Business Activities—The Source of Accounting Information1
CHAPTER 2
Business Activities—The Source of Accounting Information
Thinking Beyond the Question
How do we know how well our business is doing?
Revenues are earned when goods are transferred or services are provided to customers. In most cases, these events are associated with completion of certain critical events, such as delivery of goods. Expenses are incurred when resources are consumed in the process of providing goods and services. Therefore, a system that identifies when goods are transferred, services are provided, and resources are consumed is important for identifying revenues and expenses.
Some resources are consumed when goods or services are transferred to customers: the cost of goods, supplies, and labor associated with particular jobs. In other cases, the amount of resources consumed is measured each fiscal period: salaries and wages, utilities, rent, and insurance. Depending on the type of resource consumed, identification of the cost of the resource associated with specific sales or identification of the cost of the resource associated with a fiscal period is an important event for identifying expenses during a fiscal period.
QUESTIONS
Q2-1Chapter 2 illustrates two sources of money for companies—loans and owner contributions. Chapter 1 discussed the three forms of business organizations—proprietorships, partnerships, and corporations. To maintain control, Joan probably would want to organize her business as a proprietorship. If she has enough money or other resources, she can borrow the rest of the capital she needs from a bank. If she does not have enough money or other resources and cannot borrow as much as she needs, she may have to find one or more partners to help finance the business. Because this is a small business, she is unlikely to want or need to incorporate at this time or to issue bonds.
Q2-2Major sources of financing for corporations are stocks and debt. Bank loans also are possible. Managers should consider how much stock or how much debt they can incur, what amount of money they will receive from the issuance, and whether they can repay debt as it becomes due from the profits they expect to earn.
Q2-3From the corporation’s perspective, this event was a financing activity. The corporation raised capital (i.e., raised financing) by selling shares of stock to Jerrilyn.
Q2-4Assets = Liabilities + Equity. The question indicates that assets are accurately reported. Therefore, if liabilities are understated, equity must be overstated. For example, assume assets, liabilities, and equity are correctly reported as $10,000, $3,000, and $7,000 respectively ($10,000 = $3,000 + $7,000). If liabilities are understated by $1,000, equity must be overstated by $1,000 to make the accounting equation balance ($10,000 = $2,000 + $8,000).
Q2-5Both liabilities and owners’ equity represent claims to a company’s resources.
Q2-6The accounting equation presents the relationship between resources and claims to resources. Financial resources to acquire assets are obtained from financing activities and from revenues earned by the company. When assets are consumed, expenses are created that reduce a company’s profits. The profits earned during a period increase owners’ equity, as reported in retained earnings. The total amount of assets is equal to the total amount of liabilities and owners’ equity.
Q2-7Purchasing merchandise inventory is an operating activity. The operating activities section of the cash flow statement reports cash from selling goods and services and cash paid for expense-related activities.
Q2-8Contributed capital represents claims to resources provided by the owners. Sales revenue represents owners’ claims to resources that were earned and retained by the company.
Q2-9No. Retained Earnings represents earnings kept in the business. These earnings are reinvested and may be included in various kinds of assets. Retained Earnings does not equal cash.
Q2-10The possibilities will depend on the specific company selected and industry in which it operates. Exhibit 12 in the text should give students a good start on this question.
Q2-11The left side of a balance sheet reveals how an organization’s managers have used investors’ capital. That is, what does the organization own? Or, what amount of capital has been committed to which assets? The right side of a balance sheet reveals where the capital came from to
acquire the assets listed on the left side. It reveals how much of the organization’s capital was provided by investors loaning money or extending credit (i.e., liabilities). It also reveals how much capital was provided by the owners’ contributions (invested capital) as well as how much capital has been provided by profitable operations of the company (retained earnings).
Q2-12 A balance sheet reports the assets, liabilities, and equity of an organization. The income statement reports revenues and expenses. The statement of cash flows reports the net cash flows from operating activities, investing activities, and financing activities.
