appendix

Accounting for
Sole Proprietorships
study objectives
After studying this appendix, you should be able to:
1 Identify the differences in equity accounts between a
corporation and a sole proprietorship.

3 Describe the differences between a retained earnings

statement and an owners equity statement.

2 Understand what accounts increase and decrease

owners equity.

4 Explain the process of closing the books for a sole

proprietorship.

Chapter 1 identified three forms of business organization. Two forms, the sole
proprietorship and the partnership, were discussed only briefly. Emphasis was
placed on the corporate form in Chapter 1 as well as in subsequent chapters.
The purpose of this appendix is to discuss and illustrate the accounting for
the operations and financial condition of a sole proprietorship. The primary
difference between accounting and reporting for a sole proprietorship and
a corporation involves accounting for equity transactions. Because a sole
proprietorship has a single owner rather than numerous stockholders, a sole
proprietorship uses a permanent owners capital account, such as Sally Jones,
Capital, instead of Common Stock and Retained Earnings. In a sole proprietorship there is no need to separate owners investments from net income retained
for dividends because the sole proprietor does not declare or receive dividends.
Instead, withdrawals by the owner of cash or other assets from the business for
personal use are recorded in a temporary drawing account. The different equity
accounts are contrasted as shown in Illustration F-1.

Corporation

Sole Proprietorship

Stockholders equity
Common stock
Retained earnings

Owners equity
Owners name, capital

For purposes of comparing the accounting for a corporation with a sole proprietorship, the illustrations in this Appendix F assume a sole proprietorship
owned by R. Neal and named Sierra Company. Except for equity transactions,
we use the same accounts, amounts, and transactions as those of Sierra
Corporation presented in Chapters 1 through 4.

F-1

study objective

Identify the differences in

equity accounts between
a corporation and a sole
proprietorship.

Illustration F-1
Equity section of the
balance sheetcorporation
vs. proprietorship

F-2

appendix F Accounting for Sole Proprietorships

Owners Equity in
a Sole Proprietorship
study objective

Understand what accounts

increase and decrease
owners equity.

The ownership claim on total assets is known as owners equity. It is equal to

total assets minus total liabilities.
INCREASES IN OWNERS EQUITY
In a proprietorship, owners equity is increased by owners investments and
revenues.

Investments by Owner
Investments by owner are the assets the owner puts into the business. These
investments increase owners equity.

Revenues
Revenues are the gross increase in owners equity resulting from business
activities entered into for the purpose of earning income.
DECREASES IN OWNERS EQUITY
In a proprietorship, owners equity is decreased by owners drawings and expenses.

Drawings
An owner may withdraw cash or other assets for personal use. These withdrawals
could be recorded as a direct decrease of owners equity. However, it is generally considered preferable to use a separate classification called drawings to
determine the total withdrawals for each accounting period. Drawings decrease
owners equity.

Expenses
Expenses are the cost of assets consumed or services used in the process of
earning revenue. They are decreases in owners equity that result from operating the business.
In summary, owners equity is increased by an owners investments and by
revenues from business operations. In contrast, owners equity is decreased by
an owners withdrawals of assets and by expenses. These relationships are shown
in Illustration F-2. Net income results when revenues exceed expenses. A net
loss occurs when expenses exceed revenues.

Illustration F-2
Increases and decreases
in owners equity

INCREASES

DECREASES

Investments by owner

Withdrawals by owner

Owner's
Equity
Revenues

Expenses

Financial Statements for a Proprietorship

F-3

Recording Transactions
of a Proprietorship
Chapter 3 described the basic steps employed in the accounting process as follows:
Analyze transactions.
Record transactions in the journal.
Post journal entries to the general ledger.
Prepare a trial balance.
These same steps apply to all forms of business. Illustration 3-2 (page 104) presented the impact of Sierras transactions on its accounting equation. Illustration F-3 shows how the same transactions would have been recorded for a sole
proprietor. The only differences are related to the accounts used to record equity
transactions. Those differences are highlighted here in red.
Illustration F-3
Summary of transactions

