1. Dr Rental revenues 26k

Cr Advance rental revenue 26k

2. Dr Supplies expense 3,900

Cr Supplies 3900

3. Dr Insurance 1,800 (3/12 of 7,200)

Cr Prepaid insurance 1,800

4. Dr Advertising 110

Dr Repairs 380

Dr Utilities 240

Cr Accrued expenses 730

5. Dr Wages 3,480 (4 staff x 3 days x $290 per day)

Cr Wages payable 3,480

6. Dr Interest 280 (8%p.a on 14,000 for 3 mths)

Cr Interest payable 280

(a) Correct income statement

For the Quarter Ended March 31, 2007

Revenues

Rental revenues $63,000

Operating expenses

Advertising $ 4,310

Wages 31,080

Utilities 1,140

Depreciation 800

Repairs 3,180

Insurance 1,800

Interest 280

Supplies expense 3,900

Total operating expenses 46,490

Net income $16,510

(b) GAAP not followed:

(i) accrual basis of accounting

The accounting method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). The balance sheet is also affected at the time of the revenues by either an increase in Cash (if the service or sale was for cash), an increase in Accounts Receivable (if the service was performed on credit), or a decrease in Unearned Revenues (if the service was performed after the customer had paid in advance for the service).

Under the accrual basis of accounting, expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. The balance sheet is also affected at the time of the expense by a decrease in Cash (if the expense was paid for when it incurred), an increase in Accounts Payable (if the expense will be paid in the future), or a decrease in Prepaid Expenses (if the expense was paid in advance).

(ii) Time Period Assumption

This accounting principle assumes that it is possible to report the complex and ongoing activities of a business in relatively short, distinct time intervals such as the five months ended May 31, 2007, or the 5 weeks ended May 1, 2007. The shorter the time interval, the more likely the need for the accountant to estimate amounts relevant to that period. For example, the property tax bill is received on December 15 of each year. On the income statement for the year ended December 31, 2007, the amount is known; but for the income statement for the three months ended March 31, 2007, the amount was not known and an estimate had to be used.