Q2-13The accounting equation, Assets = Liabilities + Equity, illustrates that assets are provided by creditors (liabilities) or by owners (equity). Thus, creditors and owners have claims on a company’s assets.
Q2-14The income statement provides information about how well a company has performed during a period based on the operating activities for that period. These activities may affect cash flows of prior or future periods. The income statement helps decision makers assess the long-run success of a company.
The statement of cash flows describes the cash flows that resulted from current-period operating activities. It provides information about a company’s ability to pay current obligations. A company must generate sufficient cash to pay creditors, suppliers, employees, and other providers of goods and services. Net income, as reported on the income statement, does not ensure short-run survival of a company.
Q2-15Most companies of size have hundreds or thousands of individual accounts. A mere list of accounts and balances would overwhelm the reader with detail and be unlikely to convey any useful information. Accounts and balances are arranged into financial statements for the purpose of conveying information quickly and conveniently. Similar accounts are grouped, such as all revenues, all expenses, all assets, etc. Then, to provide further information, certain groups of accounts are arranged into financial statements. For example, revenues and expenses are matched on the income statement. Assets, liabilities, and equity are grouped on the balance sheet. Account balances are summarized on financial statements because they yield more information in this form.
EXERCISES
E2-1Definitions of all terms are listed in the glossary.
E2-21.Operating activity
2.Financing activity
3.Investing activity
4.Financing activity
5.Investing activity
6.Operating activity
7.Investing activity
8.Financing activity
9.Investing activity
10.Operating activity
E2-3a.I
b.O
c.F
d.O
e.O
f.I
g.F
h.O
i.O
j.F
E2-4
ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed
Capital / Retained
Earnings
Beginning Amounts / 40,000 / + 60,000 / = / 30,000 / + / 50,000 / + 20,000
June 1 / Merchandise Inventory / 15,000
Cash / –15,000
June 15 / Cash / 60,000
Sales Revenue / 60,000
Cost of Goods Sold / –28,000
Merchandise Inventory / –28,000
June 23 / Cash / 250,000
Bank Loan Payable / 250,000
June 25 / Supplies Expense / –2,000
Cash / –2,000
June 28 / Wages Expense / –5,000
Cash / –5,000
June 30 / Equipment / 100,000
Cash / –100,000
June 30 / Utilities Expense / –6,000
Cash / –6,000
Ending Amounts / 222,000 / +147,000 / = / 280,000 / + / 50,000 / + 39,000
E2-5June 1Operating
June 15Operating
June 23Financing
June 25Operating
June 28Operating
June 30Investing
June 30Operating
E2-6
ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed
Capital / Retained
Earnings
Beginning Amounts / 70,000 / + 90,000 / = / 60,000 / + / 60,000 / + 40,000
May 1 / Cash / 10,000
Contributed Capital / 10,000
May 5 / Cash / 35,000
Sales / 35,000
Cost of Goods Sold / –14,000
Merchandise Inventory / –14,000
May 10 / Merchandise Inventory / 45,000
Cash / –45,000
May 15 / Notes Payable / –2,000
Cash / –2,000
May 22 / Equipment / 4,000
Cash / –4,000
May 31 / Utilities Expense / –800
Cash / –800
May 31 / Wages Expense / –7,500
Cash / –7,500
Ending Amounts / 55,700 / + 125,000 / = / 58,000 / + / 70,000 / + 52,700
E2-7May 1Financing
May 5Operating
May 10Operating
May 15Financing
May 22Investing
May 31Operating
May 31Operating
E2-8a.Cash increased $18,000; Owners’ Investment increased $18,000.
The owners invested $18,000 in the company.
b.Equipment increased $12,000; Cash decreased $12,000.
The company purchased equipment using cash.
c.Cash decreased $8,500; Notes Payable decreased $8,500.
The company paid down the balance of a note.
d.Supplies inventory increased $13,500; Cash decreased $13,500.
The company purchased supplies costing $13,500 using cash.
e.Merchandise Inventory decreased $10,000; Cost of Goods Sold increased $10,000.
