Question

Short Answers  Answer in your own words

1. State the accounting equation. Provide an example for each piece of the equation.

2. What are the three TYPES of businesses? Provide an example of each. Please be original and do NOT use companies listed in our textbook.
3. The three types of businesses may be organized into one of the four business entities. What are the four business entities?

4. Of the four business entities, which is most likely to carry the lowest risk to the owner?

5. List which account appears in both Income Statement and Statement of Retained Earnings. List which account appears in both Statement of Retained Earnings and Balance Sheet?

Answer 1

1. Accounting equation which is also known as Balance sheet equation or basic accounting equation. It is the basis of double entry system of accounting. It states that all the assets of any business are either financed by outsider or came in the form of equity. Accounting equation is

Total assets = shareholder's/owners equity + Liabilities.

Total assets includes fixed assets like land & building, plant and machinery and also include current assets like inventory, trade receivables etc.

Shareholder's/ owners equity include the capital, retained earnings etc.

Liabilities can be long term in the form of Term loans from banks or short term like trade creditors, expenses payable etc.

2. The three types of businesses as as under:

A) Service business: A service type of business provides intangible product (products without intangible form). For example professional services like Salon, arvices, accounting services etc.

B) Merchandising business: It is a type of business which buys goods/ products in wholesale price and sells the same in retail price. In this type of business the profit the made by selling the products higher than the purchase cost. For example: Grocery stores and other Retail outlets like Walmart.

C) Manufacturing business: This type of business involves buying the material (known as raw material) with the intention to convert the same to other products for sale (Known as finished goods). There is a transformation of product puchased.

It involves a production process which combines raw material, labour and other factory overheads for manufacturing of goods for sale.

For example Automobiles, engineering products, electronics, furniture etc.

3. The four business entities, in which three types of business may be organised, are as under:

A) Sole proprietorship:

A sole proprietorship is a business owned by only one person. It is easy to set-up and is the least costly among all forms of ownership.

The owner faces unlimited liability; meaning, the creditors of the business may go after the personal assets of the owner if the business cannot pay them.

The sole proprietorship form is usually adopted by small business entities.

B) Partnership:

A partnership is a business owned by two or more persons who contribute resources into the entity. The partners divide the profits of the business among themselves.

In partnership, all partners have unlimited liability.

C) Corporation:

Corporation is a business organization that has a separate legal entity from its owners. Ownership in a stock corporation is represented by shares of stock.

The owners (stockholders) enjoy limited liability but have limited involvement in the company's operations. The board of directors, an elected group from the stockholders, controls the activities of the corporation.

D) Limited Liability company(LLC): LLC is a hybrid form of business organisation that have characteristics of both a corporation and a partnership. The owners have limited liability like in corporation and having lesser restrictions.

4) LLC form of business entity carry the lowest risk to the owner. Since liability of the owners is limited unlike proprietorship or partnership and owner can be involved in business operations also unlike corporation.

5) Net profit appears in both income statement and statement of retained earnings. Net profit is carried to statement of retained earnings from income statement for adding the same in the opening balance of retained earnings.

Closing balance of retained earnings which is a part of equity in balance sheet is the account which appears in both statement of retained earnings and Balance sheet. It is carried from statement of retained earnings after adding the net profit in opening balance of retained earnings and deducting the dividends.