Accounting for a Service Business Organized

Accounting for a Service Business Organized as a Proprietorship -Chapter 2- Starting a Proprietorship

As an accountant you will want to find work with a business, so let’s start out with a service business set up as a proprietorship.

What would be classified as a service business? A SERVICE BUSINESS is - Here are a couple of examples of service business - car cleaning service, landscaping service, salon service, baby sitting services, medical service, etc. just to name a few.

In the outline we are going to be learning about Julie Junior who runs a hair and nail service business for her friends. She is often busy styling friends hair for dances and for weekend date nights,

Because Julie Junior works alone she is considered a proprietorship. A PROPRIETORSHIP is -

Julie likes working alone because she gets to make all of the decisions about when she works, what she charges and what styles she uses. The only set back is that Julie doesn’t always have enough money to buy the hair and nail products when she needs them and sometimes she doesn’t come out with the amount of money she expects to have at the end of the month.

Julie decides to learn about keeping track of her business’ finances so that she sees more money coming in and less money being spent. She goes to the high school accounting teacher and asks the teacher for some basic help on keeping track of her money.

The teacher tells Julie about the accounting system and how it is important to keep good records of the money she makes, the money she spends and if any, the money she saves. Then the teacher introduces an equation to help Julie see the financial set up of an organization. The equation is called the accounting equation.

The Accounting Equation (formula) The ACCOUNTING EQUATION is –

Assets = Liabilities + Owner’s Equity What are assets, liabilities and owner’s equity? These key words are always used when talking about money and all organizations have them.

ASSETS are –

LIABILITIES are -

EQUITIES are –

OWNER’S EQUITY -

This means any money or valuable item(s) that the business has ownership of after all liabilities are paid, the owner gets to keep in the business, making the business worth more.

The main thing to remember is that Assets - Liabilities must always = Owner’s Equities, to be in balance (equal).

How does the accounting equation help a business find out how much it’s worth? When a business invests money, spends money, gets money from a customer, or owes someone else money, the value of the owner changes. These changes are called business activities. A business’ activities change the value of assets. Liabilities and owner’s equity. Accountants call the business activities transactions. Next time you are at the bank, listen to how many times the workers use the term transaction. You’ll be amazed.

To keep track of a business’ assets, liabilities and owner’s activities an account is made for each of them.

An ACCOUNT is –

To keep track of the accounts an account title is given. An ACCOUNT TITLE is – Each account has an account balance. An ACCOUNT BALANCE -

The owner of the business is to keep their financial assets in a special account called a capital account. CAPITAL -

Julie will need to set up some accounts for herself. She will need some asset accounts such as cash for when her customers pay her, supplies for the supplies she needs to do peoples hair and nails, and if she were in need of insurance incase someone decided Julie ruined their hair and they wanted to sue Julie, she would want insurance. Most often the account title used with insurance is prepaid insurance, because you always have to pay for insurance before you actually need it or use it.

Julie might also have some liability accounts if she had stores who let her get products on loan, and she paid them back later, when she got paid or maybe she wanted to set up a monthly payment plan, because she didn’t have the total amount of cash she always needed to buy her supplies, which might happen around Homecoming time or Prom time.

She would also want to have a capital account to keep track of the money she puts into the company, the money she pays out.

Julie is going to start using the accounting equation to help her keep track of her money. The very first business activity (transaction) Julie needs to write down is the amount of money she used to start up her business. This transaction would fall under the title “Received Cash from Owner as an Investment.” Let’s put Julies' money to work.

Just before school started, Julie’s junior year, she put (invested) $400 dollars in the bank to get her hair and nail business going, so she would be ready for all of her friends requests by Homecoming.

The transaction would read, August 1, 20--, Received cash from owner as an investment, $ 400.00

To break down the investment into the accounts necessary Julie would want to write down the accounting equation, record the $ 400.00 in the correct accounts and from there figure out the balance of each account changed.

Assets - Liabilities = Owner’s Equity The accounts affected are Assets - Cash - because she received cash Owner’s Equity - Julie Junior, Capital - because she invested money, making the owner, herself, worth more.

Assets - Liabilities = Owner’s Equity

Started with $ 0 Started with $ 0 Started with $ 0 Transaction Transaction New Balance - New Balance = New Balance

The equation started with Julie having no money in the Asset - Cash, Owner’s Equity - Julie Junior, Capital.

When she added + money to Cash - it increased the value of cash. The same with Julie Junior, Capital - when she added money to Julie Junior, Capital - increased the value of Julie Junior, Capital, resulting in Assets $ 400.00 - Liabilities $ 0 = Owner’s Equity $ 400.00. The equation remained in balance.

Once Julie’s had $400.00 dollars in the bank, she could start buying supplies to do the hair and nails. If Julie decided to go to Fantastic Sam’s to get the beauty supplies and she had enough money to pay for the supplies, she would most likely pay with cash.