The company sold merchandise costing $10,000.
f.Cash increased $23,500; Sales Revenue increased $23,500.
The company sold goods for $23,500 cash.
g.Supplies Expense increased $3,000; Supplies inventory decreased $3,000.
The company removed supplies costing $3,000 from inventory and used them.
E2-9
ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed
Capital / Retained
Earnings
Beginning Amounts / 5,000 / = / 1,500 / + / 3,000 / +500
Feb. 2 / Cash / 1,800
Revenues / 1,800
Feb. 3 / Rent Expense / –1,200
Cash / –1,200
Feb. 4 / Cash / –300
Loan Payable / –300
Feb. 4 / Miscellaneous Expense / –35
Cash / –35
Feb. 5 / Cash / 4,250
Revenues / 4,250
Feb. 5 / Equipment / 3,200
Cash / –3,200
Feb. 6 / Wages Expense / –525
Cash / –525
Feb. 6 / Office Supplies Expense / –128
Cash / –128
Ending Amounts / 5,662 / +3,200 / = / 1,200 / + / 3,000 / +4,662
Amelio’s Law Firm
Income Statement
For the First Week of February
Revenues$ 6,050
Rent (1,200)
Miscellaneous (35)
Wages (525)
Office supplies (128)
Net income$ 4,162
E2-10Feb. 2Operating
Feb. 3Operating
Feb. 4Financing
Feb. 4Operating
Feb. 5Operating
Feb. 5Investing
Feb. 6Operating
Feb. 6Operating
E2-11Assets=Liabilities+Owners’ Equity
Cash$1,500
Flowers and Plants26,000
Supplies Inventory4,350
Buildings79,500
Equipment12,750
Notes Payable$57,500
Proprietor’s Capital$66,600
Total$124,100=$57,500+$66,600
E2-12
ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed
Capital / Retained
Earnings
Cash / 220,000
Contributed Capital / 80,000
Bank Loan / 140,000
a. / Equipment / 45,150
Cash / –45,150
b. / Merchandise Inventory / 129,600
Cash / –129,600
c. / Cash / 85,000
Sales / 85,000
Cost of Goods Sold / –43,200*
Merchandise Inventory / –43,200
d. / Wages Expense / –12,300
Rent Expense / –15,500
Utilities Expense / –4,800
Postage Expense / –650
Insurance Expense / –1,290
Cash / –34,540
* $129,600 ÷ 3 = $43,200
E2-13Chang’s Pottery Works
Schedule of Retained Earnings
For the Month Ended November 30
Retained earnings, November 1$ 95,000
Net income for November 15,000
Less: Payment to owners in November (4,000)
Retained earnings, November 30$106,000
E2-14Christmas Cookie Company
Income Statement
For the Month Ended December 31
Sales revenue $234,000
Cost of goods sold (60,000)
Wages expense (97,500)
Utilities expense (24,000)
Net income$ 52,500
E2-15a.Cash flows from financing activities:
Proceeds from owners$ 30,957
Proceeds from issuance of note payable 13,057
Payments of debt (80,323)
Net cash used for financing activities$(36,309)
b.Cash flows from investing activities:
Proceeds from sales of plant and equipment$ 1,986
Additions to plant and equipment (5,379)
Net cash provided by investing activities$ (3,393)
E2-16Cash collected from customers $270,000
Cash paid for merchandise inventory (83,500)
Cash paid for utilities (25,000)
Cash paid for insurance (23,000)
Cash paid to employees (58,000)
Cash paid for postage (7,500)
Net cash from operating activities$ 73,000
E2-17Wages expenseIncome statement
Cost of goods soldIncome statement
