Making sense of the books: A Canadian accounting handbook

Understanding your business beyond the bank balance.

A client says yes to a substantial project. The deposit arrives on Friday.

You open the bank account. There it is: enough to make the next few weeks feel easier.

By Monday, you’re thinking about hiring help. You haven’t posted the job, but you have mentally given someone a desk.

The payment is good news. Whether it makes hiring affordable takes a little more working out. That money comes with work to deliver and costs to cover. Other customers may owe you for work already finished. Bills may be on their way.

You know these things individually. The books help you see them together.

That is what this handbook is for: learning to read your business’s records, understand what is happening, and make decisions with more than just a bank balance in front of you.

1.1Business doing well, or are things just comfortable today?#

Sometimes those are the same thing. Sometimes a large payment has arrived and several bills haven’t. The business feels healthier, even though its commitments haven’t changed.

The distinction matters when you’re deciding whether to hire, change prices, buy equipment, or take money out.

You need to know what the business has earned, what it cost to earn it, and which commitments remain. You also need to know whether the cash will be there when those commitments come due.

Accounting won’t make those decisions for you. It gives you a more dependable starting point.

It can turn a vague concern—

“We’re busy, but there never seems to be much left.”

—into questions you can investigate:

• Are our prices leaving enough margin after costs?
• Are customers taking too long to pay?
• Are we paying now for things we’ll use over several months?
• How much of the money in the bank comes with work still to deliver?

Different answers call for different decisions. You may need to change your prices, chase an invoice, or simply recognise that you paid for twelve months of something in one go. Those are rather different problems to have.

1.2Following one piece of work#

Take that new project.

First comes the agreement and a payment. Then the work begins. You buy what you need, bring someone in to help, and collect the supplier bills along the way. Eventually, you deliver the project.

Each event leaves a record. Together, those records need to tell the story clearly enough that someone can understand it later, without relying on your memory of a busy Friday.

They also need to connect.

Pick up the client’s payment in the cash account and you should be able to follow it back: first to the entry that recorded it, then to the invoice or other evidence behind the entry. You should also be able to see how the project’s revenue and costs appear in the business’s results.

If something looks wrong, there should be a way to follow it back and check.

1.3The concepts we’ll work through#

Start, with that Friday payment. There’s more money in the bank, but there’s also a promise to deliver the work. How do the books keep track of both?

The books keep separate records for things like cash, money customers owe, and amounts you owe suppliers. Each is called an account.^[0] Here, “account” means a record of one part of the business, not necessarily a bank account.

That payment changes two of those accounts: how much cash you have (the cash account) and how much paid-for work you still owe the customer (the unearned revenue account).

Each account has two columns for recording changes: the left is called debit, and the right is called credit. One side records increases; the other side records decreases.^[1] Which is which depends on the kind of account.

Separate columns let an amount’s position do the job of a plus or minus sign. Instead of mixing additions and subtractions in one list, you total each column, then subtract the smaller total from the larger. The difference is the account’s balance, recorded on the side with the larger total.

The side that usually holds this balance is called the account’s normal balance.^[2] It is also the side used to record increases in that kind of account.

Then more things happen. You buy supplies, receive a bill, and pay someone to help. How do you record each event so it still makes sense months later? Journal entries^[3] preserve what changed, by how much, when, and why. Each entry records changes across at least two accounts, with equal total debits and credits.

Soon there are dozens of payments, purchases, and bills. You need to bring them together: everything that happened to the cash, everything customers still owe, everything you owe suppliers. The general ledger^[4] organises those records by account.

You also need ways to check the records. Do the figures add up? Has anything been missed or counted twice? The trial balance^[5] brings the account balances together and checks whether total debit balances equal total credit balances. That’s one useful check, but it won’t catch every mistake.

Then there’s timing. The customer paid on Friday, but you haven’t done the work yet. You paid for a year of software, but you’ve only used a month. When should those amounts count towards how the business is doing? Cash vs. accrual^[6] accounting is an important choice. Accrual accounting records revenue when it is earned and expenses when they are incurred, rather than when money changes hands, as in cash accounting.

Finally, what did it cost to earn the revenue? Knowing how much you earned doesn’t tell you how much is left after costs. The matching principle^[7] helps place costs alongside the sales they helped generate or in the periods they belong to.

These are the concepts the next six chapters work through. You don’t need to remember every term before you begin.

1.4Even when someone else keeps the books#

But why learn all this?

You may have a bookkeeper, an accountant, and software handling most of the entries.^[8] There is still value in understanding what those entries mean.

Knowing the foundations changes the conversation.

You can ask what a balance represents, whether a cost you haven’t paid yet has been included, or why reported profit differs from the change in cash. You can follow the explanation and recognise when you need more detail.

You also bring knowledge the records depend on. Your accountant may know how to record a customer payment; you know whether the work has been delivered.

Good records need both kinds of knowledge.

1.5Bring your business with you#

As you read, keep something familiar in mind: a customer invoice, a supplier bill, or a purchase you’re planning.

