91Ó°ÊÓ

In its first year, Sam's Subway Emporium engaged in the following transactions. Indicate the effects of each transaction on Sam's balance sheet by using the balance sheet equation. Total your worksheet at the end of the first year and prepare a simple balance sheet. 1\. Sam's was formed with a cash investment of \(\$ 50,000\) in exchange for common stock. 2\. Sam's purchased a lunch cart for \(\$ 10,000\) cash. 3\. Sam's ordered food and other supplies at a cost of \(\$ 13,500,\) not yet received. 4\. Sam's received the food and supplies, but intended to pay later. 5\. Sam's felt quite generous and gave its employees an advance on their first week's wages of \(\$ 2,500\). 6\. Sam's then got a bit nervous about whether it could pay its employees and suppliers in subsequent months, so a bank loan of \(\$ 100,000\) was acquired at an annual interest rate of \(10 \%\). 7\. Sam's failed to pay for its first month's food and other supplies; the supplier billed Sam's a \(20 \%\) late fee. 8\. Sam's paid the employee's salaries of \(\$ 67,500\) during the year and also recognized the wages that were paid in advance as expenses. 9\. Assume that an entire year has passed and Sam's has made no payments on the loan or the supplier's bill. The late fee is assessed quarterly (four times each year) if the account is not paid. Accrue interest on the loan and use an interest payable account for both the late fees and the interest on the loan. 10\. On the first day of the next year, will Sam's be able to repay the loan? If so, show the effects of the loan repayment.

Step by step solution

01

Understand the Initial Conditions

Sam's Subway initially has $50,000 in cash from its common stock investment. This is an asset and equity for Sam's. So, assets = \$50,000 and equity = $50,000.

02

Analyze Each Transaction

Break down each transaction into its effects on assets, liabilities, and equity. For example, when Sam's purchases a lunch cart for \(\$ 10,000\) cash, it is reducing its cash assets by \$10,000 and gaining a fixed asset (lunch cart) worth \$10,000. So, total assets stay the same and there is no impact on equity and liabilities.

03

Handle Accruals

For transactions involving accruals, recognize the expense instantly and treat it as a payable account on the liabilities side. For example, when Sam's orders food and supplies worth \$13,500 which have not yet been received, it's an expense that is recognized immediately and a liability is created.

04

Prepare Balance Sheet

Use all the transactions to prepare the balance sheet. Assets would include cash, the lunch cart, and others as relevant. Liabilities would include debts such as bank loans, accrued expenses, and supplier bills. Equity is the value of common stock.

05

Loan Repayment Scenario

The final step is to analyze whether Sam's can repay the loan at the beginning of the next year. This would involve checking if the assets on Sam's balance sheet are enough to cover the loan.

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Key Concepts

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

Assets and Liabilities

The balance sheet equation is a fundamental principle in accounting. It states that a company's assets must equal the sum of its liabilities and equity. In simpler terms, whatever a company owns must be balanced by what it owes plus what is invested by the owners.
This relationship is given by the equation:

• Assets = Liabilities + Equity

In the case of Sam's Subway Emporium, an initial cash investment of \(\$50,000\) contributes to the company's assets and equity equally. Yet, as Sam's engages in various transactions, assets and liabilities fluctuate:

• Assets are resources owned by Sam's, such as cash, the lunch cart, and supplies.
• Liabilities are what Sam's owes, including the loan and Payable accounts for the ordered supplies and accrued expenses.

The importance of understanding assets and liabilities lies in the ability to assess financial health and the capability to meet obligations. Keeping track of these allows a business to ensure the equation always balances, reflecting a stable business structure.

Accrual Accounting

Accrual accounting is a method that records financial transactions when they occur, regardless of when cash is exchanged. This approach provides a more accurate picture of a company’s financial health.

• In Sam's example, ordering food and other supplies at a cost of \(\$13,500\) creates an obligation that needs to be accounted for, even though payment has not yet been made.
• The same principle applies to wages paid in advance, and interest on loans, reflecting them as liabilities or expenses when they happen, rather than when cash actually moves.

Accrual accounting serves to recognize and record expenses and incomes during the period in which they occur, which is crucial for understanding the actual performance of a business during a particular period. It aligns the revenues with the expenses contributed to generating those revenues, offering a truthful representation of a company's financial status.

Financial Transactions

Financial transactions are events that have a monetary impact on a business's financial statements. Each transaction affects the balance sheet equation.

• When Sam's receives the food and supplies, it recognizes an increase in assets but simultaneously records a liability due to something owed.
• Acquiring a bank loan increases both assets (cash received) and liabilities (amount owed on the loan). This type of transaction shows how borrowing can impact the financial health.

Understanding financial transactions is crucial because it allows accountants and business owners to see how day-to-day activities affect the business's financial outcomes. Proper handling and recording of these transactions ensure accurate financial statements, aiding in planning, analyzing financial health, and making informed decisions. Transactions need to be carefully analyzed and accurately documented to maintain balanced financial sheets.