Sales revenueIncome statement
Merchandise inventoryBalance sheet
Net incomeIncome statement
Retained earningsBalance sheet
Contributed capitalBalance sheet
Rent expenseIncome statement
CashBalance sheet, Statement of cash flows
Notes payableBalance sheet
E2-18Brothers’ Lawn Service
Income Statement
For the Six Months Ended June 30, 2007
Service revenue$ 12,300
Supplies expense (4,000)
Wages expense (6,000)
Utilities expense (500)
Rent expense (1,000)
Net income$ 800
E2-19Brothers’ Lawn Service
Balance Sheet
At June 30, 2007
Assets
Cash$3,000
Supplies inventory500
Equipment5,000
Total assets$8,500
Liabilities and Owners’ Equity
Notes payable$1,000
Contributed capital6,700
Retained earnings800
Total liabilities and owners’ equity$8,500
E2-20
June 1 / Merchandise Inventory / 15,000Cash / 15,000
June 15 / Cash / 60,000
Sales / 60,000
Cost of Goods Sold / 28,000
Merchandise Inventory / 28,000
June 23 / Cash / 250,000
Bank LoanPayable / 250,000
June 25 / Supplies Expense / 2,000
Cash / 2,000
June 28 / Wages Expense / 5,000
Cash / 5,000
June 30 / Equipment / 100,000
Cash / 100,000
June 30 / Utilities Expense / 6,000
Cash / 6,000
E2-21
May 1 / Cash / 10,000Contributed Capital / 10,000
May 5 / Cash / 35,000
Sales / 35,000
Cost of Goods Sold / 14,000
Merchandise Inventory / 14,000
May 10 / Merchandise Inventory / 45,000
Cash / 45,000
May 15 / Notes Payable / 2,000
Cash / 2,000
May 22 / Equipment / 4,000
Cash / 4,000
May 31 / Utilities Expense / 800
Cash / 800
May 31 / Wages Expense / 7,500
Cash / 7,500
E2-22
Feb 2 / Cash / 1,800Revenues / 1,800
Feb 3 / Rent Expense / 1,200
Cash / 1,200
Feb 4 / LoanPayable / 300
Cash / 300
Feb 4 / Miscellaneous Expense / 35
Cash / 35
Feb 5 / Cash / 4,250
Revenues / 4,250
Feb 5 / Equipment / 3,200
Cash / 3,200
Feb 6 / Wages Expense / 525
Cash / 525
Feb 6 / Office Supplies Expense / 128
Cash / 128
E2-23
Cash / 220,000Contributed Capital / 80,000
Bank Loan / 140,000
a. / Equipment / 45,150
Cash / 45,150
b. / Merchandise Inventory / 129,600
Cash / 129,600
c. / Cash / 85,000
Sales / 85,000
Cost of Goods Sold * / 43,200
Merchandise Inventory / 43,200
d. / Wages Expense / 12,300
Rent Expense / 15,500
Utilities Expense / 4,800
Postage Expense / 650
Insurance Expense / 1,290
Cash / 34,540
* $129,600 ÷ 3 = $43,200
PROBLEMS
P2-1A. / ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed Capital / Retained Earnings
1 / Cash / –5,800
Utilities Expense / –5,800
2 / Cash / 89,460
Sales / 89,460
Cost of Goods Sold / –60,000
Merchandise Inventory / –60,000
3 / Equipment / 28,600
Cash / –28,600
4 / Notes Payable / –4,900
Cash / –4,900
5 / Cash / 65,000
Notes Payable / 65,000
6 / Salaries Expense / –59,430
Cash / –59,430
7 / Maintenance Expense / –11,900
Cash / –11,900
8 / Cash / 48,600
Contributed Capital / 48,600
9 / Supplies Expense / –3,750
Cash / –3,750
B.Financing decisions: When, how much, and where to borrow.
Investing decisions: What property and equipment to purchase and when to purchase it. What future earnings is the investment likely to bring?