Follow it through the chapters. Ask what changed, what remains, and where you would look to check.

Some terms may take a few encounters to feel familiar. You can return to the chapters as you need them.

For now, the aim is simple: when a payment arrives on Friday and you start making plans for Monday, you’ll know which questions to ask before you commit to a course of action.

How to read debits and credits, and know when a balance needs a second look.

Imagine you’ve just incorporated a small design studio in British Columbia. You have a business bank account, an empty desk, and plenty to do.

The studio’s first purchase is a laptop. It costs $2,500, charged to the company credit card. In the books, the purchase looks like this:

Two lines, one laptop: one records the equipment, the other the debt.

Once you can read it, there’s a pleasing economy to this. The books capture both what the business acquired and what it still owes. But first, a quick refresher on those two column headings.

Why does the laptop get a debit and the debt get a credit?

2.1One business, two perspectives#

Before buying the laptop, you invested $10,000 in your newly incorporated studio in exchange for shares. The books record both the cash received and the owners’ investment, called share capital:

The same $10,000 appears from two perspectives: cash records what the business received; share capital records the owners’ investment.

Now add the laptop, leaving sales tax aside for the moment:

The studio now has $12,500 in resources. Of that, $2,500 is owed to the credit card company, leaving $10,000 as the owners’ interest in the business.

Accounting gives these three categories names:

• Assets are resources the business owns or controls.
• Liabilities are obligations the business owes.
• Equity is the owners’ remaining interest after liabilities are deducted.

Together, they form the accounting equation:

Assets = Liabilities + Equity

The two sides describe the same business: its resources on one side, and the creditors’ claims and owners’ interest on the other. Every transaction changes the picture, but the two sides must remain equal. In other words, they must balance. As you follow the transactions below, watch how each changes the equation without breaking that equality.

2.2Give the sides names#

Debit means the left side of an account. Credit means the right.

The recording rules mirror the accounting equation: assets on the left, liabilities and equity on the right. Assets increase with debits; liabilities and equity increase with credits. Decreases go on the opposite side:

Nothing about a laptop inherently makes it a debit. Debit and credit are simply conventions for recording changes consistently.

Your original investment was recorded like this:

Cash increased with a debit. Share capital increased with a credit.

The laptop purchase followed the same pattern: equipment increased with a debit, and the credit card liability increased with a credit.

An account’s normal balance is the side where increases are recorded and where its balance usually sits. Assets are debit-normal, meaning they normally have debit balances. Liabilities and equity are credit-normal, meaning they normally have credit balances.

In bookkeeping^[0], total debits must equal total credits in every entry. An entry can have two lines or several, but the totals must always match.

2.3Pay the bill. Keep the laptop.#

A month later, the studio pays its $2,500 credit card bill.

The equipment hasn’t changed. The cash and the debt have:

The debit reduces the liability. The credit reduces cash.

After payment, the business looks like this:

The laptop is still there, but the debt used to buy it is gone.

This is where “debit means money out” falls apart. The credit to cash recorded the money leaving the bank; the debit reduced the amount owed.

What a debit or credit does depends on the account it touches.

2.4Where earning and spending fit#

The studio earns $5,000 for a completed project and incurs $100 in software costs that month.

With no other activity, the studio has a $4,900 profit, which increases equity. The owners’ stake in the business has grown through its operations.

Recording only the net increase would hide two useful details: how much the studio earned and what it cost to earn it. Revenue and expense accounts track those amounts separately.

Revenue increases profit and, in turn, equity, so revenue accounts increase with credits. Expenses reduce profit and equity, so expense accounts increase with debits.

The pattern looks like this:

The rule to remember: assets and expenses increase with debits. Liabilities, equity, and revenue increase with credits.^[1]

2.5An invoice, then a payment#

Let’s put that project into the books.

Our studio is in British Columbia, and its service in this example is subject to 5% GST. The invoice totals $5,250: $5,000 for the work plus $250 in tax.

Accounts receivable records what customers owe the business. As an asset, it increases with a debit.

Revenue increases with a credit. So does GST payable, but for a different reason: it is a liability. The $250 is tax the studio owes, not revenue it has earned.

Two weeks later, the customer pays:

The customer no longer owes the studio. The money is now in the bank. One asset, accounts receivable, has been exchanged for another, cash.

Revenue stays where it was. Recording another sale when payment arrives would give the studio a splendid month, but an imaginary one.

Why your bank calls a deposit a credit#

Your bank records the deposit from its side of the transaction.

In your books, the money in the bank is an asset. In the bank’s books, it is a liability: money the bank owes you.

Your asset increases with a debit. The bank’s liability increases with a credit.

The statement makes more sense once you remember whose books you’re reading.

2.6Keeping the original and the adjustment#

After some use, the laptop’s carrying amount (i.e. the original amount minus the accumulated depreciation) might look like this:^[2]

The equipment account records the original cost; accumulated depreciation records how much has been depreciated so far. Keeping them separate lets you see both.

