycle 0 Student Loan 11,000 Automobile 20,000 Mortgage 150,000 House 180,000 Total Liabilities 165,000 Net Worth 41,000 Total Assets $206,000 Total Liabilities + Net Worth $206,000 Answers Assets Liabilities Cash $1,000 Unpaid Accounts $3,000 Contents of Home 4,000 Bank Loan 6,000 Motorcycle 6,000 Student Loan 11,000 Automobile 20,000 Mortgage 150,000 House 180,000 Total Liabilities 170,000 Net Worth 41,000 Total Assets $211,000 Total Liabilities + Net Worth $211,000 18

19 Chapter 1 AP-13A ( 8 ) John Hollister collected the following amounts in cash for the month of February 2016 Salary paid by employer $2,400 Winnings at the casino $270 Gifts $295 Performance bonus paid by employer $450 Required Calculate John s total revenue and total capital items for February Total Revenue = $2,400 + $450 = $2,850 Total Capital = $270 + $295 = $565 AP-14A ( 4 ) Indicate whether the terms of the accounting equation will increase, decrease or stay the same for each transaction by placing a + or - in the appropriate space. If an item is not changed by the transaction, leave the space blank. The first transaction has been completed for you. Transaction Assets = Liabilities + Net Worth Deposited salary earned Purchased a new TV on credit Received a cash gift Purchased fuel for car on credit Made a loan payment including interest Received cash from a student loan Received a paycheque

20 AP-15A ( ) The following information is available from Anna Edison s financial records Opening Balances as at June 1, 2016 Cash $18,000 Furniture 3,100 Valuables & Electronics 3,200 House 255,000 Student Loans 39,000 Family Loan 2,000 Mortgage 100,000 Net Worth 138,300 The following transactions took place during the month of June 1. $350 was taken from the bank account for a car lease payment. 2. Paid $1,000 cash against the student loans. Includes $140 of interest. 3. Won a tablet worth $800 as a raffle prize. 4. Made a mortgage payment of $2,000 with cash. Includes $400 interest. 5. $4,800 salary earned was directly deposited to the bank account. 6. Family member accepted jewellery of $2,000 in repayment of the loan. 20

21 Chapter 1 a) Record the transactions in the T-accounts. PERSONAL BALANCE SHEET As at June 30, 2016 Income Statement For the Month Ended June 30, 2016 Assets Liabilities Revenue Increase Decrease Decrease Increase Decrease Increase + Cash - - Student Loans Opening $18,000 $39,000 Opening 5. 4, , ,000 $4, ,000 $19,450 $38,140 Less EXPENSES Increase Decrease Increase Decrease Decrease Increase + Automobile EXPENSE - + Furniture - - Family Loan Opening $3,100 $2,000 Opening 6. 2,000 $350 Increase Decrease $0 + ENTERTAINMENT EXPENSE - $3,100 Decrease Increase Increase Decrease - Mortgage + + Valuables & Electronics - $100,000 Opening Opening $3, ,600 Increase Decrease Groceries EXPENSE ,000 $98,400 $2,000 Increase Decrease Increase Decrease Decrease Increase + Interest EXPENSE - + House - - net worth Opening $255,000 $138,300 Opening $ Increase Decrease + Travel Expense - $255,000 $139,100 Total Assets $279,550 Total Revenue $4,800 } Total Liabilites 136,540 $279,550 Less Total Expenses 890 Net Worth 143,010 Surplus (Deficit) $3,910 21

22 b) Complete the income statement and balance sheet. Income Statement For the Month Ended June 30, 2016 Revenue $4,800 Expenses Automobile Expense $350 Interest Expense 540 Total Expenses 890 Surplus (Deficit) $3,910 Assets Personal Balance Sheet As at June 30, 2016 Liabilities Cash and Savings $19,450 Student Loans $38,140 Valuables & Electronics 2,000 Mortgage 98,400 Furniture 3,100 Total Liabilities 136,540 House 255,000 Net Worth 143,010 Total Assets $279,550 Total Liabilities + Net Worth $279,550 AP-16A ( 4 9 ) Indicate whether assets, liabilities or net worth will increase or decrease and by how much, based on each transaction. The first one has been done for you. Always ensure the accounting equation is balanced. Provide an explanation only if net worth is affected. 1. Purchased a new television for $700 on credit. Assets = Liabilities+ Net Worth Explanation Received $2,000 salary. +2,000 +2,000 Recorded salary earned as revenue 3. Paid $1,200 cash for one year of insurance. 4. Purchased a new $500 gaming console with cash. -1,200 +1, Paid for groceries with $80 cash Paid for grocery expense 6. Paid $400 toward the car loan Paid $30 interest on the car loan Paid for interest expense 8. Paid $600 toward unpaid bills Used one month of insurance Recorded insurance expenses 22

