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Chapter 2: Problem 10

As of January 1, Seth Fite, Capital, had a credit balance of \(\$ 10,500\). During the year, withdrawals totaled \(\$ 4,000\) and the business incurred a net loss of \(\$ 8,000\). a. Calculate the balance of Seth Fite, Capital, as of the end of the year. b. Assuming that there have been no recording errors, will the balance sheet prepared at December 31 balance? Explain.

Short Answer

Expert verified
a. The ending capital balance is \(-\$1,500\). b. Yes, the balance sheet will still balance if all transactions are recorded correctly.

Step by step solution

01

Understand the Components

To find the ending capital balance, understand that the initial capital balance is adjusted by any withdrawals and the net gain or loss for the year. Here, Seth's initial capital is \(\\(10,500\), withdrawals are \(\\)4,000\), and net loss is \(\$8,000\).
02

Apply the Withdrawal Effect

Subtract the withdrawals from the initial capital balance. The formula is: \[ \text{Capital After Withdrawals} = \text{Initial Capital} - \text{Withdrawals} = \\(10,500 - \\)4,000.\]This results in a capital after withdrawals of \(\$6,500\).
03

Reflect the Net Loss

Subtract the net loss from the capital after withdrawals, using the formula: \[ \text{Ending Capital} = \text{Capital After Withdrawals} - \text{Net Loss} = \\(6,500 - \\)8,000.\]This results in an ending capital balance of \(-\$1,500\).
04

Consider the Balance Sheet Balancing

Normally, a balance sheet balances because the accounting equation \(\text{Assets} = \text{Liabilities} + \text{Capital}\) holds true. Any changes in capital due to withdrawals or losses are already reflected in the totals, indicating assets would adjust to still balance with liabilities plus capital. Therefore, despite a negative capital, the balance sheet can still balance if all other accounts are accurately reported.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Balance Sheet
The balance sheet is a crucial financial statement that provides a snapshot of a company's financial position at a specific point in time. It outlines the company's assets, liabilities, and equity, following the fundamental accounting equation:
  • Assets = Liabilities + Capital (also known as Owner's Equity)
A balance sheet helps business owners and investors understand the company's financial health. Assets are what the company owns, while liabilities are what the company owes. The difference between these two is the owner's equity or capital.
In our example, the balance sheet will account for the initial capital of Seth Fite, withdrawals during the year, and any gains or losses such as the net loss of $8,000. Despite showing a negative ending capital balance, the balance sheet as of December 31 should still be able to balance if all other entries are complete and accurate. The change in Seth Fite's capital reflects a real-time adjustment, ensuring that assets align with the sum of liabilities and equity.
Net Loss
A net loss occurs when a company's total expenses surpass its total revenues during a specific period. This negatively impacts the owner's capital, as seen in our scenario. Seth Fite's business faced a net loss of $8,000, which directly reduced the capital available at the year's end.
Net loss is an indicator of poor financial performance, which can be caused by various factors such as increased operational costs, declining sales, or unexpected expenses. Businesses must analyze the reasons behind a net loss to make informed decisions and implement strategies to return to profitability.
In the context of Seth Fite's capital account, any net loss will be subtracted from the capital after adjusting for withdrawals. This is because the capital account in financial records represents the owner's stake in the company after considering all earnings and losses.
Account Withdrawals
Account withdrawals refer to the removal of funds from a business by the owner for personal use. In accounting, such withdrawals typically decrease the owner's equity in the company.
  • Withdrawals do not affect the profit or loss of the business directly but reduce the available capital or net worth.
In Seth Fite's situation, withdrawals amounted to $4,000. This deduction is crucial because it directly impacts the calculations for the ending capital balance. After deducting withdrawals, we get a new, reduced capital balance which then serves as the base from which any net loss is subtracted.
It's important to manage withdrawals carefully to ensure that the business retains sufficient capital to support operations and investments. Maintaining a healthy balance between withdrawals and business needs is vital for the sustainability of the business.

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Most popular questions from this chapter

The Inflorescence School is a newly organized business that teaches people how to inspire and influence others. The list of accounts to be opened in the general ledger is as follows: \(\begin{array}{lll}\text { Accounts Payable } & \text { Millard Fillmore, Capital } & \text { Supplies } \\ \text { Accounts Receivable } & \text { Millard Fillmore, Drawing } & \text { Supplies Expense } \\ \text { Cash } & \text { Miscellaneous Expense } & \text { Unearned Rent } \\ \text { Equipment } & \text { Prepaid Insurance } & \text { Wages Expense } \\ \text { Fees Earned } & \text { Rent Expense } & \end{array}\) List the accounts in the order in which they should appear in the ledger of The Inflorescence School and assign account numbers. Each account number is to have two digits: the first digit is to indicate the major classification ( 1 for assets, etc.), and the second digit is to identify the specific account within each major classification (11 for Cash, etc.).

Clarendon Interiors is owned and operated by Corey Krum, an interior decorator. In the ledger of Clarendon Interiors, the first digit of the account number indicates its major account classification (1鈥�-assets, 2-liabilities, 3 -owner's equity, 4 -revenues, 5 - expenses). The second digit of the account number indicates the specific account within each of the preceding major account classifications. Match each account number with its most likely account in the list below. The account numbers are \(11,12,13,21,31,32,41,51,52\), and 53 . \(\begin{array}{ll}\text { Accounts: } & \\ \text { Accounts Payable } & \text { Fees Earned } \\ \text { Accounts Receivable } & \text { Land } \\ \text { Cash } & \text { Miscellaneous Expense } \\ \text { Corey Krum, Capital } & \text { Supplies Expense } \\ \text { Corey Krum, Drawing } & \text { Wages Expense }\end{array}\)

The following errors took place in journalizing and posting transactions: a. A withdrawal of \(\$ 15,000\) by Gerald Owen, owner of the business, was recorded as a debit to Wages Expense and a credit to Cash. b. Rent of \(\$ 4,500\) paid for the current month was recorded as a debit to Rent Expense and a credit to Prepaid Rent. Journalize the entries to correct the errors. Omit explanations.

The following errors took place in journalizing and posting transactions: a. A \(\$ 550\) purchase of supplies on account was recorded as a debit to Miscellaneous Expense and a credit to Prepaid Rent. b. Cash of \(\$ 3,750\) received on account was recorded as a debit to Accounts Payable and a credit to Cash. Journalize the entries to correct the errors. Omit explanations.

During the month, Wembley Co. received \(\$ 212,500\) in cash and paid out \(\$ 183,750\) in cash. a. Do the data indicate that Wembley Co. eamed \(\$ 28,750\) during the month? Explain. b. If the balance of the cash account is \(\$ 36,300\) at the end of the month, what was the cash balance at the beginning of the month?
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