Cash

Assets

Liabilities

Owners Equity
Prepaid
Office
Notes
Accounts
Unearned
R. Neal,
Supplies Insurance Equipment Payable Payable Revenue Capital

(1) $10,000
(2) 5,000

5,000

5,000

5,000

5,000

1,200

10,000
10,000 Service Revenue

5,000

5,000

1,200

20,000
900 Rent Expense

5,000

5,000

1,200

19,100

5,000

5,000

1,200

19,100

(3)

15,000
5,000
10,000
1,200

5,000

(4)

11,200
(5) 10,000

(6)

21,200
900

(7)

20,300
600

$5,000

$600

19,700

600

$1,200

$2,500

(8)

$10,000 Investment by owner

$5,000

10,000

10,000

$2,500

5,000

5,000

2,500

1,200

19,100
500 Drawings

19,200
4,000

2,500

600

5,000

5,000

2,500

1,200

(11)

18,600
4,000 Salaries Expense

$15,200

$2,500

$600

$5,000

$5,000

$2,500

$1,200

$14,600

$23,300

2,500

19,700
500

600

(10)

$23,300

Financial Statements
for a Proprietorship
Chapter 4 described accounting for adjusting entries. A sole proprietor makes the
same types of adjustments as a corporation. After recording and posting all of the
adjustments, an adjusted trial balance is prepared. Illustrations F-4 (page F-4)
and F-5 (page F-5) show how the adjusted trial balance is used to prepare a sole
proprietors financial statements.
The primary differences between these statements and those of a corporation (presented in Illustrations 4-23 and 4-24, page 179) relate to the way equity
is reported. A sole proprietor prepares an owners equity statement rather than
a retained earnings statement and uses different titles for the equity items shown
on the balance sheet.

study objective

Describe the differences

between a retained
earnings statement and an
owners equity statement.

F-4

appendix F Accounting for Sole Proprietorships

SIERRA COMPANY
Adjusted Trial Balance
October 31, 2010
Account

Debit

Cash
$15,200
Accounts Receivable
200
Advertising Supplies
1,000
Prepaid Insurance
550
Office Equipment
5,000
Accumulated Depreciation
Office Equipment
Notes Payable
Accounts Payable
Interest Payable
Unearned Service Revenue
Salaries Payable
R. Neal, Capital
500
Drawing
Service Revenue
Salaries Expense
5,200
Advertising Supplies Expense 1,500
Rent Expense
900
Insurance Expense
50
Interest Expense
50
Depreciation Expense
40
$30,190

SIERRA COMPANY
Income Statement
For the Month Ended October 31, 2010

Credit

Revenues
Service Revenue

40
5,000
2,500
50
800
1,200
10,000

Expenses
Salaries expense
Advertising supplies expense
Rent expense
Insurance expense
Interest expense
Depreciation expense

$10,600

$5,200
1,500
900
50
50
40

Total expenses

7,740

Net income

$ 2,860

10,600

$30,190

SIERRA COMPANY
Owners Equity Statement
For the Month Ended October 31, 2010
R. Neal, Capital, October 1
Add: Investments by owner
R. Neal, Capital
Net income

0
10,000
10,000
2,860
12,860

Less: Drawings
R. Neal, Capital, October 31

500
$12,360

To balance sheet

Illustration F-4
Preparation of the income
statement and owners
equity statement from the
adjusted trial balance

Closing the Books

of a Proprietorship
study objective
Explain the process of
closing the books for a
sole proprietorship.

At the end of the accounting period, the temporary account balances are transferred to the permanent owners equity account, Owners Capital, through the
preparation of closing entries. Closing entries for a proprietorship formally recognize in the ledger the transfer of net income (or net loss) and owners drawing
to owners capital. The results of these entries are shown in the owners equity
statement.
Journalizing and posting closing entries is a required step in the
accounting cycle. (See Illustration 4-27 on page 182 for Sierra Corporation.)
In preparing closing entries for a proprietorship, each income statement
account could be closed directly to owners capital. However, to do so would
result in excessive detail in the permanent owners capital account. Instead, the
revenue and expense accounts are closed, in the same manner as for a corporation, to another temporary account, Income Summary. Only the net income or
net loss is transferred from this account to Owners Capital.