Accumulated depreciation is a contra account: it offsets another account and has the opposite normal balance. Equipment normally carries a debit balance; accumulated depreciation normally carries a credit balance.

The opposite balance is intentional.

2.7When a balance surprises you#

A cash account normally has a debit balance. What if it has a credit balance instead?

Perhaps a payment was entered twice or an entry was reversed. Or perhaps the bank account really is overdrawn, and the overdraft needs to be presented as a liability.

The balance raises a question. The underlying transactions provide the answer.

Other accounts can also have legitimate reasons for carrying an unexpected balance:

• Retained earnings may have a debit balance because losses have accumulated. This is called an accumulated deficit.
• A shareholder loan account may move from a credit balance, meaning the corporation owes its owner, to a debit balance, meaning the owner owes the corporation. That shift can have tax consequences and deserves a closer look.

Normal means usual, not required. Don’t reverse an entry just to put a balance on its expected side. First, establish what happened.

2.8Two kinds of matches#

Every entry we’ve recorded has equal debits and credits. Once those entries are brought together, the account balances should preserve that equality. A trial balance^[3] lists those balances in debit and credit columns so you can check that the totals match.

But matching totals are one kind of check. Whether the accounts match with what actually happened in the business is another.

An owner’s investment recorded as revenue can still leave debits and credits equal. So can a purchase recorded twice. Normal balances help you look beyond the totals: which side holds each balance, and does it make sense there?

Think back to the laptop. Buying it created an asset and a debt. Paying the card reduced both the debt and cash. Later, depreciation recognised part of the laptop’s cost as an expense.

One laptop, several events. Getting the entries right means preserving both the equality of the numbers and the meaning behind them.

2.9Crib sheet: Normal balances#

When you’re checking an entry or reviewing a balance, you don’t need to retrace the aforementioned laptop’s entire journey. Here are the normal balances, common exceptions, and useful checks in one place.

Normal balances at a glance#

An account increases on its normal side and decreases on the opposite side.

A few useful checks#

Some mistakes produce an unexpected balance. Others look ordinary until you examine the transactions.

Normal balances help you ask better questions, but they don’t tell you which account to use.

When a balance changes meaning#

Two balances deserve particular attention:

• Retained earnings with a debit balance may reflect accumulated losses. Present that balance as an accumulated deficit.
• A shareholder loan with a debit balance means the shareholder owes the corporation, rather than the other way around. That is an asset, not simply an unexplained negative liability, and it can have tax consequences.

2.10How the records fit together#

A transaction starts with a journal entry. From there, its effects are grouped by account in the general ledger. Those accounts balance come together in the trial balance for checking, while the balance sheet shows what the business has (assets), what it owes (liabilities), and the owners’ stake (equity).

A record that makes sense long after you’ve forgotten the day.

On April 3, $1,200 leaves the studio’s bank account.

Six months later, the bank statement will still show the payment, but not whether it bought equipment, settled an old bill, or paid for a year of software.

The amount is recorded. The explanation needs a place in the books too.

A journal entry provides that record. It gives the date, names the accounts affected, records the debits and credits, and explains what happened. A reference connects it to the invoice, receipt, or other supporting evidence.

A good entry lets someone understand the transaction without you in the room. Often, that someone is your future self.

3.1One subscription, three dates#

The studio buys a $1,200 software subscription covering April 1 to March 31 of the following year.

The invoice is dated April 1, you pay it on April 3, and the studio uses the software throughout the year.

The books need to track three things:

• When the bill became payable.
• When it was paid.
• When the studio used the service.

We’ll leave out sales tax to keep those changes easy to follow.

April 1: Record the bill#

The studio owes $1,200 for a year of software access.

Memo: Annual software subscription, April 1–March 31.
Reference: Invoice INV-4421.

Accounts payable records what the studio owes the supplier. Prepaid expenses records the cost of the unused service. For now, that cost is an asset. It becomes an expense as the studio uses the subscription.

Why call it “prepaid” when the bill hasn’t been paid? Here, access has begun and the full invoice is payable. The asset records the unused service; the liability records the unpaid bill. The name is imperfect, but the two accounts capture different parts of the transaction.

April 3: Record the payment#

Memo: Payment of software invoice INV-4421.

The payment clears the supplier debt and reduces cash. It does not turn the full $1,200 into an expense.

Paying for twelve months of software is not the same as using it all on April 3.

April 30: Record one month’s use#

Spread evenly over twelve months, the subscription costs $100 per month.

Memo: April portion of annual subscription INV-4421.

At the end of April, the books show:

The bank recorded one payment. The journal entries show when the studio owed the money, when it paid, and how much of the cost belongs to April.

That is the distinction accrual accounting preserves: income and expenses are recorded when earned or incurred, not simply when cash changes hands.

3.2Enough lines to tell the story#

Every journal entry must have equal total debits and credits.

