chapter 2 mcgraw-hill/irwin © 2009 the mcgraw-hill companies, inc
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INVESTING AND FINANCING DECISIONS
AND THE BALANCE SHEETChapter 2
McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.
THE CONCEPTUAL FRAMEWORK
Qualitative CharacteristicsRelevancyReliabilityComparabilityConsistency
Qualitative CharacteristicsRelevancyReliabilityComparabilityConsistency
Objective of Financial Reporting
To provide useful economic information to external users for decision making and for assessing future cash flows.
Primary Characteristics•Relevancy: predictive value, feedback value, and timeliness.•Reliability: verifiability, representational faithfulness, and neutrality.
Secondary Characteristics•Comparability: across companies.•Consistency: over time.
THE CONCEPTUAL FRAMEWORK
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.).
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.
Principle______________: Cash equivalent cost given up
is the basis for the initial recording of elements.
ELEMENTS OF A BALANCE SHEET 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).
ASSETS ON THE BALANCE SHEET 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.
LIABILITIES ON THE BALANCE SHEET Listed in order of maturity (how soon
the obligation will be paid)
Classified as CURRENT or LONG-TERM
STOCKHOLDERS’ EQUITY ON THE BALANCE SHEET For simplicity, usually only includes two
accounts: Contributed Capital and Retained Earnings
Will get more complex later in the quarter.
NATURE OF BUSINESS TRANSACTIONS
External events: exchanges of assetsand liabilities between the businessand one or more other parties.
Borrow cash
from the bank
NATURE OF BUSINESS TRANSACTIONS
Internal events: not an exchange betweenthe business and other parties, but havea direct effect on the accounting entity.
Loss due to fire damage.
TYPICAL ACCOUNT TITLES
AssetsCashShort-Term InvestmentAccounts ReceivableNotes ReceivableInventory (to be sold)SuppliesPrepaid ExpensesLong-Term InvestmentsEquipmentBuildingsLandIntangibles
AssetsCashShort-Term InvestmentAccounts ReceivableNotes ReceivableInventory (to be sold)SuppliesPrepaid ExpensesLong-Term InvestmentsEquipmentBuildingsLandIntangibles
LiabilitiesAccounts PayableAccrued ExpensesNotes PayableTaxes PayableUnearned Revenue Bonds Payable
LiabilitiesAccounts PayableAccrued ExpensesNotes PayableTaxes PayableUnearned Revenue Bonds Payable
Stockholders’ EquityContributed CapitalRetained Earnings
Stockholders’ EquityContributed CapitalRetained Earnings
The Balance Sheet
TYPICAL ACCOUNT TITLES
RevenuesSales RevenueFee RevenueInterest RevenueRent Revenue
RevenuesSales RevenueFee RevenueInterest RevenueRent Revenue
ExpensesCost of Goods SoldWages ExpenseRent ExpenseInterest ExpenseDepreciation ExpenseAdvertising ExpenseInsurance ExpenseRepair ExpenseIncome Tax Expense
ExpensesCost of Goods SoldWages ExpenseRent ExpenseInterest ExpenseDepreciation ExpenseAdvertising ExpenseInsurance ExpenseRepair ExpenseIncome Tax Expense
The Income Statement
PRINCIPLES OF TRANSACTION ANALYSIS
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)
DUALITY OF EFFECTS Most transactions with external parties involve an exchange where the business
entity gives up something but
receives something in return.
FOCUS ON CASH FLOWSOperating 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 –
BALANCING THE ACCOUNTING EQUATION
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: BalancingVerify 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 Accounts1. _____________2. ________________
Identify & Classify the Accounts1. _____________2. ________________
Determine the Direction of the Effect1. ________________2. ________________
Determine the Direction of the Effect1. ________________2. ________________
ANALYZING TRANSACTIONS
A = L + SE
Cash Investments Equip.Notes
ReceivableNotes
PayableContributed
CapitalRetained Earnings
(a) 2,000 2,000
Effect =2,000 2,000
ANALYZING TRANSACTIONS
Papa John’s issues $2,000 of additional common stock to new investors for cash.
The company borrows $6,000 from the local bank, signing a three-year note.
Identify & Classify the Accounts1. _____________2. ________________
Identify & Classify the Accounts1. _____________2. ________________
Determine the Direction of the Effect1. _______________2. ___________________
Determine the Direction of the Effect1. _______________2. ___________________
ANALYZING TRANSACTIONS
A = L + SE
Cash Investments Equip.Notes
ReceivableNotes
PayableContributed
CapitalRetained Earnings
(a) 2,000 2,000 (b) 6,000 6,000
Effect =8,000 8,000
ANALYZING TRANSACTIONS
The company borrows $6,000 from the local bank, signing a three-year note.