Closing the Books of a Proprietorship

SIERRA COMPANY
Balance Sheet
October 31, 2010

SIERRA COMPANY
Adjusted Trial Balance
October 31, 2010
Account

Debit

Cash
$15,200
Accounts Receivable
200
Advertising Supplies
1,000
Prepaid Insurance
550
Office Equipment
5,000
Accumulated Depreciation
Office Equipment
Notes Payable
Accounts Payable
Interest Payable
Unearned Service Revenue
Salaries Payable
R. Neal, Capital
500
R. Neal, Drawing
Service Revenue
5,200
Salaries Expense
1,500
Advertising Supplies Expense
900
Rent Expense
50
Insurance Expense
50
Interest Expense
40
Depreciation Expense
$30,190

F-5

Credit

40
5,000
2,500
50
800
1,200
10,000
10,600

$30,190

Assets
Cash
Accounts receivable
Advertising supplies
Prepaid insurance
Office equipment
$5,000
Less: Accumulated depreciation
40
Total assets

$15,200
200
1,000
550
4,960
$21,910

Liabilities and Owners Equity

Liabilities
Notes payable
Accounts payable
Interest payable
Unearned revenue
Salaries payable
Total liabilities
Owners equity
R. Neal, Capital
Total liabilities and
owners equity

$ 5,000
2,500
50
800
1,200
9,550
12,360
$21,910

Capital Balance at Oct. 31

from Owners Equity
Statement in Illustration F-4

Illustration F-5
Preparation of the balance
sheet from the adjusted
trial balance

Closing entries for a proprietorship may be prepared directly from the adjusted balances in the ledger, from the income statement and balance sheet
columns of the work sheet, or from the income and owners equity statements.
Separate closing entries could be prepared for each nominal account, but the
following four entries accomplish the desired result more efficiently:
1. Debit each revenue account for its balance, and credit Income Summary for
total revenues.
2. Debit Income Summary for total expenses, and credit each expense account
for its balance.
3. Debit Income Summary and credit Owners Capital for the amount of net
income.
4. Debit Owners Capital for the balance in the Owners Drawing account, and
credit Owners Drawing for the same amount.
The four entries are referenced in the diagram of the closing process shown in
Illustration F-6 and in the journal entries in Illustration F-7, both on page F-6.
The posting of closing entries is shown in Illustration F-8 (page F-7).
If there were a net loss because expenses exceeded revenues, entry 3 in
Illustration F-6 would be reversed: Credit Income Summary and debit Owners
Capital.

Helpful Hint Owners Drawing is

closed directly to Capital and not
to Income Summary because
Owners Drawing is not an
expense.

(Individual)
Expenses

(Individual)
Revenues

2
Income
Summary

3
Owners
Capital

Owners Capital is a
permanent account;
all other accounts are
temporary accounts.

Key:
1 Close Revenues to Income Summary.
2 Close Expenses to Income Summary.
3 Close Income Summary to Owners Capital.
4 Close Owners Drawing to Owners Capital.

Illustration F-6
Diagram of closing process

Owners
Drawing

GENERAL JOURNAL
Date

Account Titles and Explanation

Debit

Credit

Closing Entries
2010
Oct. 31

31
Illustration F-7
Closing entries journalized

Helpful Hint Income Summary

is a very descriptive title: Total
revenues are closed to Income
Summary, total expenses are
closed to Income Summary, and
the balance in the Income
Summary is a net income or
net loss.
F-6

31

31

(1)
Service Revenue
Income Summary
(To close revenue account)
(2)
Income Summary
Salaries Expense
Advertising Supplies Expense
Rent Expense
Insurance Expense
Interest Expense
Depreciation Expense
(To close expense accounts)
(3)
Income Summary
R. Neal, Capital
(To close net income to owners capital)
(4)
R. Neal, Capital
R. Neal, Drawing
(To close drawings to owners capital)

