The corporation

1. AEach shareholder must pay the remaining debt out of personal assets.✘
2. BShareholders can lose what they invested, but their personal assets are protected.✔
3. CThe debt disappears, because a corporation is a separate legal entity.✘
4. DThe shareholders’ personal assets can be taken, because a corporation and its owners are the same entity.✘
5. EShareholders must pay the remaining debt in proportion to the number of shares they own.✘

B. A corporation is a separate legal entity, so its liabilities are not the liabilities of its owners, and a shareholder’s loss is limited to the amount invested. Being a separate entity protects the owners, but it does not make the debt go away: the corporation still owes it, which is why option C is wrong.

A = L + SHE · 1 of 3 — assets

1. AThe company earned $70,000 of revenues by selling bread to its customers.✘
2. BThe company owes $5,000 to a flour supplier for goods it has already received.✘
3. CThe company owns an oven that it bought for $25,000 and still uses.✔
4. DThe owner paid $40,000 into the business in exchange for stock.✘
5. EThe company paid $6,000 of dividends to its owner during the year.✘

C. An asset is a resource the company owns or controls that will provide a future benefit, and the oven is exactly that. Option B is an obligation and option D is an owner’s claim, while options A and E belong to the income statement and the statement of retained earnings rather than to the balance sheet.

A = L + SHE · 2 of 3 — liabilities

1. AThe company earned $70,000 of revenues by selling bread to its customers.✘
2. BThe company owes $5,000 to a flour supplier for goods it has already received.✔
3. CThe company owns an oven that it bought for $25,000 and still uses.✘
4. DThe owner paid $40,000 into the business in exchange for stock.✘
5. EThe company paid $6,000 of dividends to its owner during the year.✘

Use the same five options as Question 2.

B. A liability is an obligation that arose from a past transaction and will be settled by an outflow of resources, and the bakery has already received the flour it must pay for. The owner’s $40,000 in option D is also money the company received, but an owner is not a lender, so that amount is equity rather than a liability.

A = L + SHE · 3 of 3 — shareholders’ equity

1. AThe company earned $70,000 of revenues by selling bread to its customers.✘
2. BThe company owes $5,000 to a flour supplier for goods it has already received.✘
3. CThe company owns an oven that it bought for $25,000 and still uses.✘
4. DThe owner paid $40,000 into the business in exchange for stock.✔
5. EThe company paid $6,000 of dividends to its owner during the year.✘

Use the same five options as Question 2.

D. Equity has only two sources: what the owners put in, and the profits the company has earned and kept. Option D is the first of those, contributed capital. Option A raises equity only after it has run through net income into retained earnings, and option E reduces retained earnings, so neither is itself an equity account.

A = L + SHE · the residual

1. AIts shareholders’ equity is $65,000.✘
2. BIts shareholders’ equity is $115,000.✔
3. CIts shareholders’ equity is $180,000.✘
4. DIts shareholders’ equity is $245,000.✘
5. EIts shareholders’ equity cannot be determined without more information.✘

B. Equity is the residual, so it is found by subtraction: $180,000 − $65,000 = $115,000. It is never counted up on its own.

The statements · 1 of 2

1. AThey appear on the income statement, as an expense.✘
2. BThey appear on the statement of retained earnings, subtracted after net income.✔
3. CThey appear on the balance sheet, as a liability.✘
4. DThey appear on the income statement and on the balance sheet.✘
5. EThey do not appear on any of the three statements.✘

B. Dividends are a distribution of profit rather than a cost of operating the business, so they never enter net income. They reduce retained earnings one line below it.

The statements · 2 of 2

1. AThe balance sheet reports the revenues and expenses of a period.✘
2. BNet income is added to beginning retained earnings on the statement of retained earnings.✔
3. CEnding retained earnings is reported at the bottom of the income statement.✘
4. DDividends are subtracted on the income statement to arrive at net income.✘
5. EContributed capital increases whenever the company earns net income.✘

B. Net income is the one number that crosses from the income statement into the statement of retained earnings. The balance sheet reports a point in time rather than a period, dividends never touch net income, and earnings raise retained earnings rather than contributed capital.

Q8 · Harbor Books