Starting the business: answer key
Answer key: the accepted entries with the amounts of the worksheet, and why.
Convention: United States (US textbooks)
Owner invests cash to start the business
To start a sole proprietorship, the owner deposits $20,000.00 of personal savings into the business’s new bank account.
Assumptions: This is the opening contribution that starts the business: it is recorded directly in the owner’s capital.
Account Debit Credit Cash $20,000.00 Owner’s Capital $20,000.00 Why
Cash increases by $20,000.00 (US charts use Cash for money in the bank) and the owner’s claim on the business increases in Owner’s Capital. Common Stock is used only by corporations.
Owner contributes a machine to start the business
To start a workshop as a sole proprietorship, the owner contributes a machine from personal property to the business. Its fair value is $12,000.00.
Assumptions: This is the opening contribution that starts the business: it is recorded directly in the owner’s capital, at the fair value stated.
Account Debit Credit Equipment $12,000.00 Owner’s Capital $12,000.00 Why
An asset contributed by the owner is recorded at its fair value: Equipment increases by $12,000.00 and so does Owner’s Capital. No cash moves and nothing is owed to anyone.
Owner invests cash and a delivery van
To start a store as a sole proprietorship, the owner puts $3,000.00 in currency into the store’s cash register and contributes a delivery van from personal property, with a fair value of $15,000.00.
Assumptions: Both are the opening contribution that starts the business: they are recorded directly in the owner’s capital. The van is recorded at the fair value stated.
Account Debit Credit Cash $3,000.00 Vehicles $15,000.00 Owner’s Capital $18,000.00 Why
Cash increases by $3,000.00 and Vehicles by $15,000.00; the owner’s total contribution ($18,000.00) is credited to Owner’s Capital. A compound entry with two debits and one credit records both assets at once.
Receiving a bank loan
The business borrows $30,000.00 from its bank, signing a 5-year note payable; the bank pays the money into the business’s bank account. The whole principal is due at maturity.
Assumptions: The bank charges no fees. Interest will be paid later and is not part of this entry.
Account Debit Credit Cash $30,000.00 Notes Payable $30,000.00 Why
Cash increases by $30,000.00, and the written promise to repay the bank is a liability, Notes Payable. Interest is an expense only as time passes, so nothing is recorded for it today.
Repaying the principal of a bank loan
A one-year note payable to the bank matures today. The business pays the principal of $10,000.00 from its bank account.
Assumptions: The interest is paid in a separate transfer and is not part of this entry.
Account Debit Credit Notes Payable $10,000.00 Cash $10,000.00 Why
Repaying the principal settles the liability: Notes Payable is debited and Cash credited with $10,000.00. No expense arises, because borrowed money that is returned is not a cost; only the interest is.
Paying a loan installment: principal plus interest
The business pays this month’s installment on a 12-month note payable to its bank from its bank account: $1,500.00 of principal and $45.00 of interest.
Assumptions: No interest had been accrued for this month before the payment.
Account Debit Credit Notes Payable $1,500.00 Interest Expense $45.00 Cash $1,545.00 Why
The principal part ($1,500.00) reduces Notes Payable; the interest ($45.00) is the cost of borrowing for the month, Interest Expense. Cash decreases by the whole installment ($1,545.00).
Owner withdraws cash for personal use
The owner of the business, a sole proprietor, withdraws $1,500.00 from the business’s bank account for personal use.
Assumptions: During the year the business records the owner’s withdrawals in a separate account, not directly in capital. The owner draws no salary from the business.
Account Debit Credit Owner’s Drawings $1,500.00 Cash $1,500.00 Why
Owner’s Drawings is debited and Cash credited with $1,500.00. A withdrawal is not an expense: it reduces the owner’s equity, and Owner’s Drawings is closed to Owner’s Capital at year end.
Owner takes goods from stock for personal use
The owner of an appliance store, a sole proprietor, takes a dishwasher from the store’s inventory for use at home. It cost the store $600.00.
Assumptions: Perpetual inventory: each sale also records its cost of goods sold. The goods are recorded at cost. Sales and use taxes are ignored.
Account Debit Credit Owner’s Drawings $600.00 Inventory $600.00 Why
Goods taken by the owner are a withdrawal, not a sale: Owner’s Drawings is debited and Inventory credited at cost ($600.00). No revenue and no cost of goods sold are recorded.
Owner pays a business expense personally
The owner of a store, a sole proprietor, pays a $480.00 invoice for repairs to the store’s air conditioning from a personal bank account. The invoice is made out to the business.
Assumptions: The business will not repay the owner: the payment is an additional investment by the owner.
Account Debit Credit Repairs Expense $480.00 Owner’s Capital $480.00 Why
The repair is a business expense, so Repairs Expense is debited with $480.00. The business’s cash did not move: the owner paid, which increases Owner’s Capital.
Issuing common stock at par for cash
A newly formed corporation issues 6000 shares of common stock with a par value of $10.00 per share, at par. The stockholders pay the full amount in cash.
Assumptions: The shares are fully paid at once. Organization costs are ignored.
Account Debit Credit Cash $60,000.00 Common Stock $60,000.00 Why
The corporation receives 6000 × $10.00 = $60,000.00 in cash. Issued at par, the whole amount is Common Stock; nothing goes to Paid-in Capital in Excess of Par. Owner’s Capital is for a sole proprietorship, not a corporation.
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