Two lines are often enough, but some transactions need more. A purchase with recoverable GST/HST, for example, may have a debit for the purchase cost, another debit for the recoverable tax, and a credit for the amount owed to the supplier. The two debits together must equal the credit.

Use the normal balances guide if you need to check which side increases an account.

Matching totals don’t prove you chose the right accounts, used the right date, or recorded the transaction only once. A duplicate bill can balance perfectly. It is still a duplicate bill.

3.3Write for the day you no longer remember#

Compare these two memos:

Reimbursement

Mileage reimbursement to owner, March travel log.

The second gives a future reader something to work with. The attached log provides the details.

Likewise, “Software” tells you little. “Annual software subscription, April 1–March 31, INV-4421” identifies the service, gives the period, and points to the invoice.

You don’t need a paragraph for every transaction. Just include enough to distinguish it from the others.

Keep the supporting document linked to the entry. A clear memo saves you a lot of searching; the invoice, receipt, or other evidence backs it up.

3.4Where the entries go#

A journal records transactions in date order. The general ledger groups their effects by account. Each gives you a different view of the same records:

• Journal: What happened on April 3?
• Ledger: What changed accounts payable during April?

Manual systems may keep separate journals for sales, purchases, cash receipts, and cash payments. Software may use a general journal, subledgers, or both. When you enter a bill or record a payment, it may create the debits and credits behind the scenes.

You may never type those lines yourself. Understanding them still helps you check whether the software recorded what you intended.

3.5Entries without a new payment#

April’s $100 software expense doesn’t appear on the bank statement. No money moves on April 30.

Instead, an adjusting entry records the cost that belongs to April, bringing the accounts up to date for the reporting period.

Other adjustments may record:

• Revenue earned but not yet recorded.
• Expenses incurred but not yet recorded.
• The portion of a prepaid service used during the period.
• Depreciation.
• Estimates, such as an allowance for customer debts that may not be collected.

These entries capture changes that bank transactions alone cannot show.

3.6Crib sheet: Journal entries#

What each entry needs#

An adjustment still needs supporting evidence, even if that’s a schedule or calculation rather than an invoice.

Before posting#

How much precision is useful?#

The subscription example spreads the cost month by month. Whether a small item needs that treatment comes down to materiality: could a different approach reasonably influence someone’s decisions based on the financial statements? The amount matters, but so do the item’s nature and circumstances.

Agree on a consistent policy with your accountant. Not every small subscription needs twelve entries, but a small amount doesn’t automatically justify expensing it all at once.

A financial-reporting shortcut also does not override the tax rules for prepaid expenses, which generally allocate the deduction to the period that receives the benefit.

Correcting an entry#

Make corrections easy to follow.

If a posted entry from a prior period is wrong, record a correction that references the original rather than silently rewriting the history. Explain what changed and why. If the period has already been finalised or reported, speak with your accountant before making changes.

The record should leave a clear audit trail from the original entry to the correction.

Keeping the evidence#

CRA generally requires you to keep records and supporting documents for six years from the end of the last tax year they relate to, not from the date on the document.

Exceptions can require longer retention. Certain historical and long-term records must be kept indefinitely.

Before discarding old invoices or books, check that the retention period has actually expired.^[0]

3.7The rest of the transaction#

Journal entries feed the ledger, and the ledger’s account balances form the trial balance, where total debits and credits can be checked.

But an entry’s value begins long before the totals are checked. It records what happened while the evidence is at hand and the details are still clear.

Months later, the bank statement will show that $1,200 left on April 3.

Your books will tell you the rest.

An account is a question you expect to ask again.

How much are we spending on software?

The answer is scattered across the studio’s records: the annual subscription, the monthly design tools, the service you meant to cancel.

You could search through the transactions and add them up, but you’ll probably ask the same question next month.

A software expense account brings those amounts together, so you don’t have to start from scratch each time.

It’s one of the accounts that make up the general ledger, often shortened to GL—the complete collection of a business’s accounts. Each account shows an opening balance, the increases and decreases recorded during the period, and a closing balance.

Whether you’re looking at software expense, cash, accounts receivable, or credit card payable, the purpose is the same: to follow one part of the business without sorting through everything else.

4.1The same transaction, rearranged#

A client pays the studio $5,250 against an outstanding invoice.

The journal records the payment as a single entry:

April 10 — Client payment, invoice 102

Posting places each line in its corresponding ledger account:

Cash#

Accounts receivable#

Cash has increased, and the amount the client owes has decreased. The matching descriptions connect both lines to the same payment.

Posting hasn’t created another transaction. It has organised the original entry by account.

The journal shows what happened in date order, while the ledger brings together the changes to each account. You can follow the payment made on April 10 or review how cash changed throughout April without piecing the records together each time.

4.2A page from the cash account#

The studio’s cash account brings its cash movements together. This illustrative April account starts with a balance of $10,000:

Cash is an asset, so debits increase it and credits decrease it. The balance column shows how much remains after each transaction, while the references link each change to its journal entry.

