Balance Sheets: Understanding Sole Proprietorship

What is a balance sheet?

• A financial statement that shows a company's revenue and expenses

• A financial statement that shows a company's assets, liabilities, and owner's equity

• A document that outlines a company's business plan

• A report that details a company's cash flow

Answer explanation

A balance sheet is a financial statement that provides a snapshot of a company's financial position by detailing its assets, liabilities, and owner's equity, making the second choice the correct answer.

Which of the following is considered an asset on a balance sheet for a sole proprietorship?

• Accounts payable

• Owner's equity

• Inventory

• Revenue

Answer explanation

Inventory is considered an asset on a balance sheet as it represents goods available for sale. In contrast, accounts payable is a liability, owner's equity reflects net worth, and revenue is an income statement item.

Which of the following best describes the purpose of a balance sheet for a sole proprietorship?

• To show the profitability of the business over a period of time

• To provide a snapshot of the financial position of the business at a specific point in time

• To detail the cash inflows and outflows of the business

• To outline the business's future financial plans

Answer explanation

The correct choice describes a balance sheet's role in providing a snapshot of a sole proprietorship's financial position at a specific point in time, unlike the other options which focus on profitability, cash flow, or future plans.

• $60,000

• $140,000

• $40,000

• $100,000

Answer explanation

Owner's equity is calculated as assets minus liabilities. Here, $100,000 (assets) - $40,000 (liabilities) equals $60,000. Therefore, the owner's equity is $60,000.

Why is it important for a sole proprietorship to maintain an accurate balance sheet?

• To ensure compliance with tax regulations

• To attract potential investors

• To provide a clear picture of the business's financial health

• To determine employee salaries

Answer explanation

Maintaining an accurate balance sheet is crucial for a sole proprietorship as it provides a clear picture of the business's financial health, helping the owner make informed decisions and manage resources effectively.

• $30,000

• $40,000

• $35,000

• $20,000

Answer explanation

Owner's equity is calculated as total assets minus total liabilities. Here, total assets are Cash ($10,000) + Equipment ($25,000) = $35,000. Liabilities are Accounts Payable ($5,000). Thus, $35,000 - $5,000 = $30,000.

Explain how a decrease in liabilities would affect the owner's equity on a balance sheet.

• It would decrease the owner's equity

• It would have no effect on the owner's equity

• It would increase the owner's equity

• It would decrease the assets

Answer explanation

A decrease in liabilities means the company owes less. Since owner's equity is calculated as assets minus liabilities, reducing liabilities increases owner's equity.

• $90,000

• $100,000

• $110,000

• $140,000

Answer explanation

Owner's equity is calculated as total assets minus total liabilities. Initially, equity is $150,000 - $50,000 = $100,000. After a $10,000 withdrawal, new equity is $100,000 - $10,000 = $90,000.

Discuss the impact of purchasing new equipment on the balance sheet of a sole proprietorship.

• It increases both assets and liabilities if purchased on credit

• It decreases assets and increases liabilities

• It has no impact on the balance sheet

• It only affects the income statement

Answer explanation

Purchasing new equipment increases assets on the balance sheet. If the equipment is bought on credit, it also increases liabilities, reflecting the obligation to pay for the equipment later.

How does an increase in accounts payable affect the balance sheet of a sole proprietorship?

• It increases both assets and liabilities

• It increases liabilities

• It increases liabilities and decreases owner's equity

• It decreases owner's equity