Download Investing and Financing Decisions and the Balance

Chapter 2
McGraw-Hill/Irwin
© 2009 The McGraw-Hill Companies, Inc.
Objective of Financial Reporting
To provide useful economic information to external users for
decision making and for assessing future cash flows.
Qualitative Characteristics
Relevancy
Reliability
Comparability
Consistency
Primary Characteristics
•Relevancy: predictive value,
feedback value, and timeliness.
•Reliability: verifiability,
representational faithfulness, and
neutrality.
Secondary Characteristics
•Comparability: across companies.
•Consistency: over time.
Assumptions
__________________: Activities of the business are separate from
activities of owners.
_______________: The entity will not go out of business in the near
future.
________________: Accounting measurements will be in the national
monetary unit (i.e., $ in the U.S.).
Principle
______________: Cash equivalent cost given up
is the basis for the initial recording of elements.
 ASSET:
Economic resources with probable
future benefits owned or controlled by an
entity as a result of past transactions.
 LIABILITY:
Probable debts or obligations
(claims to a company’s resources) that result
from an entity’s past transactions AND will be
paid for with assets or services.
 STOCKHOLDERS’
EQUITY: Financing provided
by the owners (contributed capital) and by
business operations (Retained Earnings).
 Listed
in order of liquidity (how soon an asset
is expected to be turned into cash or used)
 Categorized
as CURRENT (used or turned into
cash with 1 year) and LONG-TERM.
 Listed
in order of maturity (how soon the
obligation will be paid)
 Classified
as CURRENT or LONG-TERM
 For
simplicity, usually only includes two
accounts: Contributed Capital and Retained
Earnings
 Will
get more complex later in the quarter.
External events: exchanges of assets
and liabilities between the business
and one or more other parties.
Borrow cash
from the bank
Internal events: not an exchange between
the business and other parties, but have
a direct effect on the accounting entity.
Loss due to
fire damage.
The Balance Sheet
Assets
Cash
Short-Term Investment
Accounts Receivable
Notes Receivable
Inventory (to be sold)
Supplies
Prepaid Expenses
Long-Term Investments
Equipment
Buildings
Land
Intangibles
Liabilities
Accounts Payable
Accrued Expenses
Notes Payable
Taxes Payable
Unearned Revenue
Bonds Payable
Stockholders’ Equity
Contributed Capital
Retained Earnings
The Income Statement
Revenues
Expenses
Sales Revenue
Fee Revenue
Interest Revenue
Rent Revenue
Cost of Goods Sold
Wages Expense
Rent Expense
Interest Expense
Depreciation Expense
Advertising Expense
Insurance Expense
Repair Expense
Income Tax Expense
 Every transaction affects at least two
accounts (duality of effects).
 The accounting equation must remain in
balance after each transaction.
A = L + SE
(Assets)
(Liabilities)
(Stockholders’
Equity)
Most transactions with
external parties involve
an exchange where the
business entity gives up
something but receives
something in return.
Operating activities
(Covered in the next chapter.)
Investing Activities
Purchasing long-term assets and investments for cash
Selling long-term assets and investments for cash
Lending cash to others
Receiving principal payments on loans made to others
Financing Activities
Borrowing cash from banks
Repaying the principal on borrowings from banks
Issuing stock for cash
Repurchasing stock with cash
Paying cash dividends
–
+
–
+
+
–
+
–
–
Step 1: Accounts and effects
 Identify
the accounts affected and classify
them by type of account (A,L,SE,Rev,Exp,Div).
 Determine the direction of the effect (increase
or decrease) on each account.
Step 2: Balancing
 Verify
that the accounting equation (A = L + SE)
remains in balance.
Papa John’s issues $2,000 of additional common
stock to new investors for cash.
Identify & Classify the Accounts
1. _____________
2. ________________
Determine the Direction of the Effect
1. ________________
2. ________________
Papa John’s issues $2,000 of additional common
stock to new investors for cash.
Cash
Investments
2,000
(a)
Effect
Equip.
2,000
Notes
Receivable
Notes
Payable
=
Contributed
Capital
2,000
2,000
A = L + SE
Retained
Earnings
The company borrows $6,000 from the
local bank, signing a three-year note.
Identify & Classify the Accounts
1. _____________
2. ________________
Determine the Direction of the Effect
1. _______________
2. ___________________
The company borrows $6,000 from the
local bank, signing a three-year note.
(a)
(b)
Effect
Cash
Investments
2,000
6,000
Equip.
8,000
Notes
Receivable
Notes
Payable
Contributed
Capital
2,000
6,000
=
8,000
A = L + SE
Retained
Earnings
Papa John’s purchases $10,000 of new equipment, paying
$2,000 in cash and signing a two-year note payable for the rest.
Identify & Classify the Accounts
1. __________________
2. ___________________
3. ___________________
Determine the Direction of the Effect
1. _______________
2. ________________
3. __________________
Papa John’s purchases $10,000 of new equipment, paying
$2,000 in cash and signing a two-year note payable for the rest.
Cash
Investments
2,000
6,000
(2,000)
(a)
(b)
(c)
Effect
Equip.
16,000
Notes
Receivable
Notes
Payable
Contributed
Capital
2,000
6,000
8,000
10,000
=
16,000
A = L + SE
Retained
Earnings
Papa John’s board of directors declares and
pays $3,000 in dividends to shareholders.
Identify & Classify the Accounts
1. _______________
2. ____________________
Determine the Direction of the Effect
1. _________________
2. _________________________
Papa John’s board of directors declares and
pays $3,000 in dividends to shareholders.
Cash
Investments
2,000
6,000
(2,000)
(3,000)
(1,000)
1,000
(3,000)
(a)
(b)
(c)
(d)
(e)
(f)
Effect
Equip.
13,000
Notes
Receivable
Notes
Payable
Contributed
Capital
2,000
Retained
Earnings
6,000
8,000
10,000
3,000
(3,000)
=
13,000
A = L + SE
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Transaction Type: Operating/Investing/Financing?
Amount
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Transaction Type: Operating/Investing/Financing?
Amount
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?
Accounts
Account Type
Incr./Decr.
Amount
Transaction Type: Operating/Investing/Financing?