POA- not as hard as you thought 💭: Chapter 16 - Equity in a Sole Proprietor and Company

All right, final last 2 chapters of this mypoateacher.blogspot blog😁

☝Lets move on to accounting for Equity in this chapter. This chapter mainly tests us the various components in the Equities Components in a balance sheet.

We know that:

Ending Equity = Opening Equity + Additional Capital - Drawings + Net profit - Net loss - Dividends( for Companies only)

💨Henceforth lets dive in greater details to how the equities components are adjusted:)

1.Additional Capital

When the owner of the Company contribute additional capital to the business for eg, cash of $5,000, the journal entry is

Dr Cash at bank $5,000

Cr Capital $5,000

Being contribution of Cash $5,000 to the business

☝However, when the owner contribute $10,000 in trade receivables to the business, how is this accounted? You may ask is trade receivables transferrable? Yes it is in fact alot of companies transfer their trade receivables to bank in return for a mortgage from the bank in what we termed as factoring.

Back to the transfer of trade receivable, the journal will be as such below:-

Dr Trade Receivable $10,000

Cr Capital $10,000

2.Drawings

☝When the owner takes out $5,000 cash in the business for his own personal usage, how is this accounted?

We will pass the following journal entry:-

Dr Drawings $5,000 and Cr cash $5,000

Have you wondered how are the Drawings account closed at the end of the period and transfer to capital?

Dr Capital Cr Drawings

3.Profit & losses from Income Statement

💨All losses and profits from the Profit & loss account are transferred to the capital account of a sole proprietor & retained earnings of a company.

Since profit increases the capital/retained earnings while losses reduces the capital/retained earnings account

When it is transfer of profit, the capital/retained earnings account has to be Credited while if it is the transfer of losses, the capital/retained earnings account has to be Debited.

Therefore, transfer of Profit:-

Dr Profit & Loss

Cr Capital/retained earnings

Therefore, transfer of Loss:-

Dr Capital/retained earnings

Cr Profit & Loss

4.Dividends(only for companies)

Normally there are 3 steps when a dividend is announced for a company: -

1. Declaring the dividend;

2.Transfering the dividend to the retained earnings account and

3. Payment of the dividend

💨For declaring the dividend, a company would usually declare its dividend close to the end of the year around Oct or Nov if the year end is 31 Dec.

1. Once a company declare dividend, the journal entry will be:-

Dr Dividends

Cr Dividends Payable

2. Transferring the dividend to the retained earnings account and

A company having passed the 1st declare dividend entry above would need to shift the dividend expense from the income statement to the retained earnings account, this is because dividend are not business/trading expenses and should not be reflected in the income statement. The journal entry will be

Dr Retained earnings

Cr Dividends

3. Payment of the dividend - A company usually pay the dividend after the financial year end unless its for interim dividend or quarterly dividends. Interim dividends are dividends which are paid mid way through the financial year, the payment entry will be as such:

Dr Dividends Payable

Cr Cash at bank

💥💥💥 Important !Things to note:

1. Share capital account and retained earnings account add up to form the " Shareholders Equity"component in the balance sheet.

2. In Issued Share capital account, it only contains the 1.number of shares issued & any 2.additional shares issued normally or through a rights issue. Dividends declared & profits for the year should not be added to issued share capital.

3. In Retained earnings account, only these 2 items are within the account, 1. Profit & Loss transferred & 2. Dividends, any additional issue of shares should not affect the retained earnings account.

A high % of students cannot extinguish the transactions affecting both accounts henceforth often loses mark. Drawings are not applicable to retained earnings as the owner(s) of a company are usually its shareholders and the only way for shareholder returns are the dividends or the share price appreciation.

☝Lets try one of the question on Dividends since dividend is more complex while the rest of the equity components are more on transfer to the capital account at the end of the year😀