sole proprietorship

5/26/2018 Sole Proprietorship

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study objectives

After studying this appendix, you should be able to:

1 Identify the differences in equity accounts between a

corporation and a sole proprietorship.

2 Understand what accounts increase and decrease

owners equity.

appendix

Accounting for

Sole Proprietorships

F

3 Describe the differences between a retained earnin

statement and an owners equity statement.

4 Explain the process of closing the books for a sole

proprietorship.

F-1

Chapter 1 identified three forms of business organization. Two forms, the soleproprietorship and the partnership, were discussed only briefly. Emphasis wasplaced on the corporate form in Chapter 1 as well as in subsequent chapters.

The purpose of this appendix is to discuss and illustrate the accounting forthe operations and financial condition of a sole proprietorship. The primarydifference between accounting and reporting for a sole proprietorship anda corporation involves accounting for equity transactions. Because a soleproprietorship has a single owner rather than numerous stockholders, a soleproprietorship uses a permanent owners capital account, such as Sally Jones,Capital, instead of Common Stock and Retained Earnings. In a sole proprietor-

ship there is no need to separate owners investments from net income retainedfor dividends because the sole proprietor does not declare or receive dividends.Instead, withdrawals by the owner of cash or other assets from the business forpersonal use are recorded in a temporary drawing account. The different equityaccounts are contrasted as shown in Illustration F-1.

Identify the differenc

equity accounts betw

a corporation and a

proprietorship.

Illustration F-1Equity section of thebalance sheetcorpovs. proprietorship

Corporation Sole Proprietorship

Stockholders equity Owners equityCommon stock Owners name, capitalRetained earnings

For purposes of comparing the accounting for a corporation with a sole pro-prietorship, the illustrations in this Appendix F assume a sole proprietorshipowned by R. Neal and named Sierra Company. Except for equity transactions,we use the same accounts, amounts, and transactions as those of SierraCorporation presented in Chapters 1 through 4.

study objective


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Owners Equity ina Sole Proprietorship

The ownership claim on total assets is known as owners equity. It is equal tototal assets minus total liabilities.

INCREASES IN OWNERS EQUITY

In a proprietorship, owners equity is increased by owners investments andrevenues.

Investments by Owner

Investments by owner are the assets the owner puts into the business. Theseinvestments increase owners equity.

Revenues

Revenues are the gross increase in owners equity resulting from businessactivities entered into for the purpose of earning income.

DECREASES IN OWNERS EQUITY

In a proprietorship, owners equity is decreased by owners drawings and expenses.

Drawings

An owner may withdraw cash or other assets for personal use. These withdrawalscould be recorded as a direct decrease of owners equity. However, it is gener-ally considered preferable to use a separate classification called drawings todetermine the total withdrawals for each accounting period. Drawings decrease

owners equity.

Expenses

Expenses are the cost of assets consumed or services used in the process ofearning revenue. They are decreases in owners equity that result from op-erating the business.

In summary, owners equity is increased by an owners investments and byrevenues from business operations. In contrast, owners equity is decreased byan owners withdrawals of assets and by expenses. These relationships are shownin Illustration F-2. Net income results when revenues exceed expenses. A netloss occurs when expenses exceed revenues.

F-2 appendix F Accounting for Sole Proprietorships

Illustration F-2Increases and decreasesin owners equity

Investments by owner

Revenues

Withdrawals by owner

Expenses

Owner's

Equity

DECREASESINCREASES

Understand what accounts

increase and decreaseowners equity.

2study objective


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Recording Transactionsof a Proprietorship

Chapter 3 described the basic steps employed in the accounting process as follows:

Analyze transactions.

Record transactions in the journal.

Post journal entries to the general ledger.

Prepare a trial balance.

These same steps apply to all forms of business. Illustration 3-2 (page 104) pre-sented the impact of Sierras transactions on its accounting equation. Illustra-tion F-3 shows how the same transactions would have been recorded for a soleproprietor. The only differences are related to the accounts used to record equitytransactions. Those differences are highlighted here in red.

