Problem 13 - Accounting Principles

Question

On the last day of the period, Jim Otto Company buys a \(\$ 900\) machine on credit. This transaction will affect the: a. income statement only. b. balance sheet only. c. income statement and owner's equity statement only. d. income statement, owner's equity statement, and balance sheet.

Step-by-Step Solution

Answer

The transaction affects the balance sheet only.

Step 1: Understand the Transaction Type

The exercise describes a purchase of a machine for $900 on credit. This is important to note because purchasing on credit means no immediate cash exchange takes place. Instead, the company incurs a liability.

Step 2: Determine the Financial Statements Affected

Since the machine is a long-term asset, the purchase will increase the assets on the balance sheet. Additionally, buying on credit means that liabilities (accounts payable) also increase on the balance sheet.

Step 3: Analyze the Impact on Income Statement and Owner's Equity

Purchasing a machine does not impact the income statement immediately because it is a capital expenditure, not an expense. It also does not affect the owner's equity statement right away, as it does not involve owner's contributions or profit distribution.

Step 4: Summarize the Impact of the Transaction

Only the balance sheet is affected by this transaction. Assets are increased due to the acquisition of a machine, and liabilities are increased due to the credit purchase.

Key Concepts

Assets

Assets are resources owned by a company that have future economic value. They are expected to benefit the business in the long term. In the context of the Jim Otto Company, the machine they purchased becomes an asset. This is because it will be used to operate the business and generate revenue over several years. Understanding assets involves looking at different types, including:

• Current Assets: Easily converted to cash, usually within a year, such as cash, accounts receivable, and inventory.
• Non-current Assets: Also known as long-term assets, such as machinery, buildings, and land, which are not readily converted to cash.

The machine falls under non-current assets because it will not be converted to cash within a year. Instead, it will be used for longer periods to help generate business income. It's important to note how assets are recorded on the balance sheet; they are listed based on their liquidity but non-current assets often make up the core operational capacity of a business.

Liabilities

Liabilities represent obligations that a company must settle in the future. They arise from past transactions and may require the outflow of resources. When Jim Otto Company purchased the machine on credit, it incurred a liability. This is because the company owes this amount to another party and must pay it in the future. Key points about liabilities include:

• Current Liabilities: Obligations due within a year, such as accounts payable and short-term loans.
• Long-term Liabilities: Debts not due within the current year, like bonds payable or long-term loans.

The purchase on credit led to an increase in current liabilities since it's expected to be paid off in a short period. Understanding liabilities is crucial because they impact a company's financial health and cash flow. A high level of liabilities compared to assets might suggest financial risk, affecting company valuation and investor confidence.

Capital Expenditure

Capital expenditure, often abbreviated as "CapEx," refers to funds used by a company to acquire, upgrade, and maintain physical assets like property, buildings, or equipment. When Jim Otto Company decided to buy the machine, it engaged in capital expenditure. Characteristics of capital expenditure include:

• Long-term Investments: Unlike regular expenses, CapEx items provide value for more than one year.
• Balance Sheet Impact: Recorded as an asset rather than an immediate expense since it benefits multiple years.

CapEx is crucial for business growth and expansion. It helps improve the company's operational capacity, leading to increased production and revenue. However, it requires careful planning and budgeting as it involves significant investment. It's also important to effectively track these expenditures to ensure they contribute to the company's strategic goals and do not lead to financial strain.