Common stock is classified as equity, appears in the statement of financial position and its account balance represents the amount contributed by owners of the business as capital (Pratt, 2010, p. 544). Common stock is classified as equity because it is not repaid as a loan and does not have a maturity date. It assists in determining the financial position of a company hence, recorded on the balance sheet. Its balance shows the amount of money paid by the owners of the corporation for its operations, and it changes when a new common stock is issued to add to the already existing one. Common stock account affects the cash account in most occasions because it is paid in cash after issue, though sometimes it may affect other accounts depending on the consideration. Normally, the account has a credit balance because the capital is lent to the corporate by the owners.
Equipment is categorized as an asset and recorded on the balance sheet with their balances representing the value of the assets as at the reporting date. They are sub-classified as a non-current asset because they are used by the corporate for more than one financial year. Also, they can be classified as fixed assets because of their low liquidity nature since a corporate acquires them to be used in the business operations but not for resale. The balance for equipment can be reduced by a sale of part of the equipment as a result of reduced use. They are charged with annual depreciation as an expense, which reduces their book value and reported in the income statement, while their increase results from the purchase of new equipment. The balancing figure in the equipment account is normally a debit balance showing the actual value of the equipment after depreciation and additions for the period. The debit balance of equipment is recorded on the balance sheet as it helps in the coming up of the actual value of the business.
Accounts receivable are classified as an asset and recorded on the balance sheet with its balance showing the exact amount the company owes customers and other debtors (Weil, Schipper, & Francis, 2014, p, 284). Accounts receivable are current assets and are relatively liquid because of the ability of the business to collect them within the same financial year they arise. The balance of the account increases when credit sales of goods and services are made, but decreases when debtors pay part or the whole of the amount owed or returns some of the products sold on credit. Unlike assets classified as non-current, accounts receivable do not depreciate partly because of the short-term existence in the business and also their nature of being valued in monetary terms. Normally, accounts receivable have a debit balance because they are owned by the corporate. Accounts receivable affects the sales accounts when it increases because it results from credit sales and cash account once it reduces because payments are made. However, accounts receivable can reduce when the management of the corporate declares part of the debts as bad or perceive them as part of the provision for bad and doubtful. If a provision for bad and doubtful debt is no longer viewed as one, and the management anticipates that it will be paid, the accounts receivable balance increases.
Accounts payable are liabilities and recorded on the balance sheet, and their balances represent the amount of money the corporate is owed to creditors. The account represents the entire obligations that should be paid within a period of less than one fiscal year and hence they are sub-classified as current liabilities (Weil, Schipper, & Francis, 2014, p. 344). The account normally has a credit balance since it represents an obligation to the enterprise. The balance of the account increases when purchases are made on credit and decreases when the company pays part of the creditors their money. The account can also fall when some of the goods purchased on credit are returned to the lenders because they did not meet the standards or were not requested. The account affects the cost of goods sold when they increase and cash account when they decrease because of payment made to some of the creditors.
Sales are revenue and are recorded in the income statement with their balances representing the totals of credit and cash sales. Sales are classified as revenue because they are the main source of income in a business and recorded in the income statement because they provide the base for the net income generated. Sales are increased by products sold to a customer regardless of whether it is a credit or a cash sale. The account decrease when there is returns inwards or discounts allowed to debtors because of early payments or as a result of bulky purchases. Normally, sales have a credit balance because they are revenues and are not owned by the shareholders rather than the business.
The cost of goods sold is an expense and recorded in the income statement with it balance representing the total cost that was paid on the goods that have been sold. The balance of the account is recorded in the income statement because they help in determining the gross profit generated from the sale of the products sold by the business. It can be used to determine the gross margin that the corporate applies on the goods it stocks. The cost of goods sold increases when goods and services are sold and decreases when there are return inwards. The account affects the inventory account because a sale of goods reduces the amount of inventory in the business.
Retained earnings account is an account that shows the amount of profits that is reinvested instead of distributing to the shareholders. Its balance represents the amount of equity plowed back from the profits made and the higher the value, the healthier a company is financially. The account normally has a credit balance because it is owned by the shareholders but not the corporate (Weil, Schipper, & Francis, 2014, p. 74). Retained earnings account is increased by the net profits earned in a period since they raise the chances of more income being retained rather than being distributed to the owners of the company. The account is reduced by dividends paid because they lower the proportion of the net income that is plowed back into capital. Also, net losses incurred in a period leads to a reduction of the retained earnings.
When merchandise is sold on credit, sales account, account payable account and cost of goods sold accounts increases depending on the value of sales. The sales account and the accounts payable account increases at a value equal to the value of merchandise sold and the sale margin applied by the corporation (Rich, 2012, p. 285). It is because typically when an organization sells merchandise it increases its worth with an aim of making profits and meeting its operational expenses. The goods sold account increases with the exact amount of the cost paid for the acquisition of the merchandise. When merchandise is sold, the inventory account decreases the value of that it was bought.
Pratt, J. (2010). Financial Accounting in an Economic Context. Hoboken, NJ: John Wiley & Sons.
Rich, J. (2012). Cornerstones of Financial & Managerial Accounting. Mason, OH: South-Western/Cengage Learning.
Weil, R., Schipper, K., & Francis, J. (2014). Financial Accounting. Mason, OH: South-Western Cengage Learning.
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