Chapter 1, Problem 7E

Exercise 1-7 Missing information and recording events

As of December 31, 2018, Moss Company had total cash of $195,000, notes payable of $90,500, and common stock of $84,500. During 2019, Moss earned $42,000 of cash revenue, paid $24,000 for cash expenses, and paid a $3,000 cash dividend to the stockholders.

Required

a. Determine the amount of retained earnings as of December 31, 2018.

b. Create an accounting equation and record the beginning account balances under the appropriate elements.

c. Record the revenue, expense, and dividend events under the appropriate elements of the accounting equation created in Requirement b.

d. Prove the equality of the accounting equation as of December 31, 2019.

e. Identify the beginning and ending balances in the Cash and Common Stock accounts. Explain why the beginning and ending balances in the Cash account are different, but the beginning and ending balances in the Common Stock account remain the same.

To determine

Calculate the amount of retained earnings as of December 31, 2018.

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
$195,000	=	$90,500	+	$84,500	+	$20,000 (1)

Table (1)

Working notes:

1. Calculate the value of retained earnings:

$\begin{array}{c}\text{Retained}\text{earnings}\text{=}\left[\begin{array}{l}\text{Assets}-\text{Liabilities}\left(\text{Note}\text{payable}\right)\\ -\text{Common}\text{stock}\left(\text{Retained}\text{earnings}\right)\end{array}\right]\\ \text{=\$195,000}-\text{\$90,500}-\text{\$84,500}\\ \text{=\$20,000}\end{array}$

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:

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

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

Company M
Effect of 2019 Transactions on the Accounting Equation
Event	Assets	=	Liabilities	+	Stockholders’ Equity
	Cash	=	Notes Payable	+	Common Stock	+	Retained Earnings
Beginning Balances	$195,000	=	$90,500	+	$84,500	+	$20000 (1)

Table (2)

To determine

Record the revenue, expense, and dividend events under appropriate elements of accounting equation that is 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, revenue, expense, and dividend events are recorded in the following manner:

Company M
Effect of 2019 Transactions on the Accounting Equation
Event	Assets	=	Liabilities	+	Stockholders’ Equity
	Cash	=	Notes Payable	+	Common Stock	+	Retained Earnings
Beginning Balances	$195,000	=	$90,500	+	$84,500	+	$20000 (1)
1. Earned Revenue	$42,000	=	NA	+	NA	+	$42,000
2. Paid expenses	($24,000)	=	NA	+	NA	+	($24,000)
3. Paid dividend	($3,000)	=	NA	+	NA	+	($3,000)
Ending Balance	$210,000	=	$90,500	+	$84,500	+	$35,000

Table (2)

To determine

Prove the quality of the accounting equation as of December 31, year 2019.

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:

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

Prove the quality of the accounting equation:

The quality of the accounting equation is proved as the assets side equals the liabilities and stockholders’ equity side.

Asset ($)	=	Liabilities ($) + Stockholders' equity ($)
210,000	=	210,000 (90,500+84,500+35,000)

Table (3)

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 and 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 $195,000 and $ 210,000. The common stock account had the beginning balance of $84,500, and this was not changed during the period. The accounting events of Company M during the year 2019 affected only the cash account and did not affect the common stock account.