Problem 2 - Accounting

Question

Clarendon Interiors is owned and operated by Corey Krum, an interior decorator. In the ledger of Clarendon Interiors, the first digit of the account number indicates its major account classification (1–-assets, 2-liabilities, 3 -owner's equity, 4 -revenues, 5 - expenses). The second digit of the account number indicates the specific account within each of the preceding major account classifications. Match each account number with its most likely account in the list below. The account numbers are \(11,12,13,21,31,32,41,51,52\), and 53 . \(\begin{array}{ll}\text { Accounts: } & \\ \text { Accounts Payable } & \text { Fees Earned } \\ \text { Accounts Receivable } & \text { Land } \\ \text { Cash } & \text { Miscellaneous Expense } \\ \text { Corey Krum, Capital } & \text { Supplies Expense } \\ \text { Corey Krum, Drawing } & \text { Wages Expense }\end{array}\)

Step-by-Step Solution

Answer

Matched accounts: 11 - Cash, 12 - Accounts Receivable, 13 - Land, 21 - Accounts Payable, 31 - Corey Krum, Capital, 32 - Corey Krum, Drawing, 41 - Fees Earned, 51 - Miscellaneous Expense, 52 - Supplies Expense, 53 - Wages Expense.

Step 1: Analyze the Account Number System

The account number format is a two-digit code where the first digit indicates the major classification: 1 for assets, 2 for liabilities, 3 for owner's equity, 4 for revenues, and 5 for expenses. The second digit specifies the particular account within these categories.

Step 2: Match Accounts with Assets (First digit: 1)

Accounts starting with the digit '1' belong to the asset category. The account numbers are 11, 12, and 13. - 11 matches 'Cash' - 12 matches 'Accounts Receivable' - 13 matches 'Land'

Step 3: Match Accounts with Liabilities (First digit: 2)

The account starting with the digit '2' belongs to the liability category. The account number 21 matches 'Accounts Payable'.

Step 4: Match Accounts with Owner's Equity (First digit: 3)

Accounts starting with the digit '3' are for owner's equity. - 31 matches 'Corey Krum, Capital' - 32 matches 'Corey Krum, Drawing'

Step 5: Match Accounts with Revenues (First digit: 4)

The account starting with the digit '4' is for revenues. The account number 41 matches 'Fees Earned'.

Step 6: Match Accounts with Expenses (First digit: 5)

Accounts starting with the digit '5' are for expenses. The account numbers are 51, 52, and 53. - 51 matches 'Miscellaneous Expense' - 52 matches 'Supplies Expense' - 53 matches 'Wages Expense'.

Key Concepts

Accounting Classification

Understanding accounting classification is crucial for any business to maintain organized financial records. Each transaction a business pays or receives is classified into various accounts that reflect the financial status and help in preparing financial statements. These classifications make it easier to track and manage transactions. Typically, account classifications include assets, liabilities, owner's equity, revenue, and expenses. These provide insight into what the business owns, what it owes, the investments made by owners, income earned, and what it has spent over a period. Besides, proper classification enhances decision-making and internal controls.

Asset Accounts

Asset accounts represent resources owned by the business. They provide future economic benefits and are essential for operations. In this exercise, accounts like Cash, Accounts Receivable, and Land are classified under assets.

• Cash: Refers to the money held by the business in physical cash or bank form. It is immediately available for transactions.
• Accounts Receivable: Represents money owed to the business by customers for goods or services provided on credit.
• Land: Refers to the physical property owned by the business used for operational purposes.

Assets are vital as they help generate revenue. Properly tracking and reporting them is crucial for financial stability.

Liability Accounts

Liability accounts are obligations the business owes to outsiders. They represent the company's debts and financial responsibilities. In the exercise, 'Accounts Payable' is an example of a liability. - **Accounts Payable:** This refers to amounts the business owes suppliers for products or services purchased on credit. It is a short-term liability which the company expects to settle within a year. Liabilities are crucial indicators of financial health. They show what the company owes and need to be adequately managed to ensure the business can meet its financial obligations timely, maintaining a good credit record.

Owner's Equity

Owner's equity reflects the owners' residual interest in the business after liabilities are deducted from assets. It essentially represents the owner's claims to the company's resources.

• Corey Krum, Capital: This shows the amount invested by the owner into the business. It’s observed under the owner's equity category because it highlights the owner's financial involvement.
• Corey Krum, Drawing: This signifies withdrawals made by the owner from the business for personal use. It reduces the owner's equity.

Owner's equity is vital as it shows the owner's claim's value after settling all liabilities. It's fundamental in determining the business’s total net worth.

Revenue Accounts

Revenue accounts record the income a business earns from its operations during a specific period. This exercise features 'Fees Earned' as an example. - **Fees Earned:** This represents the income from providing services or selling goods. It is an essential measure of business performance and indicates the company's ability to generate profit. Revenue is critical as it helps assess the success of sales efforts. Monitoring revenue growth is crucial for strategic planning and achieving long-term business goals.

Expense Accounts

Expense accounts track the costs incurred in the course of running a business. They reflect money spent to earn income. This exercise includes Miscellaneous Expense, Supplies Expense, and Wages Expense.

• Miscellaneous Expense: Captures small expenses that do not fit neatly into other categories.
• Supplies Expense: Reflects costs for materials used in day-to-day operations.
• Wages Expense: Represents the expense related to paying employee salaries.

Properly managing expense accounts is essential to ensure profitability. Keeping expenses in check ensures that they do not outpace revenue, safeguarding the financial health of the business.