23 Chapter 1 AP-17A ( ) Indicate whether the account balances will increase or decrease and by how much, based on each transaction. The first one has been done for you. Always ensure the accounting equation is balanced. Assets = Liabilities + Net Worth Explanation 1. Purchased a new television for $700 on credit Purchased $100 worth of gas on credit Purchased gas 3. Made a $850 car loan payment Purchased a chandelier for $200 cash Prepaid three months of rent with $3,300 cash. +3,300-3, Received a cash gift of $ Received cash gift 7. Used up one of three months of prepaid rent. -1,100-1,100 Used up rent 8. Paid interest of $50, in cash, on the car loan Paid interest on car loan 9. Received a phone bill for $ Received phone bill Analysis The net worth account is only updated at the end of an accounting period. Revenue and expense accounts, and the net worth account, track changes in net worth during the period. For each transaction that affects net worth, determine whether a revenue, expense, or net worth is used to track the change. 2. Fuel Expense increases by $ Net Worth increases by $ Rent Expense increases by $1, Interest Expense increases by $50 9. Telephone Expense increases by $110 23

24 AP-18A ( ) On December 1, 2016, Shervin decided to track his finances. On this date, his assets and liabilities were Cash $14,000 Prepaid Rent 3,000 Prepaid Insurance 300 House 160,000 Contents of Home 19,000 Automobile 30,000 Student Loan 10,000 Unpaid Accounts 17,000 Bank Loan 25,000 Mortgage 120,000 Required a) What is the value of his total assets? Cash $14,000 Prepaid Rent 3,000 Prepaid Insurance 300 House 160,000 Contents of Home 19,000 Automobile 30,000 Total Assets $226,300 b) What is the value of his total liabilities? Student Loan $10,000 Unpaid Accounts 17,000 Bank Loan 25,000 Mortgage 120,000 Total Liabilities $172,000 c) What is Shervin s net worth on December 1, 2016? Total Assets $226,300 Less Total Liabilities 172,000 Net Worth $54,300 d) During the month of December, Shervin recognized $150 of prepaid expenses as an actual expense on the income statement. Calculate the change in his cash account and net worth. Transaction Cash Net Worth Effect No change Decrease by $150 24

25 Chapter 1 AP-19A ( 4 6 ) Nick Miller wrote down his personal accounting information but some of it was destroyed. Bicycle $700 Automobile 3,000 Cash 800 Furniture? Net Worth 3,350 Overdue Rent? Television 500 Total Assets 6,100 Unpaid Bills 2,300 Required a) How much is Nick s furniture worth? Nick s assets include: Bicycle, Automobile, Cash, Furniture, and Television. Together, the Bicycle, Automobile, Cash, and Television are worth $5,000. Nick s Total Assets are $6,100 which means the Furniture must be worth $1,100. b) How much rent does Nick owe? Assets - Liabilities = Net Worth Nick s Total Assets are $6,100 and his Net Worth is $3,350. Therefore his Total Liabilities must be $2,750. Nick s liabilities include his Unpaid Bills and his Overdue Rent. Unpaid Bills total $2,300, so he must owe $450 in rent. Analysis Nick has worked 80 hours at his job as a bartender and earned $1,900 but will not get paid for another two weeks. According to accrual-based accounting has Nick s net worth increased? Why or why not? Accrual-based accounting states that net worth changes when activities occur, not necessarily when cash is paid or received. In this case, Nick has already earned his salary so his net worth has increased. An asset account could be created to record this. 25

