Question

You are interested in establishing a small business. Write a paper between 1,000 and 1,500 words discussing your small-business idea. Include the following:

1. Discuss your business idea and the product or service your small business provides.

2. Identify which accounting method (i.e. cash versus accrual) you plan to use for your business. Why did you select this choice?

3. List six business transactions you expect to incur with your company. State which accounts (from your chart of accounts) are impacted.

4. Discuss how each business transaction (see point 3) impacts your income statement, balance sheet and statement of cash flow.

5. Select one organization type (sole proprietorship, partnership, C-corporation, and S-corporation) for your company and explain why you selected this option.

I have answered questions 1,2 and 5, but need help with figuring out #3 & #4 I am not sure what direction to go in.

Answer 1

Ans: The answer to the 3^rd & 4^th part is as follows :-

PART -3) Although there are many types & kinds of transactions that we come across when running a business, still we wish to list down some common transactions, they could be as follows & the accounts which gets impacted are as :-

a) Purchase of goods & material for production of goods – Purchases can be made in cash or credit. Cash purchases are paid out immediately whereas Credit purchases are paid after some time depending on the terms of credit provided by the supplier, the time period can be 1 month or so.
Accounts Impacted – Purchase A/c & the cash A/c (in case of cash purchases) or the vendor’s account (in case of credit purchases). And when later on creditors are being paid – Creditors A/c & Cash/Bank A/c.

b) Hiring or receiving of services – Many support services are required when we are producing or carrying out any business, like repairs & maintenance, renting-leasing of machines or equipment etc.
Accounts Impacted – Respective expense A/c (Rent, Repairs & maintenance etc.) & the vendor’s A/c if providing services on credit, else the cash/bank A/c for payment of the incurred expenses.

c) Sales – Sales can be made in cash or on credit. Cash is immediately received in cash sales, whereas as in the latter one its received after some time, depending on the terms of sales.
Accounts Impacted –Sales A/c (in both types of sales be it credit or cash), Cash/ Bank A/c in case of Cash sales & Sundry debtors A/c or Accounts receivables for credit sales.

d) Deposit & withdrawal of cash in & to bank respectively.
Accounts Impacted – Cash & bank A/c.

e) Payment of wages & salaries.
Accounts Impacted – Salary payable A/c & Cash/Bank A/c

f) Purchase of fixed assets.
Accounts Impacted – Fixed Assets A/c ( Like Land, Building, Plant, Machinery etc.) & Cash/Bank A/c for its payment or Loan A/c if taken on credit

PART - 4) Explanation of impact of above listed business transactions (in point 3) is as follows:-

a) Purchase of goods & material for production of goods – Here the Purchase A/c would be debited & Cash A/c or Accounts Payable A/c would be credited. If cash a/c is credited then there would be no change in assets as purchases of material is part of current assets in balance sheet, so same is with cash. Whereas in case of credit purchases, Purchase A/c would be debited & equivalent to it Accounts Payable / Creditors A/c would be raised on the liabilities side of the balance sheet.
Purchases will also have impact on income statement in Cost of goods sold. And when the cash is paid, it would result in outflow of cash.

b) Hiring or receiving of services – The expense a/c will be debited and it will affect the Income statement, as expenses are deducted from Revenue to calculate Net Income. The vendor’s A/c would hit the accounts Payable A/c in the Balance sheet, as it would increase when services are received on credit & whenever they are paid, would result in cash outflow & reduction of the A/c’s Payable balance also, nullifying the impact on balance sheet.

c) Sales – When sales are made, it impacts the revenue in Income statement, leading to increase in profit. When cash is received from sales, it results in cash inflow & not showing any change in balance sheet as the debtors / Accounts receivables gets lowered & cash/ Bank increases.

d) Deposit & withdrawal of cash in & to bank respectively – Whenever cash is received from Accounts receivables, its deposited in bank A/c, & whenever cash in hand is low, then cash is withdrawal from bank. It doesn’t affect the balance sheet as both cash-bank are on the assets side, only their respective balances change. And if any accounts payables are paid through cash/bank then both side of the balance sheet gets reduced by that amount.

e) Payment of wages & salaries - When the labour & staff works for running the business, they are paid wages & salaries respectively in return of their hard work. It affects the income statement as the wages & salaries form part of costs of production and are deducted from revenue. When they are being paid, it lowers the cash/ bank balances, hence affecting the balance sheet.

f) Purchase of fixed assets – When the Fixed assets like Plant machinery, Land-building are purchased in cash, then it only affects the assets side of the balance sheet, but if purchased on credit/ loan then the equal amount would be there on the liabilities side, making it balanced.
Also the depreciation on fixed assets is allowed as expense in income statement.

For easy understanding, just follow the basic rule of Accounting Equation :-

ASSETS = LIABILITIES + SHAREHOLDER'S FUND.