Financial Statements for a Proprietorship

Illustration F-3Summary of transact

Assets Liabilities Owners Equity

Prepaid Office Notes Accounts Unearned R. Neal,Cash Supplies Insurance Equipment Payable Payable Revenue Capital

(1) $10,000 $10,000 Investment by

(2) 5,000 $5,000

15,000 5,000 10,000

(3) 5,000 $5,000

10,000 5,000 5,000 10,000

(4) 1,200 $1,200

11,200 5,000 5,000 1,200 10,000

(5) 10,000 10,000 Service Revenue

21,200 5,000 5,000 1,200 20,000

(6) 900 900 Rent Expense

20,300 5,000 5,000 1,200 19,100

(7) 600 $600

19,700 600 5,000 5,000 1,200 19,100

(8) $2,500 $2,500

19,700 2,500 600 5,000 5,000 2,500 1,200 19,100

(10) 500 500 Drawings

19,200 2,500 600 5,000 5,000 2,500 1,200 18,600

(11) 4,000 4,000 Salaries Expens

$15,200 $2,500 $600 $5,000 $5,000 $2,500 $1,200 $14,600

$23,300 $23,300

Financial Statementsfor a Proprietorship

Chapter 4 described accounting for adjusting entries. A sole proprietor makes thesame types of adjustments as a corporation. After recording and posting all of theadjustments, an adjusted trial balance is prepared. Illustrations F-4 (page F-4)and F-5 (page F-5) show how the adjusted trial balance is used to prepare a soleproprietors financial statements.

The primary differences between these statements and those of a corpora-tion (presented in Illustrations 4-23 and 4-24, page 179) relate to the way equityis reported. A sole proprietor prepares an owners equity statement rather thana retained earnings statement and uses different titles for the equity items shownon the balance sheet.

Describe the differen

between a retained

earnings statement a

owners equity statem

study objective


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Closing the Booksof a Proprietorship

At the end of the accounting period, the temporary account balances are trans-ferred to the permanent owners equity account, Owners Capital, through the

preparation of closing entries. Closing entries for a proprietorship formally rec-ognize in the ledger the transfer of net income (or net loss) and owners drawingto owners capital. The results of these entries are shown in the owners equitystatement.

Journalizing and posting closing entries is a required step in theaccounting cycle. (See Illustration 4-27 on page 182 for Sierra Corporation.)

In preparing closing entries for a proprietorship, each income statementaccount could be closed directly to owners capital. However, to do so wouldresult in excessive detail in the permanent owners capital account. Instead, therevenue and expense accounts are closed, in the same manner as for a corpora-tion, to another temporary account, Income Summary. Only the net income ornet loss is transferred from this account to Owners Capital.


SIERRA COMPANYAdjusted Trial Balance

October 31, 2010

CashAccounts ReceivableAdvertising SuppliesPrepaid InsuranceOffice EquipmentAccumulated Depreciation Office EquipmentNotes PayableAccounts PayableInterest PayableUnearned Service RevenueSalaries Payable

$15,2002001,000

5505,000

500

5,200

1,500900505040

$ 405,0002,500

50800

1,20010,000

10,600

$30,190 $30,190

Debit Credit

SIERRA COMPANYIncome Statement

For the Month Ended October 31, 2010

Revenues Service Revenue

Expenses Salaries expense Advertising supplies expense Rent expense Insurance expense Interest expense Depreciation expense

Total expenses

Net income

$5,2001,500

900505040

$10,600

7,740

$ 2,860

SIERRA COMPANYOwners Equity Statement

For the Month Ended October 31, 2010

R. Neal, Capital, October 1Add: Investments by ownerR. Neal, CapitalNet income

$ 010,000

10,000

2,860

12,860

Service RevenueSalaries Expense

Advertising Supplies ExpenseRent ExpenseInsurance ExpenseInterest ExpenseDepreciation Expense

R. Neal, CapitalDrawing

Account

500

$12,360

Less: Drawings

R. Neal, Capital, October 31

To balance sheet

Illustration F-4Preparation of the incomestatement and ownersequity statement from theadjusted trial balance

Explain the process ofclosing the books for a

sole proprietorship.