26 AP-20A ( 4 ) State how the following transactions would affect net worth (increase, decrease, no change) Transaction Borrow cash. Pay entertainment expense with cash. Pay food expense with cash. Buy assets with cash. Charge home repairs expense on credit card. Pay insurance expense with cash. Pay loan principal with cash. Purchase assets on account. Receive salary. Pay rent expense with cash. Effect on Net Worth no change decrease decrease no change decrease decrease no change no change increase decrease AP-21A ( 2 5 ) Using the following chart, indicate whether there would be an increase, decrease or no change to cash and net worth for the transactions provided. The first transaction has been completed for you. Cash Net Worth Transaction Increase Decrease No Change Increase Decrease No Change 1 Deposit salary earned: X X 2 Pay cash for food. X X 3 Purchase a new car. X X 4 Pay rent expense in advance. X X 5 Reduce student loan principal. X X 6 Buy a new computer with cash. X X 7 Obtain a bank loan. X X 8 Pay entertainment expenses. X X 9 Record cash earned from a part-time job. X X 26

27 Chapter 1 AP-22A ( 8 ) Joana Harwin collected the following amounts in cash for the month of March 2016 Full-time employment income $1,200 Income from part-time babysitting job $220 Rental income $525 Required Calculate Joana s total revenue and total capital items for March Total Revenue = 1, = $2,020 Total Capital = $0 27

28 Application Questions Group B AP-1B ( 2 ) Dana Shukrun was reviewing her records on December 31, Below is a list of items and their value. Cash $7,900 Computer 700 Automobile 19,100 House 255,000 Mortgage 150,000 Credit Card 4,600 Bank Loan 37,700 Required a) Calculate Dana Shukrun s total assets. Total Assets: $282,700 = $7,900 + $700 + $19,100 + $255,000 b) Calculate Dana Shukrun s total liabilities. Total Liabilities: $192,300 = $150,000 + $4,600 + $37,700 AP-2B ( 2 4 ) John Bonham was performing a year-end review of his finances and came up with this list: Cash $13,200 Furniture 1,900 Automobile 21,900 House 210,000 Credit Card 4,600 Student Loan 11,400 Mortgage 100,000 28

29 Chapter 1 Required a) Calculate John Bonham s total assets. Total Assets: $247,000 = $13,200 + $1,900 + $21,900 + $210,000 b) Calculate John Bonham s total liabilities. Total Liabilities: $116,000 = $4,600 + $11,400 + $100,000 c) Calculate John Bonham s net worth. Net Worth: $131,000 = $247,000 - $116,000 AP-3B ( 2 4 ) Consider the following information How much is the net worth? Cash $6,000 Automobile 50,000 Prepaid Insurance 3,000 Bank Loan 10,000 Unpaid Credit Card Bills 2,000 Net Worth? Assets - Liabilities = Net Worth ($6, , ,000) - ($2, ,000) = $47,000 29

30 AP-4B ( ) Christine Sutherland compiled the following information on May 31, 2016 Transactions for the month of June 2016 Cash $2,100 Jewellery 3,000 House 186,200 Mortgage 171,800 Net Worth 19, Received $4,100 cash for her monthly salary. 2. Paid $590 cash for maintenance on her car. 3. Paid cash for telephone, water and electricity for $ Purchased an automobile worth $10,600 on credit. 5. Received $30 interest earned on bank deposits. 6. Paid $320 for food with cash. Required a) What is the ending balance of cash? INCREASE DECREASE + Cash - Opening Balance $2, , Ending Balance $4,780 b) What is the surplus or deficit for the accounting period? Surplus or deficit: $2,680 = $4,100 - $590 - $540 + $30 - $320 c) What is Christine Sutherland s net worth on June 30? Net worth: $22,180 = $19,500 + $2,680 30