The transaction would read, August 5, 20--, Paid cash for supplies, $ 50.00

To break down the transaction into the accounts necessary Julie would want to write down the accounting equation, record the $ 50.00 in the correct accounts and from there figure out the balance of each account changed.

The accounts affected are Assets - Supplies - because she now has supplies worth money Assets - Cash - because she paid cash for the supplies, Assets - Liabilities = Owner’s Equity Cash Supplies Julie Junior, Capital Started with Started with Started with $ 0 $ 0 $ 0 Transaction Transaction $ 400.00 + $ 400.00 New Balance - New Balance = New Balance $ 400.00 $ 0 $ 400.00

Balance Started with Still has Balance $ 400.00 $ 0 $ 0 + $ 400.00 Transaction Transaction

New Balance - = =

The equation started with Julie having $ 400.00 in the Asset - Cash, $ 0 in the Asset -Supplies, $ 0 in the Liabilities, and $ 400.00 in the Owner’s Equity - Julie Junior, Capital.

When she paid Cash - it decreased the value of cash to $ 350.00. When she bought supplies it added value to the business Asset - Supplies – it increased by $ 50.00. The Liabilities account remained $ 0 and Julie Junior, Capital, remained $ 400.00. If you take the Assets, Cash + Supplies it = $ 400.00 - Liabilities $ 0 = Owner’s Equity = $ 400.00. The equation still remains in balance.

Now that Julie has money invested in the business and has started buying supplies, she needs to make sure that she covers herself with insurance before she actually starts advertising her business. The insurance comes in handy just incase one of her customers wanted to sue Julie for not doing their hair JUST right, or coloring their hair the wrong shades or for making their nails not strong enough and not only having the acrylic nail break off, but the nail underneath tear off too.

Julie would need to buy the insurance before she started doing peoples hair and nails. After checking around with some different financial intuitions she found a company who would give her liability insurance for $150.00 a month and she would most likely pay with cash.

The transaction would read, August 5, 20--, Paid cash for insurance, $ 150.00 To break down the transaction into the accounts necessary Julie would want to write down the accounting equation, record the $ 150.00 in the correct accounts and from there figure out the balance of each account changed.

The accounts affected are Assets - Insurance - because she now has liability insurance that is worth money Assets - Cash - because she paid cash for the insurance

Assets - Liabilities = Owner’s Equity Cash Supplies Prepaid Julie Junior, Insurance Capital Started with Started with Started with $ 0 $ 0 $ 0 Transaction Transaction $ 400.00 + $ 400.00 New Balance - = New Balance $ 400.00 $ 0 $ 400.00

Balance Started with Still has Balance $ 400.00 $ 0 $ 0 + $ 400.00 Transaction Transaction - $ 50.00 + $ 50.00 $ 0 $ 400.00 New Balance New Balance - = $ 350.00 $ 50.00 $ 0 $ 400.00

Balance Balance Started with $350.00 $50.00 $ 0 $0 $400.00 Transaction Transaction

New Balance New Balance - =

The equation started with Julie having $ 350.00 in the Asset - Cash, $ 50 in the Asset -Supplies, $ 0 in the Liabilities, and $ 400.00 in the Owner’s Equity - Julie Junior, Capital.

When she paid Cash - it decreased the value of cash to $ 200.00. When she bought insurance it added value to the business Asset – Prepaid Insurance – it increased by $ 150.00. The Liabilities account remained $ 0 and Julie Junior, Capital, remained $ 400.00. If you take the Assets, Cash + Supplies + Prepaid Insurance it = $ 400 - Liabilities $ 0 = Owner’s Equity = $ 400.00. The equation still remains in balance.

School just started and the Homecoming Dance is next month. Julie will need to get some really cool hair accessories to show her friends some of the great ideas she has for the dance. She saw an infomercial on T.V. for Hairagami and really liked the hair style ideas and accessories so she decides to buy their promotional kit for $90.00. Julie doesn’t have a credit card to pay for the kit, so she calls the 1 800 number and asks if she can get the kit today putting the amount owed on a store account that she can pay at a later time. She knows that she will get paid after the dance, so she sets up a deal with the Hairagami company that she will get the kit in the next two weeks, however, will not have to pay them until after the dance.