P2-21.Operating
2.Operating
3.Investing
4.Financing
5.Financing
6.Operating
7.Operating
8.Financing
9.Operating
P2-3Assets=Liabilities+Equity
Cash$10,000
Merchandise Inventory30,000
Equipment45,000
Notes Payable$20,000
Contributed Capital$35,000
Retained Earnings30,000
Total$85,000=$20,000+$65,000
P2-4A. / ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed Capital / Retained Earnings
June 1 / Cash / 7,000
Contributed Capital / 7,000
June 2 / Rent Expense / –525
Cash / –525
June 7 / Merchandise Inventory / 5,000
Cash / –5,000
June 12 / Advertising Expenses / –800
Cash / –800
June 26 / Cash / 7,500
Sales Revenue / 7,500
Cost of Goods Sold / –4,500
Merchandise Inventory / –4,500
June 30 / Wages Expense / –850
Utilities Expense / –228
Cash / –1,078
Ending Amounts / 7,097 / + 500 / = / 7,000 / + 597
B.Davidson Enterprises
Income Statement
For the Month Ended June 30, 2007
Sales $7,500
Cost of goods sold (4,500)
Rent expense (525)
Advertising (800)
Wages (850)
Utilities (228)
Net income $ 597
C.Davidson Enterprises
Balance Sheet
At June 30, 2007
Assets
Cash$7,097
Merchandise inventory500
Total assets$7,597
Liabilities and Owners’ Equity
Contributed capital$7,000
Retained earnings 597
Total liabilities and owners’ equity$7,597
P2-5June 1Financing
June 2Operating
June 7Operating
June 12Operating
June 26Operating
June 30Operating
P2-6A. / ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed Capital / Retained Earnings
1 / Cash / 3,000
Contributed Capital / 3,000
2 / Cash / 4,000
Notes Payable / 4,000
3 / Merchandise Inventory / 3,500
Cash / –3,500
4 / Cash / 2,500
Sales / 2,500
Cost of Goods Sold / –825
Merchandise Inventory / –825
4 / Commissions Expense / –500
Cash / –500 / *
5 / Notes Payable / –1,500
Cash / –1,500
6 / Retained Earnings / –750
Cash / –750
Ending Amounts / 3,250 / + 2,675 / = / 2,500 / + / 3,000 / + 425
*$2,500 × 0.20 = $500
P2-7 A. / ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed
Capital / Retained Earnings
June 1 / Cash / 750
Contributed Capital / 300
Note Payable—Dad / 450
June 2 / Equipment Rental Expense / –85
Cash / –85
June 3 / Equipment Rental Expense / –135
Cash / –135
June 16 / Cash / 650
Service Revenue / 650
June 16 / Gas and Oil Expense / –67
Cash / –67
June 18 / Advertising Expense / –70
Cash / –70
June 30 / Cash / 507
Service Revenue / 507
June 30 / Oil and Gas Expense / –105
Cash / –105
June 30 / Interest Expense / –5
Note Payable—Dad / –225
Cash / –230
Ending Amounts / 1,215 / = / 225 / + / 300 / + 690
B.Randi’s Lawn-Mowing Service
Income Statement
For the Month Ended June 30
Service revenue $1,157
Equipment rental expense (220)
Gas and oil expense (172)
Advertising expense (70)
Interest expense (5)
Net income$ 690
C.Randi’s Lawn-Mowing Service
Balance Sheet
At June 30
Assets
Cash$1,215
Total assets$1,215
Liabilities and Owners’ Equity
Note payable—Dad$ 225
Contributed capital300
Retained earnings690
Total liabilities and owners’ equity$1,215
D.There is no clear answer. Following are some factors to consider:
1.Was the return on her investment of money and effort satisfactory? Assuming she worked 8 hours per day for about 22 working days in June, her “rate of return” was about $3.92 per hour [$690÷ (8 hours × 22 days)].
2.Would Randi have eventually found a job that paid better?
3.Is $690 a good estimate of what she might make during each of the remaining two months of the summer? Maybe the business is just getting started and the next two months will be better.
P2-8A.1.Jill contributed $5,000 to the business.
2.The company acquired $300 of supplies inventory by paying cash.
3.The company earned $4,200 for providing services.
4.The company paid $450 for utilities consumed.
5.The company paid $500 for transportation expenses.
6.The company paid $700 for insurance.
7.Jill took $1,300 cash from the company for her personal use.