31 Chapter 1 AP-5B ( ) Arthur s financial records show that his assets and net worth as of May 1, 2016 are Cash $6,000 Computer 4,000 Contents of Home 17,500 Automobile 20,000 House 137,500 Student Loan? Net Worth 113,000 Required a) Arthur wants to find out how much he owes. Determine his total liabilities. Assets Cash $6,000 Computer 4,000 Contents of Home 17,500 Automobile 20,000 House 137,500 Total Assets $185,000 Less Net Worth 113,000 Total Liabilities $72,000 b) During the month of May, Arthur paid $2,000 for two months of rent in advance ($1,000 per month). Calculate the change in Arthur s cash account and personal net worth. Transaction Cash Net Worth Effect Decrease by $2,000 No Change AP-6B ( 4 ) Calculate the missing amounts in the following table. Scenario 1 Scenario 2 Total Assets $125,900 $150,300 Total Liabilities $33,200 $33,200 Net Worth $92,700 $117,100 31

32 AP-7B ( 1 3 ) As of December 31, 2015, Deena Balsdon had total assets of $42,800 and total liabilities of $16,700. As of December 31, 2016, Deena s total assets and liabilities increased to $48,900 and $26,100, respectively. Fill out the following table of account balances. How has Deena s net worth changed since 2015? As at December 31, 2015 As at December 31, 2016 Net Worth $26,100 $22,800 Net worth has decreased by $3,300. AP-8B ( ) Alan Marshall is preparing his balance sheet and income statement for the month ended July 31, Use the following information to help him prepare his financial statements. Transactions for the month of July Required Opening Balances as at July 1, 2016 Cash $4,400 Contents of Home 2,800 Automobile 4,800 House 287,900 Unpaid Accounts 8,500 Mortgage 239,300 Net Worth 52, Purchased a $1,600 high definition television using the credit card. 2. Paid a telephone bill of $640 for the month of July using the credit card. 3. Paid credit card bill with cash for $3, Purchased $1,010 of groceries and food using cash. 5. Paid July s utilities for $1,100 with cash. 6. Made a principal payment of $1,100 for the mortgage. 7. Deposited $4,700 salary earned during the month. 8. Earned $60 interest on savings account. a) Using the information provided, record the opening balances in the T accounts. b) Record the transactions for the month of July in the T accounts. 32

33 Chapter 1 PERSONAL BALANCE SHEET As at July 31, 2016 PERSONAL INCOME STATEMENT For the Month Ended July 31, 2016 Assets Liabilities REVENUE Increase Decrease Decrease Increase Decrease Increase + Cash - - Unpaid Accounts Opening $4,400 $8,500 Opening 7. 4, , , ,300 $4, , , ,100 Less EXPENSES 7. 4,700 Increase Decrease Clothing EXPENSE - $2,650 $7,440 Increase Decrease Decrease Increase + Contents of Home - - Mortgage + Increase Decrease Opening $2,800 $239,300 Opening + Food EXPENSE , , ,100 $1,010 Increase Decrease $4,400 $238,200 + Telephone EXPeNsE Increase Decrease + Automobile - $640 Opening $4,800 Increase Decrease + utilities EXPeNsE ,100 $4,800 net worth $1,100 Increase Decrease Decrease Increase + House - - NET WORTH + Opening $287,900 $52,100 Opening $287,900 $52,100 Total Assets $299,750 Total Revenue $4,760 } Total Liabilites 245,640 $299,750 Less Total Expenses 2,750 Net Worth 54,110 Surplus (Deficit) $2,010 33

34 AP-9B ( ) The following information is available from Tory Barnes financial records Opening Balances as at February 1, 2016 Cash $34,000 Prepaid Insurance 3,500 Automobile 45,000 Boat 81,000 Unpaid Accounts 21,000 Automobile Loan 25,000 Net Worth 117,500 The following transactions took place during the month of February 1. Purchased fuel for the boat with $85 cash. 2. Earned $1,250 wages and deposited in bank account. 3. Purchased $420 of groceries on a credit card. 4. Won $200 cash from a lottery. 5. Paid $3,600 cash for credit card bills due. 6. Paid $360 interest on credit card bill with cash. 7. Booked a flight on credit for $ Recognized one month of car insurance used up for $350. Record the transactions in the T-accounts. 34