By April 20, the account shows $10,310 in cash. That is not the studio’s profit. The client payment may relate to revenue recorded earlier, the annual software payment may cover future months, and the GST instalment goes towards a tax obligation.

These transactions explain how cash changed. To understand how much the studio earned, you need to look beyond the cash account to the revenue and expense accounts.

4.3Choose the questions carefully#

The chart of accounts defines the accounts the business uses, while the ledger holds the activity and balance of each one. How you organise those accounts shapes the questions your books can answer.

An account called “Office Admin” might bring together software, stationery, legal fees, and bookkeeping. But if you want to know how much the studio spent on software, you’ll have to sort through those transactions again. At the other extreme, an account for every small variation leaves you maintaining distinctions you never use.

Separate activity when the distinction helps you understand or report on the business. Otherwise, keep related activity together.

For a Canadian corporation, those accounts can be mapped to CRA’s General Index of Financial Information, or GIFI—the financial reporting categories used with the T2 corporate income tax return. That mapping connects your accounts to tax reporting requirements; it does not replace a chart of accounts designed to help you understand the business.

4.4A total, with names behind it#

The ledger says customers owe the studio $12,450.

The next question is obvious: who?

That detail sits in the accounts receivable subsidiary ledger, or customer subledger, which tracks each customer’s invoices, payments, and outstanding balance.

Suppose it shows:

The accounts receivable account in the general ledger should show the same $12,450 as of that date. It is called a control account because it holds the total supported by those detailed records.

Accounts payable works the same way: individual supplier balances support the GL total. A fixed-asset register similarly provides the detail behind equipment and other fixed-asset balances.

If the customer balances total $12,450 but the GL shows $11,900, the $550 difference needs explaining. Start by checking that both reports cover the same date and include the same activity, then look for missing, duplicated, or incorrectly posted amounts.

The aim is not simply to make the totals match. It is to find the cause of the difference and correct the underlying records.

4.5Compare cash with the bank#

The cash ledger and bank statement show the same activity from different sides—and sometimes at different times. A payment recorded in the books may not yet have cleared the bank, while a bank fee may appear on the statement before it reaches the ledger.

A bank reconciliation explains those differences and helps identify omissions or errors.

But what does it actually confirm? Reconciling cash cannot verify an unpaid customer invoice, an outstanding supplier bill, or depreciation. Those need their own supporting records.

A tidy bank reconciliation is one completed check, not a verdict on the whole ledger.

4.6Crib sheet: General ledger#

What each account should let you trace#

An account should let you follow the balance from its starting point through each change—and find the records behind it.

Before closing a period#

Do the balances agree with the records behind them? Compare:

• Cash with the bank reconciliation.
• Accounts receivable with customer balances.
• Accounts payable with supplier balances.
• Fixed assets with the asset register.
• Other control accounts with their supporting schedules.

A trial balance checks whether total debit balances equal total credit balances. Reconciliations check whether the supporting detail agrees with the ledger. Both matter, but they answer different questions—and neither proves that every transaction is correct.

Preserve the history#

Once a period has been reviewed, lock it if your bookkeeping system allows.

If a posted entry needs correcting, preserve the original and record a traceable correction. Reference the original entry and explain what changed and why. If the period has already been finalised or reported, involve your accountant before making changes.

Someone reviewing the account later should be able to follow the whole story, including the correction.

Keep the ledger as a long-term record#

An old receipt and an old ledger are not necessarily ready to discard at the same time. Don’t apply an ordinary receipt-disposal schedule to the whole accounting archive.

CRA generally requires records and supporting documents to be kept for six years from the end of the last tax year they relate to, but some records must be kept longer. Historical records affecting a future sale, liquidation, or wind-up may need to be kept indefinitely while the business continues.

The general ledger and records needed to reconstruct corporate history belong among those long-term records. For a corporation, these generally must be retained until two years after dissolution. Check the retention guide for that rule and other exceptions before discarding any part of the archive.

4.7Follow a number home#

The ledger’s closing balances come together in the trial balance. After adjustments, those balances form the basis of the balance sheet and income statement.

You can follow the path back, too.

Start with software expense on the income statement, then open the ledger account. Follow a posting to its journal entry, then to the invoice and the period it covers.

Now the number on the statement is something you can inspect and explain. And when you ask how much you’re spending on software next month, there’s already a place for the answer.

Two equal totals, and the questions they leave open.

The studio has $12,750 in the bank, but both columns of its trial balance total $15,850.

Has extra money appeared? No. The report is adding up something different: balances across the studio’s accounts, with debit balances in one column and credit balances in the other.

A trial balance lists the general ledger accounts and their balances at a particular date. Its purpose is to check whether total debit balances equal total credit balances—not to show how much cash the studio has.

Every journal entry should contain equal debits and credits, and that equality should carry through to the ledger balances. The trial balance checks that it has.

