Business Forms and the Accounting Equation A business is an organization in whic

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Business Forms and the Accounting Equation

A business is an organization in which basic resources (inputs), such as materials and labor, are assembled and processed to provide goods or services (outputs) to customers. A business entity may take the form of a sole proprietorship, partnership, or corporation. Regardless of the business form, the accounting equation shows the relationship among the entity's assets, liabilities, and stockholders' equity.

The Accounting Equation

The details of the activities of a company, or transactions, are recorded in a company's accounting system. These transactions are summarized in a set of reports known as the financial statements. The foundation for the accounting system and the financial statements is the accounting equation.

Assets

As transactions occur, they affect the accounting equation, but the accounting equation must always stay in balance. A transaction can increase both sides or decrease both sides. A transaction could also affect only one side by increasing one account and decreasing another on the same side of the accounting equation.

1) APPLYING THE CONCEPTS: Analyzing Changes to Assets, Liabilities and Stockholders' Equity

Thomas Company: The table below demonstrates the effect of the first three transactions for Thomas Company. Review the details of each transaction and determine the effect on the accounting equation. Then, enter the updated amounts for the assets, liabilities, and equity accounts (do not record the transaction). If an updated balance is zero, enter "0".

Jones Company: Analyze the accounting equation for another business, Jones Company. Assume that the assets are $54,000 and the liabilities are $21,600. By rearranging the accounting equation, you determine that stockholders' equity is $.

During the year, the company issued additional stock for $4,000. The company also paid off $2,500 of its debt. What would the accounting equation look like after these two transactions are recorded?

2) APPLYING THE CONCEPTS: Analyzing the Effect of Revenues and Expenses

The stockholders' equity component of the accounting equation is affected by transactions other than owner contributions. Revenues increase stockholders' equity and Expenses decrease stockholders' equity. Also in any form of business, cash may be distributed to the owners. Distributions to stockholders' decrease the stockholders' equity account. The table below demonstrates the effect of these transactions for Smith Company. Review the details of each transaction and determine the effect on the accounting equation. Then, enter the updated amounts for the assets, liabilities, and stockholders' equity accounts (do not record the transaction).

3) APPLYING THE CONCEPTS: Putting it all together

Let’s put all the pieces together now. Suppose that you are analyzing Martin Company. You know that at the beginning of the year, the assets equaled $300,000 and the liabilities equaled $165,000. During the year, assets increased by $45,000 and stockholders' equity increased by $69,750. Further analysis reveals revenues of $162,000 were earned and expenses of $105,300 were incurred during the year, and additional investments of $47,250 occurred in the first half of the year. Because of your understanding of the accounting equation, you realize that distributions (dividends) to the stockholders must have also occurred during the year. However, you must determine the amount for those distributions.

What is the amount of dividends paid during the year? $____________________

Complete the equation below with amounts for the end of the year.

Assets

= Liabilities + Stockholders' Equity The left side of the accounting equation shows
the economic resources of the company = The right side of the accounting equation
summarizes who provided those assets:
Creditors or the stockholders'.

Explanation / Answer

Answer

Transaction

Assets

Liabilities

Stockholders' Equity

Beginning

Invest in the Business The company issues stock in exchange for $21,000. This increases the assets of the business. The owners (stockholders) have a claim on the assets, so stockholders' equity also increases.

$ 21,000

$ 0

$ 21,000

Borrow Cash The company borrows $10,500 cash from the local bank. This transaction also increases assets. The company now owes the bank; therefore, the bank has a claim on the assets. Thus, liabilities increase. Notice this transaction did not affect stockholders' equity.

$ 10,500

Purchase equipment The company pays cash for a piece of equipment costing $7,500. The company has merely exchanged one asset (cash) for another asset (equipment).

$ 0 [ + 7500 – 7500]

TOTAL [Ending balance updated]

$ 31,500

$ 10,500

$ 21,000

Assets = Liabilties + Stockholder’s Equity
54000 = 21600 + Stockholder’s Equity.
Stockholders Equity = 54000 – 21600 = $ 32,400

During the year, the company issued additional stock for $4,000. The company also paid off $2,500 of its debt. What would the accounting equation look like after these two transactions are recorded?

Assets

Liabilities

Stockholders' equity

Beginning Balance

$ 54,000

$ 21,600

$ 32,400

Transaction 1: Additional stock issued

$ 4,000

Transaction 2 : Debts paid off

$ (2,500)

$ 0

Equation after these 2 transaction

$ 55,500

$ 19,100

$ 36,400

Transaction

Assets

Liabilities

Stockholders' equity

Beginning of the year

$335,000

$100,500

$234,500

Revenues earned: During the year, Smith Company earned revenues totalling $201,000. The cash has been collected from the customers for all revenue earned this year.

$ 201,000

$ 0

$ 201,000

Expenses incurred: During the year, Smith Company incurred expenses totalling $140,700. All of the expenses incurred this year were paid in cash.

$ (140,700)

Distributions: At the end of each quarter, the company paid cash dividends to stockholders. Quarterly dividends amounted to $24,120.

$ (24,120)

Ending of the year

$ 371,180

$ 100,500

$ 270,680

Stockholders’ Equity is:
Increased by revenues
Decreased by expenses
Increased by further investment, and
Decreased by dividends.

Hence,

Stockholder's Equity

Beginning balance

$ 1,35,000.00

Increased during the year

$ 69,750.00

Ending Balance

$ 2,04,750.00

Stockholder's Equity

Beginning balance

$ 1,35,000.00

Revenues

$ 1,62,000.00

Expenses

$ (1,05,300.00)

Investments

$ 47,250.00

Ending balance without deducting dividends

$ 2,38,950.00

Ending Balance calculated above

$ (2,04,750.00)

Amount of dividend paid during the year

$ 34,200.00

Amount of dividends = $ 34,200

Assets

Liabilities

Stockholders' equity

Beginning Balance

$300,000

$165,000

$135,000 [ 300000 – 165000]

Increase during the year

$ 45,000

Not given

$ 69,750

Ending balance [Answer]

$ 345,000

$ 140,250 [ 345000 – 204750]

$ 204,750

Transaction

Assets

Liabilities

Stockholders' Equity

Beginning

$ 21,000

$ 0

$ 21,000

$ 10,500

Purchase equipment The company pays cash for a piece of equipment costing $7,500. The company has merely exchanged one asset (cash) for another asset (equipment).

$ 0 [ + 7500 – 7500]

TOTAL [Ending balance updated]

$ 31,500

$ 10,500

$ 21,000

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