35 Chapter 1 PERSONAL BALANCE SHEET As at February 29, 2016 Income Statement For the Month Ended February 29, 2016 Assets Liabilities Revenue Increase Decrease Decrease Increase Decrease Increase + Cash - - Unpaid Accounts Opening $34,000 $21,000 Opening 2. 1, , ,600 $1, , $31,405 $18,720 Less EXPENSES Increase Decrease + Entertainment Expense - Increase Decrease Decrease Increase + Prepaid Insurance - - automobile Loan + Increase Decrease Opening $3,500 $25,000 Opening + Food Expense $420 Increase Decrease $3,150 $25,000 + Fuel Expense Increase Decrease + automobile - $85 Opening $45,000 Increase Decrease + Insurance Expense $350 $45,000 net worth Increase Decrease + Interest Expense - Increase Decrease Decrease Increase Boat - - net worth + Opening $81,000 $117,500 Opening $360 Increase Decrease Travel Expense $81,000 $117,700 $900 Total Assets $160,555 Total Revenue $1,250 } Total Liabilites 43,720 $160,555 Less Total Expenses 2,115 Net Worth 116,835 Surplus (Deficit) ($865) 35

36 Analysis Tory will be cancelling her auto insurance with no cancellation fee incurred. Which accounts will be affected by the insurance cancellation? How will the balances change? Prepaid Insurance will decrease by the remaining amount of coverage which is $3,150. Cash will be refunded and will increase by the same amount. AP-10B ( 2 3 ) Ethan is a famous songwriter and composer. His income is based solely on royalties that he receives regularly. Ethan opted to use three months as his accounting period. The following information pertains to income earned and expenses incurred from January 1, 2016 to March 31, 2016 January February March Royalty Income $12,000 $13,000 $10,000 Interest Expense Food Expense 2,000 2,100 1,900 Maintenance Expense Clothing Expense 900 1,500 0 Utilities Expense Rent Expense 1,500 1,500 1,500 Miscellaneous Expense Required a) Prepare a personal income statement for each of the three months. Ethan Personal Income Statement For the Period Ended March 31, 2016 January February March Total Revenue $12,000 $13,000 $10,000 $35,000 Expenses Interest Expense Food Expense 2,000 2,100 1,900 6,000 Maintenance Expense ,030 Clothing Expense 900 1, ,400 Utilities Expense Rent Expense 1,500 1,500 1,500 4,500 Miscellaneous Expense Total Expenses $5,125 $6,210 $3,645 $14,980 Surplus (Deficit) $6,875 $6,790 $6,355 $20,020 36

37 Chapter 1 b) What amount should be added to Ethan s net worth on March 31, 2016? The total surplus of $20,020 accumulated for three months should be added to net worth on March 31, 2016 since Ethan s accounting period is three months. AP-11B ( 2 3 ) Archie always prepares an income statement and balance sheet each month, but he has fallen behind. Assume the opening net worth for October 31, 2016 is $6,770. Luckily, he has kept track of his account balances as shown below October 31, 2016 November 30, 2016 Cash $2,500 $6,900 Entertainment Expense Food Expense Gasoline Expense Prepaid Rent 4,200 2,800 Rent Expense 1,400 1,400 Salary 5,050 5,050 Unpaid Accounts Automobile 3,500 3,500 Complete the table below. October 31, 2016 November 30, 2016 Opening Net Worth $6,770 $9,500 Surplus (Deficit) $2,730 $3,000 Closing Net Worth $9,500 $12,500 Analysis Archie noticed that his net worth did not increase as much as his cash did during November. Why is this the case? Some transactions, such as recognizing prepaid expenses, affect net worth but not cash. We can see that prepaid rent has decreased by $1,400. Therefore he recognized $1,400 of prepaid rent as an expense which is why the increase in net worth is $1,400 less than the increase in cash. 37

38 AP-12B ( 2 4 ) Using the opening balances provided in the balance sheets below, enter the updated amounts for each transaction in the blank balance sheets labelled Answers. 1. Applied for and received a student loan of $5,700. Opening Balances Assets Liabilities Cash $5,600 Unpaid Accounts $2,500 Investment 8,400 Bank Loan 900 Contents of Home 6,200 Automobile Loan 4,800 Automobile 22,300 Student Loan 5,500 House 287,900 Mortgage 241,500 Total Liabilities 255,200 Net Worth 75,200 Total Assets $330,400 Total Liabilities + Net Worth $330,400 Answers Assets Liabilities Cash $11,300 Unpaid Accounts $2,500 Investment 8,400 Bank Loan 900 Contents of Home 6,200 Automobile Loan 4,800 Automobile 22,300 Student Loan 11,200 House 287,900 Mortgage 241,500 Total Liabilities 260,900 Net Worth 75,200 Total Assets $336,100 Total Liabilities + Net Worth $336,100 38