4study objective


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Closing entries for a proprietorship may be prepared directly from the ad-justed balances in the ledger, from the income statement and balance sheetcolumns of the work sheet, or from the income and owners equity statements.Separate closing entries could be prepared for each nominal account, but thefollowing four entries accomplish the desired result more efficiently:

1. Debit each revenue account for its balance, and credit Income Summary fortotal revenues.

2. Debit Income Summary for total expenses, and credit each expense account

for its balance.

3. Debit Income Summary and credit Owners Capital for the amount of netincome.

4. Debit Owners Capital for the balance in the Owners Drawing account, andcredit Owners Drawing for the same amount.

The four entries are referenced in the diagram of the closing process shown inIllustration F-6 and in the journal entries in Illustration F-7, both on page F-6.The posting of closing entries is shown in Illustration F-8 (page F-7).

If there were a net loss because expenses exceeded revenues, entry 3 inIllustration F-6 would be reversed: Credit Income Summary and debit OwnersCapital.

Closing the Books of a Proprietorship

SIERRA COMPANYAdjusted Trial Balance

October 31, 2010

CashAccounts ReceivableAdvertising SuppliesPrepaid InsuranceOffice EquipmentAccumulated Depreciation Office EquipmentNotes PayableAccounts PayableInterest PayableUnearned Service RevenueSalaries PayableR. Neal, CapitalR. Neal, DrawingService RevenueSalaries ExpenseAdvertising Supplies ExpenseRent ExpenseInsurance ExpenseInterest ExpenseDepreciation Expense

$15,200200

1,000550

5,000

500

5,2001,500

900505040

$ 405,0002,500

50800

1,20010,000

10,600

$30,190 $30,190

Account Debit Credit

SIERRA COMPANYBalance Sheet

October 31, 2010

CashAccounts receivableAdvertising suppliesPrepaid insuranceOffice equipmentLess: Accumulated depreciation Total assets

$5,00040

Assets

Liabilities Notes payable Accounts payable Interest payable Unearned revenue Salaries payable Total liabilities

Owners equity R. Neal, Capital Total liabilities and owners equity

$15,200200

1,000550

4,960

$21,910

Liabilities and Owners Equity

$ 5,000 2,500 50 8001,200

9,550

12,360

$21,910

Capital Balance at Oct. 31from Owners EquityStatement in Illustration F-4

Illustration F-5Preparation of the basheet from the adjus

trial balance

Helpful Hint Owners Drclosed directly to Capital to Income Summary becaOwners Drawing is not aexpense.


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F-6

Illustration F-6Diagram of closing process

Owners Capital is apermanent account;all other accounts aretemporary accounts.

(Individual)Revenues

Income

Summary

2 1

(Individual)Expenses

OwnersCapital

3

OwnersDrawing

4

Key:

Close Revenues to Income Summary.Close Expenses to Income Summary.Close Income Summary to Owners Capital.Close Owners Drawing to Owners Capital.

2

4

1

3

Helpful Hint Income Summaryis a very descriptive title: Totalrevenues are closed to IncomeSummary, total expenses areclosed to Income Summary, andthe balance in the IncomeSummary is a net income ornet loss.

