Chapter 1, Problem 7E

a.

To determine

Calculate the amount of retained earnings as of December 31, 2014.

Explanation of Solution

Accounting equation: Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\text{Assets = Liabilities + Stockholders’ equity }$

Retained earnings:

Retained earnings are the portion of earnings kept by the business for the purpose of reinvestments, payment of debts, or for future growth.

The amount of retained earnings is calculated as follows:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash	=	Note Payable	+	Common Stock	+	Retained Earnings
$156,000	=	$85,600	+	$52,400	+	$18,000 (1)

Table (1)

Working note 1:

Calculate the value of retained earnings:

$\begin{array}{c}\text{Retained}\text{earnings}\text{=}\left[\begin{array}{l}\text{Assets (cash)}-\text{Liabilities}\left(\text{Note}\text{payable}\right)\\ -\text{Common}\text{stock}\end{array}\right]\\ \text{=\$156,000}-\text{\$85,600}-\text{\$52,400}\\ \text{=\$18,000}\end{array}$

b.

To determine

Create an accounting equation by recording the beginning account balance under appropriate elements.

Explanation of Solution

Accounting equation:

Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\text{Assets = Liabilities + Stockholders’ equity }$

Create an accounting equation by recording the beginning account balance under appropriate elements:

Company P
Effect of 2014 Transactions on the Accounting Equation
Event	Assets	=	Liabilities	+	Stockholders’ Equity
	Cash	=	Notes Payable	+	Common Stock	+	Retained Earnings
Beginning Balances	$156,000	=	$85,600	+	$52,400	+	$18,000

Table (2)

c.

To determine

Recording the revenue, expense, and dividend events under the appropriate elements of the accounting equation created in the part b.

Explanation of Solution

Accounting equation:

Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\text{Assets = Liabilities + Stockholders’ equity }$

Accounting equation is created and the beginning account balances of each account, revenue, expense, and dividend events are recorded in the following manner:

Company P
Effect of 2014 Transactions on the Accounting Equation
Event	Assets	=	Liabilities	+	Stockholders’ Equity
	Cash	=	Notes Payable	+	Common Stock	+	Retained Earnings
Beginning Balances	$156,000	=	$85,600	+	$52,400	+	$18,000
1. Earned Revenue	$36,000	=	NA	+	NA	+	$36,000
2. Paid expenses	($20,000)	=	NA	+	NA	+	($20,000)
3. Paid dividend	($3,000)	=	NA	+	NA	+	($3,000)
Ending Balance	$169,000	=	$85,600	+	$52,400	+	$31,000

Table (2)

d.

To determine

 Prove the equality of the accounting equation as of December 31, 2015.

Explanation of Solution

Accounting equation: Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners.

$\text{Assets = Liabilities + Stockholders’ equity }$

Prove the equality of the accounting equation:

Cash ($)	=	Note Payable ($)	+	Common Stock ($)	+	Retained earnings ($)
169,000		85,600		52,400		31,000

Table (4)

Conclusion

Therefore, the equality of the accounting equation is proved.

e.

To determine

Identify the beginning and ending balances in the cash and common stock accounts and explain the reason for the beginning and ending balances of cash account being different while the beginning and ending balances of common stock being same.

Explanation of Solution

Cash: Cash represents the cash reserves available with the company at a point of time.

Common stock: These are the ordinary shares that a corporation issues to the investors in order to raise funds. In return, the investors receive a share of profit from the profits earned by the corporation in the form of dividend

The reason for the beginning and ending balances of cash account being different and the beginning and ending balances of common stock being same is explained as follows:

The cash account had the beginning and the ending balance of $156,000 and $169,000 respectively. The common stock account had beginning balance of $52,400 and this was not changed during the period. The accounting events of Company P during the 2015 affected only the cash account and did not affect the common stock account.