5.1Bring the accounts together#

The general ledger holds the activity in each account. The trial balance brings together the balances that remain.

An account with fifty transactions usually contributes one line. An account with just one transaction does too. You’re looking at where the accounts stand, not everything that happened inside them.

Here is a simplified adjusted trial balance for a small design studio. It leaves out other activity, including income tax, to make the relationships easier to follow.

Design studio#

Adjusted trial balance — December 31

In this example, assets and expenses have debit balances, while liabilities, share capital, and revenue have credit balances.

But what about accumulated depreciation? It relates to an asset, yet its balance sits in the credit column. That’s because it is a contra-asset: its $500 balance reduces the equipment’s $2,500 cost to a carrying amount of $2,000.

The normal balances guide explains why each account increases on its particular side.

5.2A mistake that balances perfectly#

The studio’s owner invested $10,000 in exchange for shares. Suppose the entry credited project revenue instead of share capital.

The trial balance would then show:

Total credits would still be $15,850, and total debits wouldn’t change. The trial balance would balance perfectly.

But what story would it tell? The studio would appear to have earned an extra $10,000 from customers, while the owner’s investment would be missing from share capital.

Equal totals cannot detect every mistake:

• An omitted supplier bill leaves both sides unchanged.
• A bill recorded twice adds equal debits and credits each time.
• A transaction posted to the wrong expense account can balance just as neatly as one posted to the right account.

That is why the balances also need supporting evidence: bank reconciliations, invoices, customer and supplier records, and the calculations behind adjustments.

5.3A difference worth investigating#

Suppose someone copies the studio’s balances into a spreadsheet but leaves out the $500 depreciation expense.

The report would show:

Does that mean the ledger is wrong? Not necessarily. Here, the copied report is incomplete.

Before changing the accounts:

1. Recheck the column totals.
2. Confirm that all relevant accounts are included.
3. Compare the reported balances with the ledger.
4. Look for a balance placed in the wrong column.
5. Investigate any remaining difference in the underlying records.

Don’t post an unexplained entry just to force the totals to agree. That hides the problem rather than resolving it.

Closing the year won’t fix the imbalance either. Proper closing entries contain equal debits and credits, so they cannot eliminate an existing difference. Find the cause before relying on the report.

5.4Three stages, three versions#

A trial balance’s label tells you how far the accounting work has progressed:

An unadjusted trial balance can balance perfectly and still be missing an accrued bill, depreciation, or the cost of a prepaid subscription used during the period.

The adjusted trial balance includes the necessary entries and provides the starting point for the financial statements.

What closing changes#

Revenue and expense accounts measure activity over a period. But how do they start fresh next year? At year-end, closing transfers their net result to retained earnings and resets their balances to zero. A dividends declared account, if used, is also closed to retained earnings.

In the simplified studio example, $5,000 in revenue less $600 in expenses leaves a $4,400 profit before income tax. With income tax left out of the example, closing transfers that $4,400 to retained earnings.

The post-closing trial balance then shows the asset, liability, and equity balances carried into the next period, including retained earnings. Revenue, expense, and dividends declared accounts should all have zero balances.

5.5Crib sheet: Trial balane#

Check the heading first#

Before reviewing the numbers, make sure you have the report you need. Confirm:

• The business it covers.
• The reporting date.
• Whether it is unadjusted, adjusted, or post-closing.
• Whether all relevant accounts are included.

A correct report for the wrong date is still the wrong report.

Read beyond the totals#

If another adjustment is posted, run the report again. An exported spreadsheet or PDF won’t update itself.

From the accounts to the T2#

Accounts usually appear in chart-of-accounts order: assets, liabilities, equity, revenue, and expenses.

For a Canadian corporation’s T2 return, adjusted balances are mapped to CRA’s General Index of Financial Information, or GIFI. Schedule 100 reports balance sheet information, while Schedule 125 reports income statement information.

Check the mapping as well as the amounts. The right balance in the wrong reporting category is still an error.

5.6Three numbers, three answers#

Return to the studio. What does each number tell you?

• $15,850 is the total on each side of the trial balance, showing that total debit balances equal total credit balances.
• $12,750 is the cash balance—the amount of cash recorded in the books.
• $4,400 is the profit before income tax in this example: revenue less expenses.

The financial statements arrange those accounts around different questions. The balance sheet shows what the studio owns and owes, along with its equity, at a particular date. The income statement shows its revenue, expenses, and profit over a period.

For now, the distinction is clear: the trial balance’s matching totals are not money in the bank, and neither is profit.

The money and the work don’t always arrive together.

A client pays the studio $12,000 before the project begins. The bank balance rises immediately, but the studio still has three months of work ahead of it.

Has it earned the $12,000?

The money is real. So is the obligation to do the work. That distinction is where cash and accrual accounting part company.

Under the cash basis, revenue is recorded when payment is received and expenses when payment is made. Under the accrual basis, revenue is recorded when it is earned and expenses when they are incurred, even if the money moves at a different time.

