It is normally said as a general rule in financial accounting that the assets of a company less its liabilities are equal to the equity of that particular company. This means that each entry in the books of accounts of a company has an effect on its assets, liabilities, or equity. It, therefore, follows that for every debit entry, there is a credit entry to counter the effect on the books. This would balance the equation that Assets fewer Liabilities equal to Equity.
In the case of Witten Company, this is its first month of operation and most transactions will touch on the stockholders’ equity since its year of investment. The following transactions will therefore follow. With the $20,000, we debit cash and credit shareholders funds. This is because there is an increase in cash, as well as an increase in shareholders’ funds.
All the other transactions either lead to a cash inflow or a cash outflow. At the end of the day, we compute the net profit or income from these transactions and that would be the net increase or decrease in shareholder’s equity. This is done by basically concentrating on the income and expenditure for that period that is, August 2010.
Below is the computation of net income of Witten Company for the period August 2010.
From the above computation, it is depicted that the increase in shareholders funds in Witten Company is $2,750 which is basically the net of incomes and expenses in the month of August 2010. It is also important to note that this is its first month of operation and therefore it is not liable to tax.
Computation of the net income for the month is as follows:
The net income takes into account cash and credit sales for the period less any sale returns. In this case, there is no sales return. Therefore, the net income of Witten Company is equal to $9,800.
The transactions will either affect cash or retained earnings and are explained as below. The purchase of supplies worth $100 is a cash transaction, which affects cash and purchase. In this case, we debit purchases account and credit cash account. This means that there a decrease in cash and an increase in stocks. For adjusting entry record, $40 of the supplies is an expense to the company and we debit the relevant expense account and credit the stock account.
This has an effect on the profits and as a result, retained earnings of the company. Sales of $1,300 on account are credit sales, which have an effect on cash. Sales have been made but no cash has been realized meaning it is a cash outflow. We debit accounts receivable and credit sales account. Receipt of $800 from customers is a cash item, which affects cash account and not retained earnings. Purchase of equipment worth $2,500 is also a cash transaction, which affects cash account.
We debit equipment account and credit cash account. Depreciation is a profit and loss item, which in turn affects the retained earnings of the company. Debit depreciation account and credit provision for depreciation account. The table is thus completed as below.