# Accounting Equation(Quick Test #2 with Coaching)

Author:
Harold Averkamp, CPA, MBA

This Quick Test with Coaching includes a “View Coaching” button to the right of each answer box. If you choose to click the button, an explanation for the answer will appear.

Note: Some of the following test questions may not have been covered in the Explanation or Practice Quiz for this topic. For more insight regarding a specific question, use the search box at the top of the page.

1. 1. The accounting equation for a sole proprietorship is Assets = Liabilities + Owner’s equity. The accounting equation for a corporation is Assets = Liabilities + __________ equity.

The owners of corporations are referred to as stockholders (or shareholders). Hence, a corporation's accounting equation is either of the following:

Assets = Liabilities + Stockholders' Equity

Assets = Liabilities + Shareholders' Equity

2. 2. Which of the following is a temporary general ledger account whose balance is included in the amount reported as owner’s equity on the interim balance sheet of J. Smith’s sole proprietorship?

J. Smith, Drawing is a temporary account that is connected to the permanent account J. Smith, Capital. At the end of the accounting year, the balance in the account J. Smith, Drawing is transferred to the account J. Smith, Capital.

During the accounting year, the debit balance in J. Smith, Drawing is reported in the balance sheet section owner’s equity.

You might think of J. Smith, Drawing as a subaccount account (or contra account) of J. Smith, Capital.

3. 3. The normal or expected balance in the owner’s capital account of a successful sole proprietorship is a __________ balance.

The normal balance in the owner’s capital account is a credit balance.

Here’s a Tip:
The owner’s capital account is part of the owner’s equity which appears on the right side of the accounting equation. In accounting, debit means left or left side. Credit means right or right side.

The combined asset account balances are debit balances and appear on the left side of the accounting equation. The combined liability account balances and the combined owner’s equity account balances are credit balances and appear on the right side of the accounting equation.

For instance, when an owner starts a sole proprietorship business, the company’s asset account Cash is debited and the owner’s capital account is credited. If the company earns \$400 in revenues and is paid immediately, the Cash account is debited and the Revenues account (a temporary income statement account and a subaccount of the owner’s capital account) is credited.

The owner’s capital account could have a debit balance if the owner had cumulative draws and company losses that were greater than the owner’s investments in the company.

You can learn more from our Explanation of Accounting Equation and our Explanation of Debits and Credits.

4. 4. Which type of balance in the income statement accounts will cause the normal/expected balance in owner’s capital account to increase?

The income statement accounts with credit balances (generally revenue and gain accounts) cause the owner’s capital account to increase.

(Expenses and losses are income statement accounts with debit balances that will cause the normal credit balance in the owner’s capital account to decrease.)

You can think of the income statement accounts as subaccounts of the owner's capital account.

You can learn more from our Explanation of Accounting Equation and our Explanation of Debits and Credits.

5. 5. The combination of the balances in the income statement accounts of J. Smith’s sole proprietorship is the net income for the accounting period. How will a positive amount of net income be recorded in the owner’s equity accounts?

If a company has a positive amount of net income (credit balances in its income statement accounts are greater than the debit balances) the net credit amount will be a credit to the account J. Smith, Capital.

In a manual system, the credit to J. Smith, Capital occurs when the income statement accounts (revenues, gains, expenses, losses) are closed at the end of the accounting year.

Basically, the net credit amount of the income statement account balances increases the normal credit balance in J. Smith, Capital.

6. 6. The combination of the balances in the income statement accounts of Jones Corporation is the net income for the accounting period. How will a positive amount of net income be recorded in the stockholders’ equity accounts?

If a corporation has a positive amount of net income (the balances in the temporary income statement accounts such as expenses, revenues, gains, and losses result in a net credit amount), the net income should be credited to the account Retained Earnings.

In a manual system, the credit to Retained Earnings occurs when the income statement accounts are closed at the end of the accounting year.

Basically, the net credit amount of the income statement account balances increases the normal credit balance Retained Earnings, an account that is part of stockholders' equity.

7. 7. Which of the following will cause the owner’s equity of a sole proprietorship to increase?

For example, if the owner invests \$10,000 in her sole proprietorship, the business asset Cash is increased with a debit of \$10,000 and the owner’s capital account is increased with a credit of \$10,000.

If her business earns \$1,000 by delivering a consulting service for a client, a business asset (Cash or Accounts Receivable) is increased with a debit entry and the Revenues account will be credited. Revenues increase owner’s equity even though the \$1,000 is temporarily recorded in an income statement account such as Revenues, Service Revenues, or Fees Earned.

8. 8. How does an expense affect the amount of a corporation’s stockholders’ equity?

An expense is recorded in a temporary income statement account as a debit amount. The debit in an expense account reduces a corporation’s net income. The reduction in net income is basically a reduction in the normal credit balance of the corporation’s retained earnings, which is a main component of the corporation’s stockholders’ equity.

Paid-in capital is another main component of stockholders’ equity. Paid-in capital reports the amounts the corporation received at the time it issued shares of stock.