The transaction would read,

August 15, 20--, Bought supplies on Account from Hairagami, $ 90.00

The accounts affected are Assets – Supplies - because she now has hair accessories worth money Liability - Hairagami - because she owes Haiogami money

Assets - Liabilities = Owner’s Equity Cash Supplies Prepaid Hairagami Julie Junior, Insurance Capital Started with Started with Started with $ 0 $ 0 $ 0

Transaction Transaction $ 400.00 + $ 400.00 New Balance = New Balance $ 400.00 $ 0 $ 400.00

Balance Started with Still has Balance $ 400.00 $ 0 $ 0 + $ 400.00 Transaction Transaction - $ 50.00 + $ 50.00 $ 0 $ 400.00 New Balance New Balance = $ 350.00 $ 50.00 $ 0 $ 400.00

Balance Balance Started with $350.00 $ 50.00 $ 0 $ 0 $400.00 Transaction Transaction - $ 150.00 + $ 150.00 $ 0 $ 400.00 New Balance New Balance = $ 200.00 $ 50.00 + $ 150.00 $ 0 $ 400.00

Balance Balance Balance $ 200.00 $ 50.00 $ 150.00 $ 0 $ 400.00 Transaction Transaction

New Balance New Balance =

The equation started with Julie having $ 200.00 in the Asset - Cash, $ 50.00 in the Asset -Supplies, $150.00 in the Asset – Prepaid Insurance, $ 0 in the Liabilities, and $ 400.00 in the Owner’s Equity - Julie Junior, Capital.

When she received the Hair Accessories kit - it increased the value of supplied to $ 90.00. When she bought supplies on account from Hairagami she added money to her new account she set up with Hairagami which added value to the business Liability - Hairagami – it increased by $ 90.00. The Asset account – Cash remained $200, the Asset account – Prepaid Insurance account remained $150.00 and Julie Junior, Capital, remained $ 400.00. If you take the Assets, Cash + Supplies + Prepaid Insurance it = $ 490.00 - Liabilities $ 90.00 = Owner’s Equity = $ 400.00. The equation still remains in balance.

The Homecoming Dance was last week and Julie made some good money. She now needs to pay back Hairagami the $90.00 she has on account with them. Since her friends paid her in cash, Julie will need to write out a check to Hairagami for the 90.00.

The transaction would read, October3, 20--, Paid cash on Account to Hairagami, $ 90.00

The accounts affected are Assets – Cash - because she paid cash on Account to Hairagami Liability - Hairagami - because she pays Hairagami the cash due

Assets - Liabilities = Owner’s Equity Cash Supplies Prepaid Hairagami Julie Junior, Insurance Capital Started with Started with Started with $ 0 $ 0 $ 0 Transaction Transaction $ 400.00 + $ 400.00 New Balance = New Balance $ 400.00 $ 0 $ 400.00

Balance Started with Still has Balance $ 400.00 $ 0 $ 0 + $ 400.00 Transaction Transaction - $ 50.00 + $ 50.00 $ 0 $ 400.00 New Balance New Balance = $ 350.00 $ 50.00 $ 0 $ 400.00

Balance Balance Started with $ 350.00 $ 50.00 $ 0 $ 0 $ 400.00 Transaction Transaction - $ 150.00 + $ 150.00 $ 0 $ 400.00 New Balance New Balance = $ 200.00 $ 50.00 + $ 150.00 $ 0 $ 400.00

Balance Balance Balance $ 200.00 $ 50.00 $ 150.00 $ 0 $ 400.00 Transaction Transaction + $ 90.00 + $ 90.00 New Balance New Balance = $ 200.00 $ 140.00 $ 150.00 $ 90.00 $ 400.00

Balance New Balance $ 200.00 $ 140.00 $ 150.00 $ 90.00 $ 400.00 Transaction Transaction

New Balance New Balance =

The equation started with Julie having $ 200.00 in the Asset - Cash, $ 140.00 in the Asset -Supplies, $ 150.00 in the Asset – Prepaid Insurance, $ 90.00 in the Liabilities, and $ 400.00 in the Owner’s Equity - Julie Junior, Capital.

W hen she paid cash to Liability - Hairagami - it decreased the value of the Hair Kit owed to $ 0, and decreased the business Asset – Cash – it decreased to $ 110.00. The Asset account – Supplies remained $ 140,00 the Asset account – Prepaid Insurance account remained $ 150.00 and Julie Junior, Capital, remained $ 400.00. If you take the Assets, Cash + Supplies + Prepaid Insurance it = $ 400 - Liabilities $ 0 = Owner’s Equity = $ 400.00. The equation still remains in balance.

Reporting Financial Information on a Balance Sheet Julie has paid back Hairagami and the accounting equation for her business still remains in balance. Julie would like to prepare a formal report so she can see all of the details in each of the accounts she as set up (Assets, Liabilities and Owner’s Equity). This financial statement is called a Balance Sheet. A BALANCE SHEET is - a financial statement that reports assets, liabilities, and owner’s equity on a specific date.

The balance sheet has three main sections: 1- Assets, 2- Liabilities, 3- Owner’s Equity

The Body of a Balance Sheet 1- 2- 3-

Preparing a Balance Sheet 1- Write the heading on the three lines at the top of the balance sheet in the center of each line.

2- Prepare the assets section on the LEFT side.

3- Prepare the liabilities section on the RIGHT side.

4- Prepare the owner’s equity section on the RIGHT side.

5- Determine if the balance sheet is in balance.

6- Complete the balance sheet.