91Ó°ÊÓ

Susan's Shoe Shop opened on January 1. The following transactions took place during the first month: 1\. Deposited \(\$ 30,000\) in the firm's checking account. 2\. Purchased shoes, boots, socks, and other inventory for \(\$ 45,000\) on account. 3\. Purchased display shelving, chairs, and other fixtures for \(\$ 10,000\) cash and \(\$ 40,000\) on account. Assume a useful life of five years. 4\. Obtained \(\$ 20,000\) and signed a three-year, \(\$ 20,000\) bank loan at \(8 \%\) annual in- terest. 5\. Had sales revenue during January of \(\$ 75,000\). Of this amount, \(\$ 25,000\) was received in cash and the balance was on account. 6\. The cost of the merchandise sold in item 5 was \(\$ 32,000\) 7\. Paid \(\$ 10,000\) to each of two different creditors. 8\. Signed an application for a one-year insurance policy and paid the year's premium of \(\$ 2,400\) 9\. Paid three employees a monthly salary of \(\$ 2,000\) each. 10\. Collected \(\$ 35,000\) from (accounts receivable) customers. Required a. Analyze these transactions, including any appropriate adjustments, using the basic accounting equation. b. Prepare a simple income statement for the firm. c. Identify any significant missing elements in your income statement. d. Prepare a simple balance sheet for Susan's Shoe Shop.

Step by step solution

01

Accounting Equation Analysis

Identify each transaction's impact on Assets, Liabilities, and Owner's Equity, keeping in mind that the equation must be balanced after each transaction. For example, the first transaction increases both Assets and Owner's Equity by $30,000, hence, it's recorded as: Assets (+$30,000) = Liabilities (+$0) + Owner's Equity (+$30,000). Proceed to analyze each transaction likewise.

02

Prepare a Simple Income Statement

An income statement shows the net profit or loss during a particular period. In this case, calculate the Gross profit first, which is Sales revenue minus Cost of goods sold (75,000 - 32,000 = $43,000). Deduct the Operating expenses such as Salaries and Insurance from the gross profit to get the Net Income.

03

Identify Missing Elements in Income Statement

Any expenses incurred but not accounted for in making the income statement are considered missing. In this case, Depreciation on fixtures is not taken into account, which is a missing element.

04

Prepare a Simple Balance Sheet

The balance sheet reflects the company's financial position at a specific point in time. List all assets (Cash, Accounts Receivable, Inventory, and Fixed Assets), liabilities (Accounts Payable and Bank Loan), and Owner's Equity calculated from the transactions to construct the balance sheet. Assets should equal Liabilities plus Equity.

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Key Concepts

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

Accounting Equation

The accounting equation is a fundamental concept in financial accounting. It's expressed as: Assets = Liabilities + Owner's Equity. This equation represents the balance sheet's core idea and maintains that the total value of assets owned by a business will always equal the total value of its liabilities and the equity of its owners.
For Susan's Shoe Shop, each transaction must be analyzed in terms of how it affects this equation. When Susan deposited $30,000 in the firm's checking account, assets and owner's equity increased by $30,000. When she purchased inventory on account for $45,000, assets increased by the inventory value, while liabilities also increased because it was on account.
Every transaction affects at least two accounts, ensuring that the accounting equation remains balanced. It's crucial for students to comprehend each transaction's impact to effectively prepare financial statements.

Income Statement

An income statement shows a company's financial performance over a period, summarizing revenues and expenses. For Susan's Shoe Shop, we calculate the gross profit first, which is Sales Revenue minus Cost of Goods Sold (COGS). Here, the sales revenue is $75,000, from which we subtract the COGS of $32,000, resulting in a gross profit of $43,000.
Next, we subtract operating expenses such as salaries ($6,000) and insurance ($2,400) from the gross profit to derive the net income. It's important to note that depreciation on fixtures is often a missing element in preliminary income statements like this one.
Understanding how to structure an income statement is vital for assessing how much a company has earned or lost during a specific period.

Balance Sheet

A balance sheet shows a company's financial position at a particular point in time. It lists all of a company's assets and liabilities, with the leftover value being the owner's equity.
For Susan's Shoe Shop, assets consist of cash (both from deposits and collections), accounts receivable, inventory, and fixed assets (like shelving and fixtures). Liabilities include amounts owed to creditors and the bank loan. Owner's equity reflects the initial investment and retained earnings.
The assets must equal liabilities plus owner's equity, serving as proof that the financial statements have been prepared correctly. This statement gives a snapshot of what the business owns and owes, which is crucial for financial planning.

Accounts Receivable

Accounts receivable represents money owed to the company by its customers. It's an asset because it promises future cash inflows when customers settle their debts. For Susan's Shoe Shop, $50,000 of total sales were on account, creating accounts receivable.
Later, Susan collected $35,000 from her customers, decreasing accounts receivable and increasing cash. Managing accounts receivable effectively is vital to ensure healthy cash flow.
The ability to track and collect outstanding balances impacts the company's liquidity, and proper management of accounts receivable is key to maintaining a steady flow of working capital.