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 Accounts1. __________________2. ___________________3. ___________________
Identify & Classify the Accounts1. __________________2. ___________________3. ___________________
Determine the Direction of the Effect1. _______________2. ________________3. __________________
Determine the Direction of the Effect1. _______________2. ________________3. __________________
ANALYZING TRANSACTIONS
A = L + SE
Cash Investments Equip.Notes
ReceivableNotes
PayableContributed
CapitalRetained Earnings
(a) 2,000 2,000 (b) 6,000 6,000 (c) (2,000) 10,000 8,000
Effect =16,000 16,000
ANALYZING TRANSACTIONS
Papa John’s purchases $10,000 of new equipment, paying $2,000 in cash and signing a two-year note payable for the rest.
Papa John’s board of directors declares andpays $3,000 in dividends to shareholders.
ANALYZING TRANSACTIONS
Identify & Classify the AccountsIdentify & Classify the Accounts
Determine the Direction of the EffectDetermine the Direction of the Effect
Identify & Classify the Accounts1. _______________2. ____________________
Identify & Classify the Accounts1. _______________2. ____________________
Determine the Direction of the Effect1. _________________2. _________________________
Determine the Direction of the Effect1. _________________2. _________________________
A = L + SE
Cash Investments Equip.Notes
ReceivableNotes
PayableContributed
CapitalRetained Earnings
(a) 2,000 2,000 (b) 6,000 6,000 (c) (2,000) 10,000 8,000 (d) (3,000) 3,000 (e) (1,000) 1,000 (f) (3,000) (3,000)
Effect =13,000 13,000
Papa John’s board of directors declares andpays $3,000 in dividends to shareholders.
ANALYZING TRANSACTIONS
LET’S DO E2-2 (PAGE 84-85)
A) A COMPANY ORDERS AND RECEIVES 10 PERSONAL COMPUTERS FOR OFFICE USE FOR WHICH IT SIGNS A NOTE PROMISING TO PAY $25,000 WITHIN THREE MONTHS.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
B) A COMPANY PURCHASES FOR $21,000 CASH A NEW DELIVERY TRUCK THAT HAS A LIST, OR STICKER, PRICE OF $24,000.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
C) A WOMEN’S CLOTHING RETAILER ORDERS 30 NEW DISPLAY STANDS FOR $300 EACH FOR FUTURE DELIVERY.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
D) A NEW COMPANY IS FORMED AND SELLS 100 SHARES OF STOCK FOR $12 PER SHARE TO INVESTORS.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
E) A MANUFACTURING COMPANY SIGNS A CONTRACT FOR THE CONSTRUCTION OF A NEW WAREHOUSE FOR $500,000. AT THE SIGNING, THE COMPANY WRITES A CHECK FOR $50,000 TO THE CONSTRUCTION COMPANY AS THE INITIAL PAYMENT FOR THE CONSTRUCTION (RECEIVING CONSTRUCTION IN PROGRESS). ANSWER THE QUESTION FROM THE STANDPOINT OF THE MANUFACTURING COMPANY.
Accounts Account Type Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
F) A PUBLISHING FIRM PURCHASES FOR $40,000 CASH THE COPYRIGHT (AN INTANGIBLE ASSET) TO A MANUSCRIPT FOR AN INTRODUCTORY ACCOUNTING TEXT.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
G) A MANUFACTURING FIRM PAYS STOCKHOLDERS A $100,000 CASH DIVIDEND.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
H) A COMPANY PURCHASES 100 SHARES OF APPLE, INC. COMMON STOCK FOR $5,000 CASH.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
I) A COMPANY PURCHASES A PIECE OF LAND FOR $50,000 CASH. AN APPRAISER FOR THE BUYER VALUED THE LAND AT $52,500.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
J) A MANUFACTURING COMPANY ACQUIRES THE PATENT (AN INTANGIBLE ASSET) ON A NEW DIGITAL SATELLITE SYSTEM FOR TELEVISION RECEPTION, PAYING $500,000 CASH AND SIGNING A $400,000 NOTE PAYABLE DUE IN ONE YEAR.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
K) A LOCAL COMPANY IS A SOLE PROPRIETORSHIP (ONE OWNER); ITS OWNER BUYS A CAR FOR $10,000 FOR PERSONAL USE. ANSWER FROM THE COMPANY’S POINT OF VIEW.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
L) A COMPANY BORROWS $1,000 FROM A LOCAL BANK AND SIGNS A SIX MONTH NOTE FOR THE LOAN.
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?
M) A COMPANY PAYS $1,500 PRINCIPAL ON ITS NOTE PAYABLE (IGNORE INTEREST). – WHAT ABOUT INTEREST?
Accounts Account Type
Incr./Decr. Amount
Transaction Type: Operating/Investing/Financing?