Illustration F-7Closing entries journalized

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Closing Entries

2010 (1)Oct. 31 Service Revenue 10,600

Income Summary 10,600(To close revenue account)

(2)31 Income Summary 7,740

Salaries Expense 5,200Advertising Supplies Expense 1,500Rent Expense 900

Insurance Expense 50Interest Expense 50Depreciation Expense 40

(To close expense accounts)(3)

31 Income Summary 2,860R. Neal, Capital 2,860

(To close net income to owners capital)(4)

31 R. Neal, Capital 500R. Neal, Drawing 500

(To close drawings to owners capital)


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Preparing a Post-Closing TrialBalance for a Proprietorship

After all closing entries are journalized and posted, the post-closing trialbalance is prepared from the ledger. A post-closing trial balance is a list of allpermanent accounts and their balances after closing entries are journalized and

posted. As with a corporation, the purpose of a proprietorship post-closingtrial balance is to prove the equality of the permanent account balancesthat are carried forward into the next accounting period. Since all temporaryaccounts will have zero balances, the post-closing trial balance will containonly permanentbalance sheetaccounts.

Summary of Study Objectives

4,0001,200

Salaries

Expense

5,200

5,200

5,200

(2)

726

900

RentExpense

900(2)

729

50

InsuranceExpense

50(2)

722

40

DepreciationExpense

40(2)

711

50

InterestExpense

50(2)

905

1,500

AdvertisingSupplies Expense

1,500(2)

631

500

R. Neal,Capital

10,0002,860

Bal. 12,360

(3)(4)

10,600

ServiceRevenue

10,600

10,000400200

10,600

(1)

500

R. Neal,Drawing

500(4)

7,7402,860

IncomeSummary

10,600

10,600

10,600

(1)(2)(3)

2

2

3

4

1

Illustration F-8Posting of closing en

Summary of Study Objectives

1 Identify the differences in equity accounts between acorporation and a sole proprietorship. A sole propri-etorship uses a permanent owners equity Capitalaccount instead of Common Stock and Retained Earn-

ings. Withdrawals of cash or other assets by thefor personal use are recorded in a temporary ing account.


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2 Understand what account transactions increase anddecrease owners equity. Investments by the ownerand revenue increase owners equity. Owners draw-ings and expenses decrease owners equity.

3 Describe the differences between a retained earningsstatement and an owners equity statement. A sole pro-

prietor prepares an owners equity statement ratherthan a retained earnings statement. The owners eq-uity statement shows the beginning balance in theowners capital account (instead of retained earnings,

as shown in the retained earnings statement), plus anyinvestments made by the owner, less any drawings (inplace of dividends, shown in the retained earningsstatement).

4 Explain the process of closing the books for a soleproprietorship. In closing the books for a sole propri-

etorship, separate entries are made to close revenuesand expenses to Income Summary, Income Summaryto Owners Capital, and Owners Drawing to OwnersCapital.

Glossary

Drawings (p. F-2) Withdrawal of cash or other assetsfrom a sole proprietorship for the personal use of theowner.

Investments by owner (p. F-2) The assets put into thebusiness by a sole proprietor.

1. What is the basic accounting equation for a soleproprietorship?

2. What are the differences in the equity accounts of asole proprietorship versus those of a corporation?

3. What items affect owners equity, and in what direction?

4. In February 2010, Joe Kirby invested an additional$10,000 in his business, Kirbys Pharmacy, which isorganized as a proprietorship. Kirbys accountant,Lance Jones, recorded this receipt as an increase in

Owners equity (p. F-2) The ownership claim on the to-tal assets of a sole proprietorship.

Owners equity statement (p. F-3) The financial state-

ment prepared for a sole proprietorship to summarize thechanges in owners equity for a specific period of time.

cash revenues. Is this treatment appropriate? Why orwhy not?

5. What are the steps in preparing an owners equitystatement?

6. Identify the account(s) debited and credited in eachof the required closing entries for a sole proprietor-ship, assuming the company has net income for theyear.

Questions

Brief Exercises

BEF-1 Presented below are three business transactions. On a sheet of paper, list theletters (a), (b), (c) with columns for assets, liabilities, and owners equity. For each col-umn, indicate whether the transactions increased (), decreased (), or had no effect(NE) on assets, liabilities, and owners equity.

(a) Invested cash in the business.(b) Withdrawal of cash by owner.(c) Received cash from a customer who had previously been billed for services provided.