39 Chapter 1 2. Purchased some furniture and Jewellery for $5,000 cash. Opening Balances Assets Liabilities Cash $8,200 Unpaid Accounts $2,400 Investment 7,200 Bank Loan 200 Contents of Home 6,100 Automobile Loan 4,400 Automobile 22,900 Student Loan 6,200 House 272,300 Mortgage 242,200 Total Liabilities 255,400 Net Worth 61,300 Total Assets $316,700 Total Liabilities + Net Worth $316,700 Answers Assets Liabilities Cash $3,200 Unpaid Accounts $2,400 Investment 7,200 Bank Loan 200 Contents of Home 11,100 Automobile Loan 4,400 Automobile 22,900 Student Loan 6,200 House 272,300 Mortgage 242,200 Total Liabilities 255,400 Net Worth 61,300 Total Assets $316,700 Total Liabilities + Net Worth $316, Paid a portion of the principal of the automobile loan for $1,200. Opening Balances Assets Liabilities Cash $4,500 Unpaid Accounts $2,200 Contents of Home 5,500 Bank Loan 600 Automobile 19,000 Automobile Loan 4,200 House 290,000 Student Loan 6,800 Mortgage 242,800 Total Liabilities 256,600 Net Worth 62,400 Total Assets $319,000 Total Liabilities + Net Worth $319,000 39

40 Answers Assets Liabilities Cash $3,300 Unpaid Accounts $2,200 Contents of Home 5,500 Bank Loan 600 Automobile 19,000 Automobile Loan 3,000 House 290,000 Student Loan 6,800 Mortgage 242,800 Total Liabilities 255,400 Net Worth 62,400 Total Assets $317,800 Total Liabilities + Net Worth $317, Bought a motorcycle for $7,100 paid a $1,400 deposit with cash and borrowed $5,700 from the bank. Opening Balances Assets Liabilities Cash $5,000 Unpaid Accounts $2,000 Contents of Home 6,700 Bank Loan 1,000 Motorcycle 0 Student Loan 11,000 Automobile 17,000 Mortgage 242,000 House 283,300 Total Liabilities 256,000 Net Worth 56,000 Total Assets $312,000 Total Liabilities + Net Worth $312,000 Answers Assets Liabilities Cash $3,600 Unpaid Accounts $2,000 Contents of Home 6,700 Bank Loan 6,700 Motorcycle 7,100 Student Loan 11,000 Automobile 17,000 Mortgage 242,000 House 283,300 Total Liabilities 261,700 Net Worth 56,000 Total Assets $317,700 Total Liabilities + Net Worth $317,700 40

41 Chapter 1 AP-13B ( 8 ) Stacey Green received the following amounts in cash for the month of November 2016 Salary $2,100 Gifts $240 Winnings at the casino $170 Performance bonus paid by employer $460 Calculate Stacey s total revenue and total capital items for November Total Revenue = $2,100 + $460 = $2,560 Total Capital = $170 + $240 = $410 AP-14B ( 4 ) Indicate whether the terms of the accounting equation will increase, decrease or stay the same for each transaction by placing a + or - in the appropriate space. If an item is not changed by the transaction, leave the space blank.the first transaction has been completed for you. Transaction Assets = Liabilities + Net Worth Deposited salary earned Purchased a new bicycle on credit Purchased groceries on credit Borrowed money from the bank Purchased a ring for $200 cash. (-/+) 5. Received a cash gift Made a loan payment with interest

42 AP-15B ( ) The following information is available from Drew Bernard s financial records Opening Balances as at September 1, 2016 Cash $1,500 Automobile 9,400 Boat 18,000 Instruments 7,600 House 415,000 Student Loans 67,000 Unpaid Accounts 8,500 Mortgage 250,000 Net Worth 126,000 The following transactions took place during the month of September 1. Purchased a piano worth $900 using cash. 2. Put $720 food expenses on a credit card. 3. Purchased a $800 guitar on credit. 4. Received cash inheritance of $45, Paid off unpaid accounts with $9,570 cash. 6. Received $50 interest on the bank account. 42