B.The company earned $2,550 ($4,200 −$450 −$500 −$700).
P2-9A.Mar.1Jacqueline contributed $10,000 cash to the business.
3The company borrowed $7,000 by issuing a note payable.
5The company purchased $8,100 of inventory and paid cash.
18The company sold goods costing $7,500 for $15,250 in cash.
18The company paid wages of $650.
23The company paid $2,500 on the note.
31Jacqueline took $2,000 cash from the company for her personal use.
B.1.The company earned $7,100 ($15,250 − $7,500 − $650).
2.Owners’ Equity is $15,100 ($10,000 + $5,100).
P2-101.Owners contributed $15,000 to the business.
2.A bank loan of $6,285 was obtained.
3.Equipment costing $11,000 was purchased. A loan was obtained to purchase the equipment.
4.Services totaling $2,250 were performed.
5.Rent of $400 was paid.
6.Wages of $250 were paid.
7.Internet service costs of $35 were paid.
P2-11A. / ASSETS / = / LIABILITIES / + / OWNERS' EQUITYDate / Accounts / Cash / Other Assets / Contributed Capital / Retained Earnings
1 / Cash / 10,000
Contributed Capital / 10,000
2 / Cash / 30,000
Bank Loan Payable / 30,000
3 / Equipment / 25,000
Cash / –25,000
4 / Merchandise Inventory / 12,000
Cash / –12,000
5 / Cash / 27,000
Sales Revenue / 27,000
6 / Cost of Goods Sold / –10,000
Merchandise Inventory / –10,000
7 / Bank Loan Payable / –300
Cash / –300
8 / Retained Earnings / –800
Cash / –800
Ending Amounts / 28,900 / +27,000 / = / 29,700 / + / 10,000 / +16,200
B.Sand Dune Trading Company
Income Statement
For the Month Ended May 31, 2007
Sales revenue$27,000
Cost of goods sold10,000
Net income$17,000
C.Sand Dune Trading Company
Balance Sheet
At May 31, 2007
Assets
Cash$28,900
Merchandise inventory2,000
Equipment25,000
Total assets$55,900
Liabilities and Owners’ Equity
Bank loan$29,700
Contributed capital10,000
Retained earnings16,200
Total liabilities and owners’ equity$55,900
P2-121.I
2.B
3.B
4.B
5.C
6.I
7.C
8.I, C
9.B
10.C
P2-13Moonbeam Enterprises
Income Statement
For the Month Ended April 30, 2007
Sales revenue $26,000
Cost of goods sold (15,050)
Supplies expense (1,300)
Interest expense (900)
Wage expense (1,500)
Insurance expense (550)
Income tax expense (1,060)
Net income$ 5,640
Moonbeam Enterprises
Balance Sheet
At April 30, 2007
Assets
Cash$ 10,360
Merchandise inventory12,480
Buildings50,000
Land45,000
Total assets$117,840
Liabilities and Owners’ Equity
Notes payable$ 33,000
Contributed capital38,770
Retained earnings46,070
Total liabilities and owners’ equity$117,840
P2-14
ASSETS = / LIABILITIES / +OWNERS' EQUITYDate / Accounts / Cash / Other
Assets / Contributed Capital / Retained Earnings
Beginning Amounts / 90,000 / + 150,000 / = / 80,000 / + / 60,000 / + 100,000
June 3 / Merchandise Inventory / 120,000
Cash / –120,000
June 4 / Retained Earnings / –25,000
Cash / –25,000
June 5 / Cash / 140,000
Sales Revenue / 140,000
Cost of Goods Sold / –112,000
Merchandise Inventory / –112,000
June 5 / Advertising Expense / –9,000
Cash / –9,000
June 6 / Utility Expense / –450
Cash / –450
June 6 / Equipment / 15,000
Cash / –15,000
June 7 / Wages Expense / –12,900
Cash / –12,900
Ending Amounts / 47,650 / +173,000 / =80,000 / +60,000 / +80,650
P2-15June 3Operating