Page 47 - Accounting Principles (A Business Perspective)

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• The accounting equation is Assets = Liabilities + Stockholders’ equity.
• The left side of the equation represents the left side of the balance sheet and shows things of value

owned by the business.
• The right side of the equation represents the right side of the balance sheet and shows who provided
the funds to acquire the things of value (assets).
• Some transactions affect only balance sheet items: assets (such as cash, accounts receivable, and
equipment), liabilities (such as accounts payable and notes payable), and stockholders’ equity (capital

stock). Other transactions affect both balance sheet items and income statement items (revenues,
expenses, and eventually retained earnings).
• Exhibit 2 (Part A) and Exhibit 4 (Part A) show the effects of business transactions on the accounting
equation.
• The income statement appears in Exhibit 3 (Part A) and Exhibit 4 (Part C).

• The statement of retained earnings appears in Exhibit 3 (Part B).
• The balance sheet appears in Exhibit 3 (Part C) and Exhibit 4 (Part B).
• The equity ratio is the stockholders’ equity divided by total equities (or total assets).
• The equity ratio shows the percentage that assets would have to shrink before a company would become
insolvent (liabilities exceed assets).

Appendix: A comparison of corporate accounting with accounting for a sole proprietorship and a partnership
Some textbook authors use a sole proprietorship and a partnership form of business ownership to illustrate
accounting concepts and practices. In a survey of users and nonusers of our text, we learned that the majority
preferred the corporate approach because most students will probably work for or invest in corporations. Also,
many small businesses operate as corporations because of the investors’ desire for limited liability.
This appendix briefly describes the differences in accounting for these three forms of business ownership. The
major difference is in the stockholders’ equity or owner’s equity section of the balance sheet.

As you learned in this chapter, the stockholders’ equity section of the balance sheet for a corporation consists of
capital stock and retained earnings. The owner’s equity section of the balance sheet for a sole proprietorship
consists only of the owner’s capital account. The owner’s equity section of a partnership is similar to that of a single
proprietorship except that it shows a capital account and its balance for each partner.
Corporation Sole Proprietorship Partnership
Stockholders' Owner's equity: Partners' capital:
equity: John Smith, John Smith,
Capital stock...$100,000 Capital....$150,000 Capital............ $75,000
Retained Sam Jones,
earnings..... 50,000 Capital............ 75,000
Total..................$150,000 $150,000 $150,000
The stockholders’ equity section of a corporate balance sheet can become more complex as you will see later in
the text. However, the items in the owner’s equity section of the balance sheets of a sole proprietorship and a
partnership always remain as just shown. In a sole proprietorship, the owner’s capital balance consists of the
owner’s investments in the business, plus cumulative net income since the beginning of the business, less any
amounts withdrawn by the owner. Thus, all of the amounts in the various stockholders’ equity accounts for a
corporation are in the owner’s capital account in a single proprietorship. In a partnership, each partner’s capital

Accounting Principles: A Business Perspective 48 A Global Text