43 Chapter 1 Record the transactions in the T-accounts. PERSONAL BALANCE SHEET As at September 30, 2016 Income Statement For the Month Ended September 30, 2016 Assets Liabilities Revenue Increase Decrease Decrease Increase Decrease Increase + Cash - - Student Loans Opening $1,500 $67,000 Opening ,000 $ ,570 $36,080 $67,000 Less EXPENSES Increase Decrease Increase Decrease Decrease Increase + entertainment expense - + Automobile - - Unpaid Accounts + Opening $9,400 $8,500 Opening $9, ,570 Increase Decrease $450 + Groceries expense - Increase Decrease Boat - Decrease Increase Opening $18,000 - Mortgage + $720 $250,000 Opening Increase Decrease $18,000 + interest expense - Increase Decrease $250,000 + Instruments - Opening $7, Decrease Increase Increase Decrease NET WORTH + + Maintenance expense - $9,300 $126,000 Opening Increase Decrease 4. 45,000 + House - Opening $415,000 $171,000 $415,000 Total Assets $487,780 Total Revenue $50 } Total Liabilites 317,450 $487,780 Less Total Expenses 720 Net Worth 170,330 Surplus (Deficit) ($670) 43

44 AP-16B ( 4 9 ) Indicate whether assets, liabilities or net worth will increase or decrease and by how much, based on each transaction. The first one has been done for you. Always ensure the accounting equation is balanced. Provide an explanation only if net worth is affected. 1. Purchased a new television for $700 on credit. Assets = Liabilities+ Net Worth Explanation Won $700 in a lottery Recorded winnings as capital 3. Deposited a $2,800 salary earned. +2,800 +2,800 Recorded salary earned as revenue 4. Purchased furniture for $400 in cash. 5. Transferred $500 of a chequing account to savings. 6. Paid $150 for concert tickets with a credit card Recorded expense for purchasing tickets 7. Paid $200 cash for utilities Paid for utility expense incurred 8. Paid $1,500 toward the mortgage. -1,500-1, Paid $1,100 toward unpaid bills. -1,100-1,100 AP-17B ( 4 9 ) The following information is available from Lily s financial record Opening Balances as at November 1, 2016 Cash $18,000 Furniture 3,100 Valuables & Electronics 3,200 House 255,000 Student Loans 39,000 Mortgage 100,000 Family Loan 2,000 Net Worth 138,300 Indicate whether the account balances will increase or decrease and by how much, based on each transaction. Always ensure the accounting equation is balanced. 44

45 Chapter 1 Assets = Liabilities + Net Worth Explanation 1. Purchased $1,600 of new furniture for the bedroom with cash. +$1,600 -$1, Won a tablet worth $800 as a raffle prize Won a tablet 3. $350 was taken from the bank account for a car lease payment Paid for car lease 4. Family member accepted $2,000 worth of Jewellery in repayment of the loan. -2,000-2, Made a $2,000 mortgage payment with cash. Includes $400 of interest. 6. Paid $1,000 towards the student loans with cash. Includes $140 of interest. 7. Salary earned of $4,800 was directly deposited to the bank account. -2,000-1, Paid interest on mortgage -1, Paid interest on student loan + 4, ,800 Received salary Analysis The net worth account is only updated at the end of an accounting period. Revenue and expense accounts, and the net worth account track changes in net worth during the period. For each transaction that affects net worth, determine whether a revenue, expense, or net worth is used to track the change. 2. Net Worth increases by $ Car Lease Expense increases by $ Interest Expense increases by $ Interest Expense increases by $ Revenue increases by $4,800 AP-18B ( 2 ) Consider the following financial information of Pete Griphin Automobile $66,000 Boat 55,000 Automobile Loan 50,000 Cash 14,500 Coin Collection 1,200 Cottage 84,000 House and Property 510,000 Prepaid House Insurance 8,500 Mortgage Principal 450,000 Trailer 4,000 45

