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EXERCISE 1
Natalie Koebel spent much of her childhood learning the art of cookie-making from her
grandmother. They passed many happy hours mastering every type of cookie imaginable and
later creating new recipes that were both healthy and delicious. Now at the start of her second
year in college, Natalie is investigating various possibilities for starting her own business as part
of the requirements of the entrepreneurship program in which she is enrolled. A long-time friend
insists that Natalie has to somehow include cookies in her business plan. After a series of
brainstorming sessions, Natalie settles on the idea of operating a cookie-making school. She will
start on a part-time basis and offer her services in people’s homes. Now that she has started
thinking about it, the possibilities seem endless. During the fall, she will concentrate on holiday
cookies. She will offer individual lessons and group sessions (which will probably be more
entertainment than education for the participants). Natalie also decides to include children in her
target market. The first difficult decision is coming up with the perfect name for her business. In
the end, she settles on “Cookie Creations” and then moves on to more important issues.

Solution:
(a) Natalie has a choice between a sole proprietorship and a corporation. A partnership
is not an option since she is the sole owner of the business. A proprietorship is easier to
create and operate because there are no formal procedures involved in creating the
proprietorship. However, if she operates the business as a proprietorship she will
personally have unlimited liability for the debts of the business. Operating the business
as a corporation would limit her liability to her investment in the business. Natalie will in
all likelihood require the services of a lawyer to incorporate. Costs to incorporate as well
as additional ongoing costs to administrate and operate the business as a corporation
may be costly. Also, her taxes would be higher if she incorporates.
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(b) Yes, Natalie will need accounting information to help her operate her business. She
will need information concerning her cash balance on a daily or weekly basis to help her
determine if she can pay her bills. She will need to know the cost of her services so she
can establish her prices. She will need to know revenue and expenses so she can report
her net income for personal income tax purposes, on an annual basis. If she borrows
money, she will need financial statements so lenders can assess the liquidity, solvency,
and profitability of the business. Natalie would also find financial statements useful to
better understand her business and identify any financial issues as early as possible.
Monthly financial statements would be best because they are more timely, but they are
also more work to prepare.

(c) Assets: Cash, Accounts Receivable, Supplies, Equipment, Prepaid

Insurance
Liabilities: Accounts Payable, Unearned Revenue, Notes Payable
Revenue: Teaching Revenue
Expenses: Advertising Expense, Supplies Expense, Travel Expense,
Telephone Expense, Insurance Expense

(d) Natalie should have a separate bank account. This will make it easier to prepare
financial statements for her business. The business is a separate entity from Natalie and
must be accounted for separately.

(e) I recommend that Natalie keep the car as a personal asset and pay for all costs
personally. She should keep track of how many miles she drives for business purposes
versus personal use and determine the percentage of business use versus personal use.
She should keep track of all costs of owning and operating her car including such things
as fuel, insurance, registration, and repairs and maintenance. Then she can multiply the
percentage of business use by the total cost of owning and operating her car to
calculate the amount of expense the business can record for travel. The business will
record this as an expense. Natalie can either reimburse herself for these business
expenses by taking cash out of the business to pay for these costs or she can treat it as
an investment in the business.
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EXERCISE 2

Graham Roofing Company, owned by R. Graham, began operations in May and completed the
following transactions during that first month of operations. Show the effects of the transactions
on the accounts of the accounting equation by recording increases and decreases in the
appropriate columns in the table below. Do not determine new account balances after each
transaction. Determine the final total for each account and verify that the equation is in balance.
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Solution:

EXERCISE 3

If a parcel of land that was originally purchased for $85,000 is offered for sale at $150,000, is
assessed for tax purposes at $95,000, is recognized by its purchasers as easily being worth
$140,000, and is sold for $137,000. What is the effect of the sale on the accounting equation for
the seller?

Solution:
Assets increase $52,000; owner's equity increases $52,000.
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EXERCISE 4

Indicate in the space provided by each item whether it would appear on the Income
Statement (IS), Balance Sheet (BS), or Owner's Equity Statement (OE):

a. Service Revenue g. Accounts Receivable

b. Utilities Expense h. James, Capital
c. Cash i. Equipment
d. Accounts Payable j. Advertising Expense
e. Office Supplies k. James, Drawing
f. Wage Expense l. Notes Payable

Solution
a. IS g. BS
b. IS h. OE, BS
c. BS i. BS
d. BS j. IS
e. BS k. OE
f. IS l. BS

EXERCISE 5

At the beginning of 2008, Clemens Company had total assets of $550,000 and total liabilities of
$330,000. Answer each of the following questions.
1. If total assets increased $60,000 and owner's equity decreased $90,000 during the year,
determine the amount of total liabilities at the end of the year.
2. During the year, total liabilities decreased $75,000 and owner's equity increased $50,000.
Compute the amount of total assets at the end of the year.
3. If total assets decreased $100,000 and total liabilities increased $55,000 during the year,
determine the amount of owner's equity at the end of the year.

Solution:
1. Ending Total Liabilities = ($550,000 + $60,000) – ($550,000 – $330,000 - $90,000)
= $610,000 – $130,000 = $480,000
2. Ending Total Assets = ($330,000 – $75,000) + ($550,000 – $330,000 + $50,000)
= $255,000 + $270,000 = $525,000
3. Ending Owner's Equity = ($550,000 – $100,000) – ($330,000 + $55,000)
= $450,000 – $385,000 = $65,000