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Chapter 2: Problem 5

Accounting Equation Determine the following: a. The stockholders' equity of a company that has assets of \(\$ 480,000\) and liabilities of \(\$ 360,000\). b. The retained earnings of a company that has assets of \(\$ 625,000\), liabilities of \(\$ 225,000\), and common stock of \(\$ 165,000\). c. The assets of a corporation that has liabilities of \(\$ 500,000\), common stock of \(\$ 350,000\), and retained earnings of \(\$ 255,000\).

Short Answer

Expert verified
a. $120,000; b. $235,000; c. $1,105,000.

Step by step solution

01

Understand the Accounting Equation

The accounting equation is the foundation of the double-entry accounting system. It is given by: \( \text{Assets} = \text{Liabilities} + \text{Stockholders' Equity} \). This equation ensures that the balance sheet remains balanced, as every financial entry affects two aspects of this equation.
02

Calculate Stockholders' Equity

For part (a), use the accounting equation to find the stockholders' equity. Rearrange the equation to solve for stockholders' equity: \[ \text{Stockholders' Equity} = \text{Assets} - \text{Liabilities} \]Substituting the given values:\[ \\( 480,000 - \\) 360,000 = \\( 120,000 \] So, the stockholders' equity is \( \\) 120,000 \).
03

Calculate Retained Earnings

For part (b), to find the retained earnings, you can rearrange the equation considering the components of stockholders' equity (Common Stock + Retained Earnings):\[ \text{Retained Earnings} = \text{Assets} - \text{Liabilities} - \text{Common Stock} \]Substituting the given values:\[ \\( 625,000 - \\) 225,000 - \\( 165,000 = \\) 235,000 \]So, the retained earnings are \( \$ 235,000 \).
04

Calculate Total Assets

For part (c), use the accounting equation to find the total assets. Rearrange the equation:\[ \text{Assets} = \text{Liabilities} + \text{Stockholders' Equity} \]First calculate stockholders' equity (Common Stock + Retained Earnings):\[ \text{Stockholders' Equity} = \\( 350,000 + \\) 255,000 = \\( 605,000 \]Then, substitute the stockholders' equity back into the assets calculation:\[ \text{Assets} = \\) 500,000 + \\( 605,000 = \\) 1,105,000 \]Therefore, the total assets are \( \$ 1,105,000 \).

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Key Concepts

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

Assets
Assets are everything a company owns that holds value and is expected to provide future benefits. They are often seen as resources that a company can use to generate revenue. Assets can be tangible, like machinery, buildings, or cash, or intangible, like patents and trademarks. In accounting, assets are crucial because they inform business operations and help evaluate the company's financial health.
When you look at a balance sheet, assets are usually divided into different categories:
  • Current Assets: These are assets that can be converted into cash within a year, such as inventory, accounts receivable, and cash.
  • Non-current Assets: These are long-term investments like property, equipment, and long-term investments.
Understanding how assets function in a business is key to managing and planning for growth.
Liabilities
Liabilities are obligations that a company needs to pay in the future. They signify what the business owes to others, such as debts, loans, or unpaid bills. Just like assets, liabilities are a critical part of understanding a company's financial position.
Liabilities can similarly be broken down into categories:
  • Current Liabilities: Debts or obligations that the company needs to settle within one year, like accounts payable or short-term loans.
  • Non-current Liabilities: Long-term obligations such as mortgages or long-term lease obligations.
Liabilities are essential in the accounting equation because they partly finance the assets a company has.
Stockholders' Equity
Stockholders' Equity represents the owners' claim after all the liabilities have been settled. It reflects the net value of the company and can be derived from the accounting equation:
  • Stockholders' Equity = Assets - Liabilities
This term gives insight into the financial value or 'net worth' that goes to the shareholders. Stockholders' Equity typically includes:
  • Common Stock: The initial investment by shareholders, usually represented by shares or stocks.
  • Retained Earnings: The profits that the company has decided to reinvest in the business rather than pay out as dividends.
The health of a company is often measured by its stockholders' equity, revealing the balance between liabilities and income potential.
Retained Earnings
Retained Earnings are the accumulated net earnings of a company that are not distributed to shareholders as dividends. Instead, these funds are reinvested in the business to facilitate growth, pay off debts, or fund new product development. You can calculate retained earnings by using this formula:
  • Retained Earnings = Net Income - Dividends
In the context of the accounting equation, retained earnings contribute to stockholders' equity and offer a long-term perspective of how well the company is performing financially. Retained earnings provide a continuous source of funding without needing to acquire liabilities.
Balance Sheet
The balance sheet is a financial statement that provides a snapshot of a company's assets, liabilities, and stockholders' equity at a specific point in time. It's a fundamental part of financial documentation because it summarizes what the company owns and owes.
The structure of a balance sheet is straightforward:
  • Assets: Listed as the first section to show what the company owns.
  • Liabilities: Showing what the business owes, placed on the opposite side or section.
  • Stockholders' Equity: Representing the net value after all liabilities are paid.
The accounting equation ensures that the balance sheet is always going to balance: Assets = Liabilities + Stockholders' Equity. This equation ensures accuracy and provides insights into the company鈥檚 financial health.