The difference is timing: which period gets the revenue, and which period bears the cost?

6.1Money now, work later#

The studio agrees to provide services evenly over November, December, and January. The client pays the full $12,000 on November 1, before work begins.

We’ll leave sales tax out of this example and follow the financial-reporting treatment. The tax qualifications appear in the reference section below.

November 1: Receive the payment#

The cash has arrived, but has the studio earned it? Not yet. Unearned revenue is a liability: the studio has the money but still owes the client the service.

November 30: Recognise the first month’s revenue#

By the end of November, the studio has completed one month’s work and earned $4,000:

The studio records the same entry at the end of December and January. Each month, the liability falls by $4,000 as that amount becomes earned revenue.

By the end of January, the studio has received and earned the same $12,000. Until then, cash received and revenue earned tell different stories.

Simple cash-basis books record the full receipt as November revenue. Accrual books spread the revenue across the months in which the studio performs the work.

At a December year-end, that leaves $4,000 unearned. The money has arrived; January’s service has not yet been delivered.

6.2Work now, money later#

The studio completes a separate project in March and sends the invoice. The client pays in April.

Which month gets the revenue? Under accrual accounting, it is March, provided the revenue-recognition requirements are met. Accounts receivable records the amount the client owes until payment arrives.

April’s payment replaces the receivable with cash; it does not create a second sale. Under cash accounting, the revenue is recorded in April, when the money arrives.

A quiet bank account can coexist with a busy, productive month. The work is finished; the client just hasn’t paid yet.

6.3Costs have their own calendar#

The studio incurs a professional fee in December but pays the bill in January. Which month bears the cost?

Accrual accounting records the expense in December, along with the amount owed. January’s payment settles that obligation; it does not create another expense.

An advance payment works the other way around. In the journal entries chapter, the studio pays $1,200 for twelve months of software. Under the full accrual treatment, the unused portion stays in a prepaid asset account, and $100 becomes an expense each month.

In both cases, the aim is to keep reported results tied to the period’s activity. Otherwise, the timing of a customer’s payment or the studio’s decision to pay a bill could shift profit between months without any change in the underlying work.

6.4Profit doesn’t tell you whether you can pay the rent#

Accrual accounting can recognise revenue before the client pays and an expense after the cash has left the bank, as with a prepaid subscription.

So a profitable studio may still be short of cash because customers haven’t paid. And a healthy bank balance? Some of that money may have come from clients whose work is still ahead.

You need both views:

• Profit shows revenue less the expenses recognised for the period.
• Available cash helps you assess what the business can pay now.

Accrual accounting adds context to the bank balance. It doesn’t make that balance any less important.

6.5Crib sheet: Cash vs. accrual basis#

What changes under each basis?#

The same event can land in different periods depending on the accounting basis. The cash column below illustrates simple cash bookkeeping—not a complete Canadian cash-method tax calculation.

Does sending an invoice mean the revenue has been earned? Not automatically. Recognition depends on the applicable reporting framework and the goods or services actually provided—not simply the invoice date.

Which basis applies?#

Start by separating financial reporting from tax. They are related, but they do not follow the same rulebook.

Financial statements#

Financial statements prepared under Accounting Standards for Private Enterprises (ASPE) or International Financial Reporting Standards (IFRS) use accrual accounting. Permission to use a cash method for tax does not make cash-basis financial statements ASPE-compliant.

Cash and accrual results may happen to match when no relevant timing differences remain at period-end. Matching results do not change the basis being used.

Income tax#

Most businesses calculate income on the accrual basis. Limited cash-method exceptions include qualifying farming and fishing businesses and self-employed commission agents. Being a sole proprietor does not, by itself, permit cash-method reporting.

The farming and fishing provisions in section 28 can also apply to qualifying corporations. These are adjusted tax methods with their own requirements—not simply the cash column above.

Two qualifications deserve particular attention:

• Advance receipts may be subject to specific income inclusions and reserves. Recording a client payment as unearned revenue in the financial statements does not automatically determine its tax treatment.
• Prepaid expenses have tax restrictions. Paying an amount does not necessarily make the full deduction available that year.

GST/HST has its own timing rules, too. Check the applicable requirements and reporting method rather than assuming the income statement tells you when to report the tax.

What to check at period-end#

The bank feed shows money moving. What might it leave out?

• Revenue earned but not yet invoiced or recorded.
• Bills and other costs incurred but not yet recorded.
• Customer advances for services still to be delivered.
• Payments covering future periods.
• Depreciation and other non-cash adjustments.
• Bonuses and professional fees that may need to be accrued.

The bonus accrual guide covers the additional requirements for accrued bonuses, including payment timing for tax deductibility.

These checks help identify the adjusting entries needed to reflect the period’s activity. They also support the matching principle: recognising costs alongside the revenue they helped generate, or in the periods in which their benefits are used.

Changing methods#

Choosing a different software report does not, by itself, change your accounting method. Neither does leaving out receivables or ignoring unpaid bills.