10,600
10,600

7,740
5,200
1,500
900
50
50
40

2,860
2,860

500
500

Summary of Study Objectives

Advertising
Supplies Expense
1,500

(2)

Depreciation
Expense
40

(2)

F-7

Service
Revenue

631

(1)

1,500

10,600

10,000
400
200

10,600

10,600

711

40
Income
Summary

Insurance
Expense

722

50

50

(2)

Salaries
Expense
4,000
1,200

(2)

5,200

(2)

7,740
2,860

(1)

10,600

10,600

10,600

726

5,200

R. Neal,
Capital

5,200

Rent
Expense
900

(2)
(3)

(4)

500

(3)

10,000
2,860

Bal.

12,360

729

900
4

Interest
Expense

905

50

50

(2)

R. Neal,
Drawing
500

(4)

500

Preparing a Post-Closing Trial

Balance for a Proprietorship

Illustration F-8
Posting of closing entries

After all closing entries are journalized and posted, the post-closing trial
balance is prepared from the ledger. A post-closing trial balance is a list of all
permanent accounts and their balances after closing entries are journalized and
posted. As with a corporation, the purpose of a proprietorship post-closing
trial balance is to prove the equality of the permanent account balances
that are carried forward into the next accounting period. Since all temporary
accounts will have zero balances, the post-closing trial balance will contain
only permanentbalance sheetaccounts.

Summary of Study Objectives

1

Identify the differences in equity accounts between a

corporation and a sole proprietorship. A sole proprietorship uses a permanent owners equity Capital
account instead of Common Stock and Retained Earn-

ings. Withdrawals of cash or other assets by the owner

for personal use are recorded in a temporary Drawing account.

F-8

appendix F Accounting for Sole Proprietorships

Understand what account transactions increase and

decrease owners equity. Investments by the owner
and revenue increase owners equity. Owners drawings and expenses decrease owners equity.

Describe the differences between a retained earnings

statement and an owners equity statement. A sole proprietor prepares an owners equity statement rather
than a retained earnings statement. The owners equity statement shows the beginning balance in the
owners capital account (instead of retained earnings,

as shown in the retained earnings statement), plus any

investments made by the owner, less any drawings (in
place of dividends, shown in the retained earnings
statement).

Explain the process of closing the books for a sole

proprietorship. In closing the books for a sole proprietorship, separate entries are made to close revenues
and expenses to Income Summary, Income Summary
to Owners Capital, and Owners Drawing to Owners
Capital.

Glossary
Drawings (p. F-2) Withdrawal of cash or other assets
from a sole proprietorship for the personal use of the
owner.
Investments by owner (p. F-2) The assets put into the
business by a sole proprietor.

Owners equity (p. F-2) The ownership claim on the total assets of a sole proprietorship.
Owners equity statement (p. F-3) The financial statement prepared for a sole proprietorship to summarize the
changes in owners equity for a specific period of time.

Questions
1. What is the basic accounting equation for a sole
proprietorship?

cash revenues. Is this treatment appropriate? Why or

why not?

2. What are the differences in the equity accounts of a

sole proprietorship versus those of a corporation?

5. What are the steps in preparing an owners equity

statement?

3. What items affect owners equity, and in what direction?

6. Identify the account(s) debited and credited in each

of the required closing entries for a sole proprietorship, assuming the company has net income for the
year.

4. In February 2010, Joe Kirby invested an additional

$10,000 in his business, Kirbys Pharmacy, which is
organized as a proprietorship. Kirbys accountant,
Lance Jones, recorded this receipt as an increase in

Brief Exercises
Determine effect of
transactions on basic
accounting equation.

(SO 2)

Determine effect of
transactions on owners
equity.

(SO 2)

Indicate debit and credit

effects and normal balance.