BEF-2 Presented below are three transactions. Mark each transaction as affectingowners investment (I), owners drawing (D), revenue (R), expense (E), or not affectingowners equity (NOE).(a) Received cash for services performed(b) Paid cash to purchase equipment(c) Paid employee salaries

BEF-3 For each of the following accounts indicate the effects of (a) a debit and (b) acredit on the accounts and (c) the normal balance of the account.1. Accounts Payable. 4. Accounts Receivable.2. Advertising Expense. 5. B. C. Jardine, Capital.3. Service Revenue. 6. B. C. Jardine, Drawing.

Determine effect oftransactions on basic

accounting equation.

(SO 2)

Determine effect of

transactions on owners

equity.

(SO 2)

Indicate debit and credit

effects and normal balance.

(SO 2)


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Exercises

Analyze transactions acompute net income.

(SO 2)

(b) Increase in O.E. $12,250(c) Net income $2,250

Prepare an owners eq

statement.

(SO 3)

Prepare income statem

owners equity statemand balance sheet.

(SO 1, 2, 3, 4)

Capital, Dec. 31 $98,000

(a) Net loss $3,000

Exercises

EF-1 An analysis of the transactions made by Roberta Mendez & Co., a certifiedpublic accounting firm, for the month of August is shown below. Each increase and de-crease in owners equity is explained.

Accounts Office Accounts Owners Equity

Cash Receivable Supplies Equipment Payable R. Mendez, Capital

1. $12,000 $12,000 Investment

2. 2,000 $5,000 $3,000

3. 750 $750

4. 2,600 $3,700 6,300 Service Revenue

5. 1,500 1,500

6. 2,000 2,000 Drawings

7. 650 650 Rent Expense

8. 450 450

9. 2,900 2,900 Salaries Expense

10. 500 500 Utilities Expense

Legal service revenue2010 $360,000Total expenses2010 211,000Assets, January 1, 2010 85,000Liabilities, January 1, 2010 62,000Assets, December 31, 2010 168,000Liabilities, December 31, 2010 70,000Drawings2010 ?

MOZART COMPANYAdjusted Trial Balance

July 31, 2010

No. Account Titles Debits Credits

101 Cash $ 14,940112 Accounts Receivable 8,780157 Equipment 15,900167 Accumulated Depreciation $ 5,400201 Accounts Payable 4,220

208 Unearned Rent Revenue 1,800301 W.A. Mozart, Capital 45,200306 W.A. Mozart, Drawing 14,000404 Commission Revenue 65,100429 Rent Revenue 6,500711 Depreciation Expense 4,000720 Salaries Expense 55,700732 Utilities Expense 14,900

$128,220 $128,220

Instructions

(a) Describe each transaction that occurred for the month.

(b) Determine how much owners equity increased for the month.(c) Compute the amount of net income for the month.

EF-2 Presented below is information related to the sole proprietorship of Mark Garland,attorney.

Instructions

Prepare the 2010 owners equity statement for Mark Garlands legal practice.

EF-3 The adjusted trial balance of Mozart Company at the end of its fiscal year is:

Instructions

(a) Prepare an income statement and an owners equity statement for the year. Mozartdid not make any capital investments during the year.

(b) Prepare a classified balance sheet at July 31. (b) Total assets $34,220


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Problems

PF-1 On May 1, Dennis Chambers started Skyline Flying School, a company thatprovides flying lessons, by investing $45,000 cash in the business. Following are the as-sets and liabilities of the company on May 31, 2010, and the revenues and expenses forthe month of May.

Prepare income statement,owners equity statement,

and balance sheet.

(SO 1, 2, 3, 4)

(a) Net income $3 ,600Owners equity $46,900Total assets $77,700

(b) Net income $1,200Owners equity $44,500

Prepare financial statements,closing entries, and post-

closing trial balance.

