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Accounting Equation

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Accounting Equation for a Sole Proprietorship — Transactions 7–8


Sole Proprietorship Transaction #7.

On December 7, 2006 ASC uses a temporary help service for 6 hours at a cost of $20 per hour. ASC will pay the invoice when it is due in 10 days. The effect on its accounting equation is:


Assets = Liabilities + Owner’s Equity     
No Effect = +$120 + –$120     


ASC’s liabilities increase by $120 and the expense causes owner’s equity to decrease by $120.


The liability will be recorded in Accounts Payable and the expense will be reported in Temp Service Expense. The journal entry for recording the use of the temp service is:



Date Account Titles Debit Credit
Dec. 7, 2006 Temp Service Expense 120
Accounts Payable 120


The effect of the first seven transactions on the accounting equation can be viewed here:


Transaction Assets = Liabilities + Owner’s Equity     
1 +$10,000 = No Effect + +$10,000     
2 –$100 = No Effect + –$100     
3 +$5,000 = No Effect + No Effect     
–$5,000
4 +$7,000 = +$7,000 + No Effect     
5 –$600 = No Effect + –$600     
6 +$900 = No Effect + +$900     
7 No Effect =   +$120 + $120     
Totals $17,200 = $7,120 + $10,080     


The totals show us that the company has assets of $17,200 and the sources are the creditors with $7,120 and the owner of the company with $10,080. The accounting equation totals also tell us that the company has assets of $17,200 with the creditors having a claim of $7,120. This means that the owner’s residual claim is $10,080.


The financial position of ASC as of midnight on December 7, 2006 is:


Accounting Software Co.
Balance Sheet
December 7, 2006
ASSETS LIABILITIES
Cash $ 11,300 Notes Payable $ 7,000 
Accounts Receivable 900 Accounts Payable $ 120 
Equipment 5,000 Total Liabilities $ 7,120 
OWNER’S EQUITY
. J. Ott, Capital $ 10,080*
Total Assets $ 17,200 Total Liab & Owner's Equity $ 17,200 
.
.
Beginning Owner's Equity $ 0
+ Owner's Investment + 10,000 
+ Net Income** + 180 
  Subtotal $ 10,180 
– J. Ott, Drawing 100 
Ending Owner's Equity at Dec. 7 $ 10,080*
.

**The income statement (which reports the company’s revenues, expenses, gains, and losses for a specified
time interval) is a link between balance sheets. It provides the results of operations—an important part
of the change in owner’s equity.



Accounting Software Co.’s income statement for the first seven days of December is:


Accounting Software Co.
Income Statement
For the Seven Days Ended December 7, 2006
REVENUES
Service Revenues $ 900
EXPENSES
Advertising Expense 600
Temp Service Expense 120
    Total Expenses 720
NET INCOME $ 180




Sole Proprietorship Transaction #8.

On December 8, 2006 ASC receives $500 from the clients it had billed on December 6, 2006. The collection of accounts receivables has this effect on the accounting equation:


Assets = Liabilities + Owner’s Equity     
+$500 = No Effect + No Effect     
–$500


The company’s asset (cash) increases and another asset (accounts receivable) decreases. Liabilities and owner’s equity are unaffected. (There are no revenues on this date. The revenues were recorded when they were earned on December 6.)


The general journal entry to record the increase in Cash, and the decrease in Accounts Receivable is:



Date Account Titles Debit Credit
Dec. 8, 2006 Cash 500
Accounts Receivable 500


The combined effect of the first eight transactions is shown here:


Transaction Assets = Liabilities + Owner’s Equity     
1 +$10,000 = No Effect + +$10,000     
2 –$100 = No Effect + –$100     
3 +$5,000 = No Effect + No Effect     
–$5,000
4 +$7,000 = +$7,000 + No Effect     
5 –$600 = No Effect + –$600     
6 +$900 = No Effect + +$900     
7 No Effect = +$120 + –$120     
8 +$500 = No Effect + No Effect     
$500
Totals $17,200 = $7,120 + $10,080     


The totals for the first eight transactions indicate that the company has assets of $17,200. The creditors provided $7,120 and the owner provided $10,080. The accounting equation also indicates that the company’s creditors have a claim of $7,120 and the owner has a residual claim of $10,080.


ASC’s balance sheet as of midnight December 8, 2006 is:


Accounting Software Co.
Balance Sheet
December 8, 2006
ASSETS LIABILITIES
Cash $ 11,800 Notes Payable $ 7,000 
Accounts Receivable 400 Accounts Payable $ 120 
Equipment 5,000 Total Liabilities $ 7,120 
OWNER’S EQUITY
. J. Ott, Capital $ 10,080*
Total Assets $ 17,200 Total Liab & Owner's Equity $ 17,200 
.
.
Beginning Owner's Equity $
+ Owner's Investment + 10,000 
+ Net Income** + 180 
Subtotal $ 10,180 
– J. Ott, Drawing 100 
Ending Owner's Equity, at Dec. 8 $ 10,080*
.

**The income statement (which reports the company’s revenues, expenses, gains, and losses during a specified
period of time) is a link between balance sheets. It provides the results of operations—an important part
of the change in owner’s equity.



The income statement for ASC for the eight days ending on December 8 is shown here:


Accounting Software Co.
Income Statement
For the Eight Days Ended December 8, 2006
REVENUES
Service Revenues $ 900
EXPENSES
Advertising Expense 600
Temp Service Expense 120
    Total Expenses 720
NET INCOME $ 180


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