Chapter 2, Problem 3AE

a.

To determine

Record the events in the accounting equation and provide the suitable titles for the retained earnings amount.

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.

$\text{Assets = Liabilities + Stockholders' Equity}$

Record the effect of the event in the accounting equation.

Table (1)

b.

To determine

Prepare the income statement, statement of changes in stockholders’ equity, statement of cash flows, and balance sheet for the year 1 accounting period.

Explanation of Solution

Income statement:

This is a financial statement that shows the net income earned or net loss suffered by Incorporation through reporting all the revenues earned and expenses incurred by the company over a specific period of time. An income statement is also known as an operations statement, an earnings statement, a revenue statement, or a profit and loss statement. The net income is the excess of revenue over expenses.

Prepare the income statement to calculate the net income.

Incorporation M
Income statement
For the year ended 31st December, Year 1
Particulars	Amount ($)	Amount ($)
Revenue	$56,000
Total revenue (A)		$56,000
Less: Expenses
Utility expense	$2,500
Salaries expense	$10,000
Total expenses (B)		$12,500
Net income $\left(\text{A-B}\right)$		$43,500

Table (2)

Stockholders’ equity statement:

Stockholders’ equity statement shows the events and transaction that cause changes in the stockholders’ equity account during the accounting period. Stockholders’ equity statement starts with the beginning balances, shows the changes that occurred during the accounting year and end with the ending balances of the components of the stockholders’ equity account.

Statement of changes in the stockholders’ equity:

This statement reflects whether the components of stockholders’ equity have increased or decreased during the period.

Prepare the statement of changes in the stockholders’ equity.

Incorporation M
Statement of changes in stockholders’ equity
For the year ended 31st December, Year 1
Particulars	Amount ($)	Amount ($)
Beginning common stock	$0
Add: Issued common stock	$20,000
Ending common stock		$20,000
Beginning retained earnings	$0
Add: Net income	$43,500
Less: Dividends	($2,000)
Ending retained earnings		$41,500
Total stockholders’ equity		$61,500

Table (3)

Cash Flow Statement:

Cash Flow Statement is a fundamental financial statement that renders valuable information regarding the cash inflows or the cash receipts of a business and the cash outflows or cash payments for a specific period of time.

Prepare the statement of cash flows.

Incorporation M
Statement of cash flows
For the year ended 31st December, Year 1
Particulars	Amount ($)	Amount ($)
Cash Flow From Operating Activities
Cash Received from Customers	$48,000
Cash Paid for Expenses	($2,500)
Net Cash Flow from Operating Activities		$45,500
Cash Flow From Investing Activities	$0
Cash flows from investing activities
Issue of stocks	$20,000
Dividends paid	($2,000)
Net cash flow from financing activities		$18,000
Net change in cash		$63,500
Add: Beginning cash balance		$0
Ending cash balance		$63,500

Table (4)

Balance sheet:

This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors..

Prepare the year 1 balance sheet as of 31^st December.

Incorporation M
Balance sheet
As of 31st December, Year 1
Particulars	Amount ($)	Amount ($)
Assets
Cash	$63,500
Accounts receivable	$8,000
Total assets		$71,500
Liabilities
salaries payable	$10,000
Total liabilities		$10,000
Stockholders’ equity
Common stock	$20,000
Retained earnings	$41,500
Total stockholders' equity		$61,500
Total liabilities and stockholders' equity		$71,500

Table (5)

c.

To determine

Explain the reason for the difference in the net income and the amount of net cash flow from the operating activities.

Explanation of Solution

Reason for the difference:

Net income is the difference between the revenue and expenses incurred, irrespective of the cash received or paid. Cash flow from operating activities is the difference between the cash received and the payment of cash made for the operating activities. The amount revenue earned is $56,000, whereas only $48,000 is received in cash. Similarly, $12,500 is the amount of expenses incurred, out of which payment is made for the only $2,500. This causes the difference in the amount of net income and cash flow from operating activities.