9. The following information pertains to Questions 9 through 12:
For the six months of July 1 through December 31, Smith Company (a sole proprietorship) had the following information:

• As of the end of the day on June 30, Smith Company had total assets of \$50,000 and total liabilities of \$30,000.
• Six months later, at the end of the day on December 31, its total assets were \$90,000 and total liabilities were \$33,000.
• During the six months of July through December, the owner did not invest any additional money, nor did the owner withdraw/draw money from the company for his or her personal use.
10. 9. What was the amount of Smith Company’s owner’s equity as of December 31?

See the following image of Smith Company’s accounting equation at the end of the day on December 31 and the solution:

11. 10. What was the increase in Smith Company’s owner’s equity from July 1 through December 31?

The image that follows shows the change in the accounting equation from the end of the day on June 30 to the end of the day on December 31. (The balance at the end of the day on June 30 becomes the beginning balance on July 1.)

The change in the balance of the owner’s equity could be due to the combination of several factors such as the company’s net income or net loss, the owner’s investments, and the owner’s draws.

12. 11. What was Smith Company’s net income for the six months ended December 31?

Since the owner did not invest additional money in the business and did not withdraw any money from the business, the change in the amount of owner’s equity is the result of the company’s net income as shown in the following image:

13. 12. Assuming Smith Company’s expenses during the six months were \$80,000 and there were no gains or losses, what were Smith Company’s revenues during the six months?

A company’s net income is calculated by subtracting its expenses and losses from its revenues and gains.

In Question 11, we calculated Smith Company’s net income to be \$37,000. In this question, we were told that the company’s expenses were \$80,000. Therefore, the revenues and gains must have been \$117,000. The amount is verified on the image that follows.

14. 13. Assume that the owner’s equity of Helpful Company increased by \$60,000 during its most recent year. During that year the owner invested an additional \$75,000 and made no withdrawals for personal use. What was Helpful Company’s net income in the recent year?

The following image lists the items which will cause the owner’s equity to change.

We then fill in the amounts that were given and the amounts that were \$0. Next, we show that the Net income or (Net loss) is the amount that must be determined.

We conclude with a "proof" that Helpful Company had negative net income, or net loss, of \$15,000.

15. The following information pertains to Questions 14 through 16:
Assume that Lee Company (a sole proprietorship) had the following information:

• At the start of the year, its total assets were \$170,000 and its total liabilities were \$90,000.
• At the end of the year, its total assets were \$195,000 and its total liabilities were \$130,000.
• During the year, the owner invested an additional \$60,000 in the company, and had draws of \$38,000.
16. 14. What was the amount of Lee Company’s owner’s equity at the end of the year?

The accounting equation for Lee Company at the end of the year and the solution are:

17. 15. What was Lee Company’s net income or (net loss) for the year?

The following image arranges the known amounts to determine the unknown amount of Lee Company’s net loss:

18. 16. If Lee Company’s expenses and losses for the year were \$300,000, what was the total amount of its revenues and gains during the year?

A company’s net income or net loss is calculated by subtracting its expenses and losses from its revenues and gains. Answer #15 showed that Lee Company’s net loss was \$37,000.

Since the expenses and losses were stated to be \$300,000, the revenues and gains had to be \$37,000 less than \$300,000. In other words, the revenues and gains must have been \$263,000. This is shown in the following image:

19. The following information pertains to Questions 17 through 20:
Tiger Corporation’s stockholders' equity consists of two general ledger accounts:

• Common Stock (referred to as a paid-in capital account) which reports the amount the corporation received when it sold/issued its no-par common stock to investors.
• Retained Earnings, which reports the corporation’s net earnings since the corporation was formed minus all the dividends declared/distributed to stockholders.
• At the end of its most recent accounting year, Tiger Corporation had total assets of \$490,000 and total liabilities of \$370,000.
• At the beginning of that year, its total assets were \$410,000 and its total liabilities were \$300,000.
• During that year, Tiger Corporation declared and paid dividends of \$25,000. It did not issue, purchase, or retire any shares of common stock.
20. 17. Which of the following was Tiger Corporation’s stockholders’ equity at the end of the year?

The accounting equation for Tiger Corporation at the end of the recent year and the solution are shown in the following image:

21. 18. What was Tiger Corporation’s net income for the recent year?

The following image shows which items will change the amount of stockholders’ equity during the year. We then show the amounts that are known (were given in the introduction to Question 17). This allows us to determine the unknown amount. In this case, the missing amount needed is the net income of \$35,000.

22. 19. By what amount did the balance in the Common Stock account change during the year?

One component of stockholders’ equity is the paid-in capital accounts such as Common Stock. The balance in the Common Stock account(s) can change from:

• The amount received from issuing new shares of common stock
• The retirement of some shares of the corporation’s common stock

Since the question stated there were no shares issued or retired, there was no change in the balance in the Common Stock account during the year.

This is confirmed in the following image:

23. 20. By how much did the balance in Tiger Corporation’s Retained Earnings change during the year?

Another major component of stockholders’ equity is retained earnings. The balance in a corporation’s Retained Earnings account can change from:

• The amount of net income or net loss
• The stockholders’ dividends declared by the corporation

The following image shows that the net of these two items caused the Retained Earnings balance to increase by \$10,000 during the year.

Any questions left unanswered will be marked incorrect.

### Accounting Equation Outline

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