(SO 2)

BEF-1 Presented below are three business transactions. On a sheet of paper, list the
letters (a), (b), (c) with columns for assets, liabilities, and owners equity. For each column, indicate whether the transactions increased (), decreased (), or had no effect
(NE) on assets, liabilities, and owners equity.
(a) Invested cash in the business.
(b) Withdrawal of cash by owner.
(c) Received cash from a customer who had previously been billed for services provided.
BEF-2 Presented below are three transactions. Mark each transaction as affecting
owners investment (I), owners drawing (D), revenue (R), expense (E), or not affecting
owners equity (NOE).
(a) Received cash for services performed
(b) Paid cash to purchase equipment
(c) Paid employee salaries
BEF-3 For each of the following accounts indicate the effects of (a) a debit and (b) a
credit on the accounts and (c) the normal balance of the account.
1. Accounts Payable.
4. Accounts Receivable.
2. Advertising Expense.
5. B. C. Jardine, Capital.
3. Service Revenue.
6. B. C. Jardine, Drawing.

Exercises

F-9

Exercises
EF-1 An analysis of the transactions made by Roberta Mendez & Co., a certified
public accounting firm, for the month of August is shown below. Each increase and decrease in owners equity is explained.
Accounts
Office
Accounts
Receivable Supplies Equipment Payable

Cash
1. $12,000
2.
2,000
3.
750
4.
2,600
5.
1,500
6.
2,000
7.
650
8.
450
9.
2,900
10.

$3,700

$750

$5,000

$3,000
1,500

450
500

Analyze transactions and

compute net income.

(SO 2)

Owners Equity
R. Mendez, Capital
$12,000

Investment

6,300

Service Revenue

2,000
650

Drawings
Rent Expense

2,900
500

Salaries Expense
Utilities Expense

Instructions
(a)
Describe each transaction that occurred for the month.
(b) Determine how much owners equity increased for the month.
(c) Compute the amount of net income for the month.

(b) Increase in O.E. $12,250

(c) Net income
$2,250

EF-2 Presented below is information related to the sole proprietorship of Mark Garland,
attorney.

Prepare an owners equity

statement.

(SO 3)
Legal service revenue2010
Total expenses2010
Assets, January 1, 2010
Liabilities, January 1, 2010
Assets, December 31, 2010
Liabilities, December 31, 2010
Drawings2010

$360,000
211,000
85,000
62,000
168,000
70,000
?

Instructions
Prepare the 2010 owners equity statement for Mark Garlands legal practice.
EF-3

The adjusted trial balance of Mozart Company at the end of its fiscal year is:
MOZART COMPANY
Adjusted Trial Balance
July 31, 2010
No.

Account Titles

Debits

101
112
157
167
201
208
301
306
404
429
711
720
732

Cash
Accounts Receivable
Equipment
Accumulated Depreciation
Accounts Payable
Unearned Rent Revenue
W.A. Mozart, Capital
W.A. Mozart, Drawing
Commission Revenue
Rent Revenue
Depreciation Expense
Salaries Expense
Utilities Expense

$ 14,940
8,780
15,900

Capital, Dec. 31 $98,000

Prepare income statement,
owners equity statement,
and balance sheet.

(SO 1, 2, 3, 4)
Credits

5,400
4,220
1,800
45,200

14,000
65,100
6,500
4,000
55,700
14,900
$128,220

$128,220

Instructions
(a) Prepare an income statement and an owners equity statement for the year. Mozart
did not make any capital investments during the year.
(b) Prepare a classified balance sheet at July 31.

(a) Net loss

$3,000

(b) Total assets $34,220

F-10

appendix F Accounting for Sole Proprietorships

Problems
Prepare income statement,
owners equity statement,
and balance sheet.