46 Required a) Calculate Pete s total assets. b) Calculate Pete s total liabilities. c) Calculate Pete s net worth. Automobile $66,000 Boat 55,000 Cash 14,500 Coin Collection 1,200 Cottage 84,000 House and Property 510,000 Prepaid House Insurance 8,500 Trailer 4,000 Total $743,200 Automobile Loan $50,000 Mortgage Principal 450,000 Total $500,000 Total Assets $743,200 Total Liabilities 500,000 Net Worth $243,200 Analysis Pete makes payments against his liabilities and updates all of his account balances at the end of each month. Which account balances will change at the end of the month? Which will increase and which will decrease? Cash will decrease as he makes Cash payment against his bills. Mortgage Principal and Automobile Loan will decrease as they are paid off. Prepaid insurance will decrease as it is recognized. 46

47 Chapter 1 AP-19B ( ) Jess Day stored her personal accounting information in the computer but some of it was deleted by accident. Appliances $1,100 Cell Phone 500 Family Loan? Jewellery 800 Net Worth 4,500 Unpaid Bills 350 Automobile 5,000 Required a) What are Jess total assets? Jess assets include: Appliances, Cell Phone, Jewellery, and Automobile. Together, these assets total $7,400 b) What is the amount of Jess family loan? Assets - Liabilities = Net Worth Jess Total Assets are $7,400 and her Net Worth is $4,500. Therefore her Total Liabilities must be $2,900. Jess liabilities include her Unpaid Bills and her Family Loan. Unpaid Bills total $350, so she must owe $2,550 to her family. Analysis Jess works as a teacher. She has agreed to work as a substitute during one day next week for extra wages. According to accrual-based accounting, has Jess net worth increased? Why or why not? Accrual-based accounting states that net worth changes when activities occur, not necessarily when cash is paid or received. In this case, Jess has not yet earned the money so her net worth has not changed. 47

48 AP-20B ( ) Dex had the following transactions during the month of May 1. Purchased a new laptop for $1,200 cash. 2. Put $1,600 of car repairs on his credit card. 3. Spent $80 on a steak dinner with his sister and paid with his credit card. 4. Prepaid his son s nanny $850 cash for future services. 5. Received salary of $5,500. How have these transactions affected Dex s net worth? The costs of the repairs and the dinner represent expenses that have decreased net worth while the salary has increased net worth. Net worth has changed for an overall increase of $3,820. The other transactions represent assets and do not affect net worth. Impact on Net Worth = +$5,500 - $1,600 - $80 = $3,820 Analysis Has Dex s cash changed the same amount as his net worth? Why or why not? Dex s cash has increased by $3,450 which is different from his increase in net worth. This is because there is no necessary relationship between cash and net worth. Some cash transactions will affect net worth (if they are due to expenses or revenue) and other cash transactions will not affect net worth (if they are matched with assets or liabilities). Impact on Cash = +$5,500 - $1,200 - $850 = $3,450 48

49 Chapter 1 AP-21B ( ) On June 1, 2016, Joey had $3,100 in cash (including his bank account). The following transactions took place for the month of June 1. Returned a newly purchased cell phone to the store for $150 cash. 2. Purchased a new laptop for $1,200 cash. 3. Went to a concert ticket price was $90 paid by cash. 4. Received wages of $3,200 for the month. 5. Spent $300 cash on food for the month. 6. Received monthly utility bills of $310, due July Received interest on a savings account of $35. Required a) What is the balance of cash on June 30? INCREASE DECREASE + CASH - Opening: $3, , , Closing: $4,895 49

50 b) Prepare a personal income statement for Joey for June. Personal Income Statement For the Month Ended June 30, 2016 Revenue Salary $3,200 Interest Earned 35 Total Revenue $3,235 Expenses Entertainment Expense 90 Food Expense 300 Utility Expense 310 Total Expenses 700 Surplus (Deficit) $2,535 Analysis Joey purchased his car using 0% financing. This means there is no interest on the loan. What is the effect on net worth after each car payment? Would the effect be any different if the loan had interest? Explain. With an interest-free loan, each payment reduces the loan by the same amount of the payment. Net worth is not affected. If loan has interest, then each payment reduces the loan by an amount smaller than the payment. The remainder is interest and is recorded as an expense which reduces net worth. 50