Financial Accounting: Practice Problems and Applications

Financial Accounting Practice Questions and Applications

1. Preparation of Financial Statements for a Service Business

This section focuses on preparing core financial statements for a service business at the end of an accounting period. The statements include the income statement, statement of owner's equity, and balance sheet.

• Income Statement: Summarizes revenues and expenses to determine net income or net loss for a specific period.

• Statement of Owner's Equity: Shows changes in the owner's capital account, including investments, withdrawals, and net income or loss.

• Balance Sheet: Presents the financial position of the business at a specific date, listing assets, liabilities, and owner's equity.

Example: Given account balances for Wilson Towing Service as of June 30, 2023, students are required to:

1. Prepare the income statement for the month ending June 30, 2023.

2. Prepare the statement of owner's equity, considering an $11,000 withdrawal during June.

3. Prepare the balance sheet as of June 30, 2023.

Key Formulae:

• Net Income = Total Revenues - Total Expenses

• Ending Owner's Equity = Beginning Owner's Equity + Investments + Net Income - Withdrawals

• Assets = Liabilities + Owner's Equity

Additional info: These are foundational exercises in financial accounting, reinforcing the structure and interrelation of the three main financial statements.

2. Accounting for Sole Proprietorships and Personal vs. Business Transactions

This section explores the distinction between business and personal transactions, the impact of liability, and the preparation of a balance sheet for a sole proprietorship.

• Sole Proprietorship: A business owned and operated by one individual, where there is no legal distinction between the owner and the business.

• Personal vs. Business Transactions: Only business transactions are recorded in the accounting records of the business. Personal transactions of the owner are not included.

• Liability Exposure: In a sole proprietorship, the owner has unlimited personal liability for business debts and obligations.

Example: Shawn Steele, a realtor, operates as a sole proprietor. Students are asked to:

1. Identify liability exposure and the effect of the sole proprietorship structure on personal liability.

2. Distinguish between personal and business items in a list of transactions.

3. Prepare a balance sheet as of November 30, 2022.

Key Points:

• Business assets and liabilities are reported on the balance sheet; personal assets and liabilities are not.

• Personal liability means the owner's personal assets may be used to satisfy business debts.

HTML Table: Classification of Transactions

Transaction	Business or Personal	Reported on Balance Sheet?
Note payable for land	Business	Yes
Personal mortgage on residence	Personal	No
RE/MAX Ltd. franchise fee	Business	Yes
Personal bank account	Personal	No
Business bank account	Business	Yes

Additional info: Understanding the separation of business and personal finances is crucial for accurate financial reporting and legal protection.

3. Accounting for New Business Operations and Transaction Classification

This section covers the initial accounting for a new business, including the classification of transactions and their effects on the accounting equation.

• Accounting Equation: The fundamental equation of accounting is$\text{Assets} = \text{Liabilities} + \text{Owner's Equity}$.

• Transaction Classification: Transactions are classified as business transactions, business-related but not recorded, or personal transactions not recorded by the business.

Example: Jon Conlin, CPA, starts a new accounting business. Students are asked to:

1. Classify each event as a business transaction, business-related but not recorded, or personal transaction.

2. Analyze the effects of each event on the accounting equation.

HTML Table: Example Transaction Classification

Date	Event	Classification
4	Received $100,000 cash from partners	Business transaction
5	Paid $5,000 cash for rent	Business transaction
6	Paid $1,000 cash for stationery	Business transaction
10	Sold 20,000 shares of Royal Bank stock	Personal transaction
12	Transferred $25,000 cash from sale of stock to business bank account	Business transaction

Key Steps in Analyzing Transactions:

1. Identify the accounts affected (assets, liabilities, owner's equity).

2. Determine the increase or decrease in each account.

3. Ensure the accounting equation remains balanced after each transaction.

Additional info: This exercise reinforces the importance of proper transaction classification and the impact of each transaction on the financial position of a business.