(SO 1, 2, 3, 4)

PF-1 On May 1, Dennis Chambers started Skyline Flying School, a company that
provides flying lessons, by investing $45,000 cash in the business. Following are the assets and liabilities of the company on May 31, 2010, and the revenues and expenses for
the month of May.
Cash
Accounts Receivable
Equipment
Lesson Revenue
Advertising Expense

$ 6,500
7,200
64,000
8,600
500

Notes Payable
Rent Expense
Repair Expense
Fuel Expense
Insurance Expense
Accounts Payable

$30,000
1,200
400
2,500
400
800

Dennis Chambers made no additional investment in May, but he withdrew $1,700 in cash
for personal use.
(a) Net income
$ 3,600
Owners equity $46,900
Total assets $ 77,700
(b) Net income
$1,200
Owners equity $44,500
Prepare financial statements,
closing entries, and postclosing trial balance.

Instructions
(a) Prepare an income statement and owners equity statement for the month of May
and a balance sheet at May 31.
(b) Prepare an income statement and owners equity statement for May assuming that
the data above need to be adjusted for the following items: (1) $900 of revenue was
earned and billed but not collected at May 31, and (2) $3,300 of fuel expense was incurred but not paid.
PF-2 The adjusted trial balance columns of the work sheet for Shmi Skywalker Company are as follows.

(SO 1, 2, 3, 4)

SHMI SKYWALKER COMPANY

Adjusted Trial Balance
For the Year Ended December 31, 2010
Adjusted
Trial Balance

Account
No.

Account Titles

Dr.

101
112
126
130
151
152
200
201
212
230
301
306
400
610
631
711
722
726
905

Cash
Accounts Receivable
Supplies
Prepaid Insurance
Office Equipment
Accumulated DepreciationOffice Equipment
Notes Payable
Accounts Payable
Salaries Payable
Interest Payable
S. Skywalker, Capital
S. Skywalker, Drawing
Service Revenue
Advertising Expense
Supplies Expense
Depreciation Expense
Insurance Expense
Salaries Expense
Interest Expense

20,800
15,400
2,300
4,800
44,000

Totals

(a) Net income

$13,300
Current assets $43,300
Current liabilities $22,000

Cr.

18,000
20,000
8,000
3,000
1,000
36,000
12,000
79,000
12,000
3,700
6,000
4,000
39,000
1,000
165,000

165,000

Instructions
(a) Prepare an income statement, owners equity statement, and a classified balance
sheet. $10,000 of the notes payable become due in 2011. S. Skywalker did not make
any additional investments in the business during 2010.
(b) Prepare the closing entries.

Problems

(c) Post the closing entries. Use the three-column form of account. Income summary is
No. 350.
(d) Prepare a post-closing trial balance.
PF-3 The adjusted trial balance columns of the work sheet for Boss Nass Company,
owned by Boss Nass, are as follows.

(d) Post-closing trial

balance
$87,300
Prepare financial statements,
closing entries, and postclosing trial balance.

(SO 1, 2, 3, 4)

BOSS NASS COMPANY

Adjusted Trial Balance
For the Year Ended December 31, 2010
Adjusted
Trial Balance

Account
No.

Account Titles

Dr.

101
112
126
130
151
152
200
201
212
230
301
306
400
610
631
711
722
726
905

Cash
Accounts Receivable
Supplies
Prepaid Insurance
Office Equipment
Accumulated DepreciationOffice Equipment
Notes Payable
Accounts Payable
Salaries Payable
Interest Payable
Boss Nass, Capital
Boss Nass, Drawing
Service Revenue
Advertising Expense
Supplies Expense
Depreciation Expense
Insurance Expense
Salaries Expense
Interest Expense

13,600
15,400
1,500
2,800
34,000

Totals

Cr.

8,000
16,000
6,000
3,000
500
25,000
10,000
88,000
12,000
5,700
4,000
5,000
42,000
500
146,500

146,500

Instructions
(a) Prepare an income statement, owners equity statement, and a classified balance sheet
(Note: $10,000 of the notes payable become due in 2011.) Boss Nass did not make
any additional investments in the business during the year.
(b) Prepare the closing entries. Use J14 for the journal page.
(c) Post the closing entries. Use the three-column form of account. Income Summary is
No. 350.
(d) Prepare a post-closing trial balance.

F-11

(a) Net income

$18,800
Current assets $33,300
Current liabilities $19,500

(d) Post-closing trial

balance
$67,300