Financial-reporting policy changes must follow the applicable framework, including ASPE Section 1506 where relevant. Tax-method changes have separate requirements. A farming or fishing business generally needs CRA permission to change from cash to accrual, along with adjustments to account for the transition.

6.6How much has the studio earned?#

At the end of November, the bank shows the full $12,000 payment. The accrual accounts show $4,000 in revenue and $8,000 still unearned.

The money has arrived. Has all the work been done? Not yet.

These figures answer different questions: the bank shows what the client has paid, while the accrual accounts show how much the studio has earned—and how much of its commitment remains.

What did it cost to earn that revenue?

The studio starts selling a small run of prints. They arrive from the printer in August at a cost of $20 each. In September, the studio sells and delivers one to a customer for $50.

Which month should bear the $20 cost?

If the studio records it as an expense in August, the two sides of the sale fall into different months. August bears the cost without the revenue; September gets the revenue without the cost.

The matching principle brings them together: recognise an expense in the same period as the revenue it helped generate. When a cost cannot be tied to a particular sale, recognise it in the period when its benefit is used.

The question is when the cost belongs in expenses—not when the bill was paid.

7.1Let the cost follow the sale#

While the print remains unsold, its $20 production cost sits in inventory, an asset account. When the sale is recognised in September, that cost moves to an expense account called cost of goods sold.

Leaving sales tax aside, September’s income statement includes:

The sale and its direct cost appear together, leaving $30 before the studio’s other expenses.

This is direct matching: the connection is specific, because the cost belongs to the print sold.

Other costs are less obliging. Which print should bear the cost of a day’s insurance coverage? There’s no sensible one-to-one connection.

7.2A year of protection, paid in July#

On July 1, the studio pays $2,400 for business insurance covering July through the following June. Its financial year ends on December 31.

The payment buys twelve months of coverage. July uses just one.

July 1: Record the payment#

Prepaid insurance is an asset representing coverage the studio has paid for but not yet used.

December 31: Recognise the coverage used#

By year-end, six months of coverage have been used. Assuming the premium is allocated evenly, half the cost belongs to the year just ended:

This example recognises all six months in one year-end adjustment. If the studio had already recorded the expense monthly, it wouldn’t record it again.

The original payment is now split between two places:

But what if the studio never makes a claim? The coverage still becomes an expense. The studio uses the protection simply by being covered.

Here, the cost follows time rather than individual sales.

7.3Three ways a cost becomes an expense#

Matching doesn’t mean finding a particular dollar of revenue for every dollar spent. The way a cost becomes an expense depends on what it relates to:

What about rent and ordinary administrative salaries? They generally belong to the period they serve. They don’t wait for a customer invoice.

A quiet month still has expenses. Matching is not permission to postpone costs until there is enough revenue to make the results look better.

Nor does every cost that might help the business qualify as an asset. Carrying a cost forward requires a valid basis under the reporting framework—not just the hope of a future benefit.

7.4When payment comes later#

Suppose the studio pays December’s rent in January. It used the premises in December, so accrual accounting records the expense in that month, along with a liability for the unpaid amount. January’s payment clears the liability; it doesn’t create a new expense.

Utilities, professional fees, commissions, and bonuses raise the same question: has the business incurred a cost that hasn’t yet reached the books?

If so, an adjusting entry may be needed. Bonuses also have specific requirements, including payment deadlines that affect tax deductibility. The accrual guide explains those rules.

Matching works within accrual accounting. Following the payments alone won’t consistently put costs in the periods they belong to.

7.5Crib sheet: Matching principle#

Check the period, not just the payment#

The payment date is easy to find. But does it tell you when the cost belongs in expenses? Check what the business bought, when it used the benefit, and what remains at period-end.

Keep a calculation or other supporting record for each adjustment. The journal entry should identify the period covered and explain how the amount was determined.

Separate financial reporting from tax#

Paragraph 18(1)(a) of the Income Tax Act generally limits deductions to expenses incurred for the purpose of earning income. But that answers a question about purpose—not, by itself, which year gets the deduction.

Specific timing, deductibility, and capitalisation rules still apply. A financial-reporting materiality judgment does not automatically determine the tax treatment.

For equipment, distinguish between:

• Book depreciation or amortisation, which allocates depreciable cost over the asset’s useful life.
• Tax capital cost allowance, or CCA, which follows statutory classes, rates, and applicable incentive rules.

The two amounts need not be equal.

The nature of the spending matters, too. Before deciding how to recognise its cost, establish whether the work is a repair or a capital improvement. The repairs vs. capital guide explains the distinction.

7.6What remains from the $50 sale?#

The print generated $50 in revenue. Recognising its $20 production cost in the same period leaves $30 of gross profit.

But the studio still has rent, insurance, software, and other expenses to cover. Some costs follow particular sales; others belong to the month or year as a whole.

Putting each cost in its proper period lets the income statement answer more than “How much did we sell?”

What did it take to earn it?