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Most popular questions from this chapter

Transaction Analysis Grace Stewart began the Stewart Answering Service in December. The firm provides services for professional people and is currently operating with leased equipment. On January 1 , the assets and liabilities of the business were: Cash, \(\$ 6,400\); Accounts Receivable, \(\$ 6,900 ;\) Accounts Payable, \(\$ 1,600\); and Notes Payable, \(\$ 1,500\). Assume that Retained Earnings as of January 1 were zero. The balance of Common Stock was \(\$ 10,200\). The following transactions occurred during the month of January: 1 Paid rent on office and equipment for January, \$1,800. 2 Collected \(\$ 6,000\) on account from clients. 3 Borrowed \(\$ 3,000\) from a bank and signed a note payable for that amount. 4 Billed clients for work performed on account, \(\$ 12,500\). 5 Paid \(\$ 1,400\) on accounts payable. 6 Received invoice for January advertising, \(\$ 800\). 7 Paid January salaries, \$3,200. 8 Paid January utilities, \(\$ 430\). 9 Paid stockholders a dividend of \(\$ 3,600\) cash. 10 Purchased a printer (on January 31 ) for business use, \(\$ 1,400\). 11 Paid \(\$ 30\) to the bank as January interest on the outstanding notes payable. Required a. Set up an accounting equation in columnar form with the following individual assets, liabilities, and stockholders' equity accounts: Cash, Accounts Receivable, Equipment, Accounts Payable, Notes Payable, Common Stock, and Retained Earnings. Enter the January 1 balances below each item. (Note: The beginning Equipment account balance is $0.) b. Show the impact (increase or decrease) of the January transactions on the beginning balances, and total all columns to show that assets equal liabilities plus stockholders' equity as of January 31.

Which of the following accounts has a normal debit balance? a. Accounts Payable b. Notes Payable c. Common Stock d. Advertising Expense

Posting refers to the process of transferring information from: a. A journal to the general ledger accounts b. General ledger accounts to a journal c. Source documents to a journal d. A joumal to source documents

Transaction Analysis and Trial Balance Mary Baker opened a tax practice on June 1. The following accounts will be needed to record her transactions for June: Cash; Accounts Receivable; Office Supplies; Tax Library; Office Furniture and Fixtures; Accounts Payable; Notes Payable; Common Stock; Dividends; Professional Fees Earned; Rent Expense; Salaries Expense; Advertising Expense; Utilities Expense; and Interest Expense. The following transactions occurred during the month of June: 1 Baker opened a business checking account at a local bank, investing \(\$ 13,500\) in her practice in exchange for common stock. 2 Purchased office furniture and fixtures for \(\$ 9,800\), paid \(\$ 2,800\) cash, and gave a note payable for the balance. 3 Purchased books and software for a tax library on account, \(\$ 4,500\). 4 Purchased office supplies for cash, \(\$ 950\). 5 Paid rent for June, \(\$ 750\). 6 Retumed \(\$ 300\) of books with defective bindings. The return reduced the amount owed to the supplier. 7 Billed clients for professional services rendered, \(\$ 9,200\). 8 Paid \(\$ 1,700\) on account for the library items purchased on June \(3 .\) 9 Collected \(\$ 5,900\) on account from clients billed on June 7 . 10 Paid June salaries, \(\$ 4,900\). 11 Received invoice for June advertising, to be paid in July, \$300. 12 Paid stockholders \(\$ 800\) cash as a dividend. 13 Paid utilities for June, \(\$ 160\). 14 Paid interest for June on note payable, \$310. Required a. Prepare journal entries and record the above transactions in T-accounts, and key entries with the number of the transactions. b. Prepare a trial balance as of June 30.

Transaction Analysis and Trial Balance Make T-accounts for the following accounts that appear in the general ledger of Dave Jennings, an attorney: Cash; Accounts Receivable; Office Equipment; Legal Database Subscription; Accounts Payable; Common Stock; Dividends; Legal Fees Eamed; Salaries Expense; Rent Expense; and Utilities Expense. Using the accounting equation, record each of the transactions in columnar format. Prepare journal entries and record the following October transactions in the T-accounts and key all entries with the number identifying the transaction. Determine the balance in each account and prepare a trial balance sheet as of October 31 . 1 Jennings started his law practice by contributing \(\$ 21.500\) cash to the business on October 1 . receiving shares of common stock in the company. 2 Purchased office equipment on account, \$11,400. 3 Paid office rent for October, \(\$ 1,100\). 4 Paid \(\$ 9,750\) to access online legal database for two years. 5 Billed clients for services rendered, \(\$ 14,000\). 6 Made \(\$ 6,000\) payment on account for the equipment purchased on October \(2 .\) 7 Paid legal assistant's salary, \(\$ 2,800\). 8 Collected \(\$ 7,500\) from clients previously billed for services. 9 Received invoice for October utilities, \(\$ 190\); it will be paid in November. 10 Paid stockholders \(\$ 1,500\) as a cash dividend.
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