Problem 8 - Accounting

Question

Identify each of the following accounts of Universal Services Co. as asset, liability, owner's equity, revenue, or expense, and state in each case whether the normal balance is a debit or a credit. a. Accounts Payable f. Fees Earned b. Accounts Receivable g. Office Equipment c. Cash h. Rent Expense d. Cindy Yost, Capital i. Supplies e. Cindy Yost, Drawing j. Wages Expense

Step-by-Step Solution

Answer

Assets are debit, and liabilities and revenues are credit accounts.

Step 1: Understanding Account Types

Understand the five types of accounts in accounting: assets, liabilities, owner's equity, revenues, and expenses. Assets are resources owned by a company; liabilities are obligations; owner's equity is the owner's share; revenues are earnings; and expenses are costs incurred.

Step 2: Classify Accounts

Match each account to its type based on its function and usual nature. For example, liabilities include accounts like "Accounts Payable," while expenses include "Rent Expense."

Step 3: Determine Normal Balance

Identify the normal balance of each account. Assets, expenses, and the drawing account typically have a normal debit balance, whereas liabilities, owner's equity, and revenues usually have a normal credit balance.

Step 4: Apply to Exercise

Place each item in the exercise into its correct category and state the normal balance: a. Accounts Payable (Liability, Credit) b. Accounts Receivable (Asset, Debit) c. Cash (Asset, Debit) d. Cindy Yost, Capital (Owner's Equity, Credit) e. Cindy Yost, Drawing (Contra Owner's Equity, Debit) f. Fees Earned (Revenue, Credit) g. Office Equipment (Asset, Debit) h. Rent Expense (Expense, Debit) i. Supplies (Asset, Debit) j. Wages Expense (Expense, Debit)

Key Concepts

Assets and Liabilities

In accounting, it is important to distinguish between assets and liabilities, as they represent two fundamental components of a company's financial position.

• Assets refer to resources that a company owns and are expected to provide future economic benefits. Examples include cash, accounts receivable, office equipment, and supplies. Assets are crucial because they help a business operate effectively and gain revenue.
• Liabilities, on the other hand, are obligations that the company needs to repay in the future. They represent what the company owes to others. Common examples include accounts payable, which are amounts a company must pay to suppliers for goods or services received.

Understanding the difference between assets and liabilities helps in assessing the financial health of a company. Generally, assets lead to inflows of cash (benefits), while liabilities require outflows (obligations). It’s important to track these carefully to ensure that liabilities do not exceed assets, which would indicate financial trouble.

Normal Balance

Every account in accounting has a normal balance, which is the side (debit or credit) that increases the account's value.

• For assets and expenses, the normal balance is a debit. This means that when these accounts increase, you record the transaction on the debit side. For example, when a company receives cash or incurs an expense, these accounts will be debited.
• Conversely, for liabilities, owner’s equity, and revenues, the normal balance is a credit. Thus, these accounts increase on the credit side. For instance, when a company earns income, the revenue account is credited.

This system helps ensure accuracy in the accounting records, as it conforms to the double-entry accounting method. Each transaction must have equal debits and credits, maintaining the accounting equation in balance at all times.

Owner's Equity

Owner's equity represents the owner's interest in the company after liabilities are subtracted from assets. It can be seen as the net worth or book value of the business.

• The main components of owner's equity are the capital provided by the owner and accumulated earnings not distributed as dividends.
• In accounting, owner's equity typically increases with profits and capital contributions and decreases with losses and withdrawals.

The 'Cindy Yost, Capital' account reflects the total amount of capital invested by the owner, while 'Cindy Yost, Drawing' represents withdrawals made by the owner. Keeping track of these accounts helps in understanding how much of the business's resources actually belong to the owner, which is crucial for business valuation and decision-making.

Revenues and Expenses

Revenues and expenses are the backbone of a company's income statement. They determine the financial performance of a business over a particular period.

• Revenues refer to the income generated from normal business operations, such as selling goods or providing services. For instance, 'Fees Earned' is a type of revenue account that tracks income from services provided by Universal Services Co.
• Expenses, on the other hand, are the costs incurred in the course of earning revenues. They include costs such as rent, wages, and utilities. Accounts like 'Rent Expense' and 'Wages Expense' represent these outlays.

The relationship between revenues and expenses dictates the profitability of the business. When revenues exceed expenses, the business makes a profit; when the opposite is true, it incurs a loss. Therefore, managing both efficiently is essential for achieving financial success.