(SO 1, 2, 3, 4)

(a) Net income $13,300Current assets $43,300Current liabilities $22,000

Cash $ 6,500 Notes Payable $30,000Accounts Receivable 7,200 Rent Expense 1,200Equipment 64,000 Repair Expense 400Lesson Revenue 8,600 Fuel Expense 2,500Advertising Expense 500 Insurance Expense 400

Accounts Payable 800

Dennis Chambers made no additional investment in May, but he withdrew $1,700 in cashfor personal use.

Instructions

(a) Prepare an income statement and owners equity statement for the month of Mayand a balance sheet at May 31.

(b) Prepare an income statement and owners equity statement for May assuming thatthe data above need to be adjusted for the following items: (1) $900 of revenue wasearned and billed but not collected at May 31, and (2) $3,300 of fuel expense was in-curred but not paid.

PF-2 The adjusted trial balance columns of the work sheet for Shmi Skywalker Com-pany are as follows.

SHMI SKYWALKER COMPANYAdjusted Trial Balance

For the Year Ended December 31, 2010

Adjusted

Account Trial Balance

No. Account Titles Dr. Cr.

101 Cash 20,800112 Accounts Receivable 15,400126 Supplies 2,300130 Prepaid Insurance 4,800151 Office Equipment 44,000152 Accumulated DepreciationOffice Equipment 18,000200 Notes Payable 20,000201 Accounts Payable 8,000212 Salaries Payable 3,000230 Interest Payable 1,000301 S. Skywalker, Capital 36,000306 S. Skywalker, Drawing 12,000400 Service Revenue 79,000610 Advertising Expense 12,000

631 Supplies Expense 3,700711 Depreciation Expense 6,000722 Insurance Expense 4,000726 Salaries Expense 39,000905 Interest Expense 1,000

Totals 165,000 165,000

Instructions

(a) Prepare an income statement, owners equity statement, and a classified balancesheet. $10,000 of the notes payable become due in 2011. S. Skywalker did not makeany additional investments in the business during 2010.

(b) Prepare the closing entries.


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(c) Post the closing entries. Use the three-column form of account. Income summary isNo. 350.

(d) Prepare a post-closing trial balance.

PF-3 The adjusted trial balance columns of the work sheet for Boss Nass Company,owned by Boss Nass, are as follows.

Problems

(a) Net income $18,800Current assets $33,300Current liabilities $19,500

(d) Post-closing trialbalance $67,300

Prepare financial state

closing entries, and poclosing trial balance.

(SO 1, 2, 3, 4)

Instructions

(a) Prepare an income statement, owners equity statement, and a classified balance sheet(Note: $10,000 of the notes payable become due in 2011.) Boss Nass did not makeany additional investments in the business during the year.

(b) Prepare the closing entries. Use J14 for the journal page.(c) Post the closing entries. Use the three-column form of account. Income Summary is

No. 350.(d) Prepare a post-closing trial balance.

BOSS NASS COMPANYAdjusted Trial Balance

For the Year Ended December 31, 2010

Adjusted

Account Trial Balance

No. Account Titles Dr. Cr.

101 Cash 13,600112 Accounts Receivable 15,400126 Supplies 1,500130 Prepaid Insurance 2,800151 Office Equipment 34,000152 Accumulated DepreciationOffice Equipment 8,000

200 Notes Payable 16,000201 Accounts Payable 6,000212 Salaries Payable 3,000230 Interest Payable 500301 Boss Nass, Capital 25,000306 Boss Nass, Drawing 10,000400 Service Revenue 88,000610 Advertising Expense 12,000631 Supplies Expense 5,700711 Depreciation Expense 4,000722 Insurance Expense 5,000726 Salaries Expense 42,000905 Interest Expense 500

Totals 146,500 146,500

(d) Post-closing trial

balance $87,300


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sole proprietorship

Documents

owners equity statement

owners drawings

owners equityin

equity transactions

decreaseowners equity

owners investments andrevenues

sole proprietorship

sole proprietorship