Chapter 2: Reporting Investing Chapter 2: Reporting Investing and Financing Results on the and Financing Results on the Balance SheetBalance Sheet

Learning Objective 1Learning Objective 1

Identify financial effects of common financing and

investing activities.

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Building a Balance SheetBuilding a Balance Sheet

Assets

amounts presently owed by a business to creditors.

the amount invested and reinvested in a company by its

shareholders.

resources presently owned by a business that generate future

economic benefit.

Stockholders’ Equity

Liabilities

=

+

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Assets

Debt Financing

Equity Financing

Companies rely on two sources of financing:

Stockholders’ Equity

Liabilities

=

+

Financing and Investing ActivitiesFinancing and Investing Activities

Invest in Assets

&

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Financing and Investing ActivitiesFinancing and Investing Activities

1. A company always documents its activities.

2. A company always receives something and gives something.

3. A dollar amount is determined for each exchange.

Key Features Your Goals

Picture each activity.

Name the items.

Analyze the effects.

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Transactions and Other ActivitiesTransactions and Other Activities

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Learning Objective 2Learning Objective 2

Apply transaction analysis to financing and investing

transactions.

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Study the Accounting MethodsStudy the Accounting Methods

1 Analyze 2 Record 3 Summarize

A systematic accounting process is used to capture and report the financial effects of a company’s transactions.

A transaction is a business activity that affects the basic accounting equation.

Duality of Effects

Every transaction has at least two effects on the basic

accounting equation.

A = L+ SE

Assets must equal liabilities plus stockholders’ equity for every accounting transaction.

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Step 1: Analyze TransactionsStep 1: Analyze TransactionsThe chart of accounts is tailored to each company’s

business, so although some account titles are common across all companies (Cash, Accounts Payable) others

may be used only by that particular company (Cookware). Depending on the company, you may see a liability for a

bank loan called a Note Payable or a Loan Payable.

AccountNumber Account Name Description

101 Cash Dollars amount of coins, paper money, funds in bank113 Cookware Cost of cutlery, pizza pans dishes, ets.135 Equipment Cost of pizza ovens, restaurant booths, dishwasher, etc.201 Accounts Payable Owed to suppliers for goods and services bought on credit222 Note Payable Owed to lenders, as per terms of promissory note.301 Contributed Capital Stock issued for contributions made to the company310 Retained Earnings Accumulated earnings (not yet distributed as dividends)

Pizza Aroma's Chart of Accounts (Partial)

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Step 1: Analyze TransactionsStep 1: Analyze Transactions(a) Issue Stock to Owners.

Mauricio Rosa incorporates Pizza Aroma Inc., on August 1. The company issues stock to Mauricio and his wife as evidence of their contribution of $50,000 cash,

which is deposited in the company’s bank account.

1. Pizza Aroma receives $50,000 Cash.

2. Pizza Aroma gives $50,000 Stock (Contributed Capital).

Assets = Liabilities + Stockholders' Equity(a) Cash +$50,000 Contributed

Capital + $50,000

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Step 1: Analyze TransactionsStep 1: Analyze Transactions(b) Investment in Equipment.

1. Pizza Aroma receives $42,000 of Equipment.

2. Pizza Aroma gives $42,000 Cash.

Assets = Liabilities + Stockholders' Equity(b) Equipment +$42,000 Cash -$42,000

Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment.

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Step 1: Analyze TransactionsStep 1: Analyze Transactions(c) Obtain Loan from Bank.

1. Pizza Aroma receives $20,000 Cash.

2. Pizza Aroma gives a note, payable to the bank for $20,000.

Assets = Liabilities + Stockholders' Equity(c) Cash +$20,000 = Note Payable +$20,000

Pizza Aroma borrows $20,000 from a bank depositing those funds in its bank account and signing a formal agreement to repay the loan in two years.

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Step 1: Analyze TransactionsStep 1: Analyze Transactions(d) Investment in Equipment.

1. Pizza Aroma receives $18,000 in equipment (pizza ovens).

2. Pizza Aroma gives a Cash of $16,000 and Accounts Payable of $2,000.

Assets = Liabilities + Stockholders' Equity(d) Cash -$16,000 = Accounts Payable +$2,000

Equipment +$18,000

Pizza Aroma purchases $18,000 in pizza ovens and other restaurant equipment, paying $16,000 in cash and giving an informal promise to pay

$2,000 at the end of the month.

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Step 1: Analyze TransactionsStep 1: Analyze Transactions(e) Order Cookware.

1. An exchange of only promises is not a transaction.

2. This does not affect the accounting equation.

Assets = Liabilities + Stockholders' EquityNo Impact = No Impact No Impact

Pizza Aroma orders $630 of pans, dishes, and other cookware. None have been received yet.

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Step 1: Analyze TransactionsStep 1: Analyze Transactions(f) Pay Suppliers.

1. Pizza Aroma gives cash to settle its debt to the supplier.

2. Pizza Aroma receives a release from its promise to pay.

Assets = Liabilities + Stockholders' Equity(f) Cash -$2,000 = Accounts Payable -$2,000

Pizza Aroma pays $2,000 to the equipment supplier from transaction (d).

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Step 1: Analyze TransactionsStep 1: Analyze Transactions(g) Receive Cookware.

1. Pizza Aroma receives cookware with a cost of $630.

2. Pizza Aroma gave a promise to pay $630 on account.

Assets = Liabilities + Stockholders' Equity(g) Cookware +$630 = Accounts Payable +$630

Pizza Aroma receives $630 of the cookware ordered in (e) and promises to pay for it next month.

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Learning Objective 3Learning Objective 3

Use journal entries and T-accounts to show how

transactions affect the balance sheet.

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Step 2 and 3: Record and Step 2 and 3: Record and SummarizeSummarize

Most companies use computerized accounting systems, which can handle a large number of transactions. These systems

follow a cycle, called the accounting cycle, which is repeated day-after-day, month-after-month, and year-after-year.

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The Debit/Credit FrameworkThe Debit/Credit FrameworkASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY

+ ASSETS

*

Increase DecreaseUsing UsingDebit Credit

*

LIABILITIES +Decrease Increase

Using UsingDebit Credit

*

STOCKHOLDERS' EQUITY +Decrease Increase

Using UsingDebit Credit

Asset accounts increase on the left or

debit side and decrease on the right

or credit side.

Liability accounts increase on the right

or credit side and decrease on the left or

debit side.

Stockholders’ equity accounts increase on the

right or credit side and decrease on the left or

debit side.

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Page G1

Date Account Title and Explanation Ref. Debit Credit

General Journal

Steps 2 & 3: Record and SummarizeSteps 2 & 3: Record and Summarize1 Analyze

2 Record

3 Summarize

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Page G1

Date Account Title and Explanation Ref. Debit Credit20108/1 Cash 101 50,000

Contributed Capital 301 50,000 (Financing from stockholders)

General Journal

Account: Cash Acct. 101

Date Explanation Ref. Debit Credit Balance20108/1 G1 50,000 50,000

General Ledger

Steps 2 & 3: Record and SummarizeSteps 2 & 3: Record and Summarize1 Analyze

2 Record

3 Summarize

Account: Contributed Capital Acct. 301

Date Explanation Ref. Debit Credit Balance20108/1 G1 50,000 50,000

General Ledger

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Account: Cash Acct. 101

Date Explanation Ref. Debit Credit Balance20108/1 G1 50,000 50,000

General Ledger

Steps 2 & 3: Record and SummarizeSteps 2 & 3: Record and Summarize1 Analyze

2 Record

3 Summarize

Account: Contributed Capital Acct. 301

Date Explanation Ref. Debit Credit Balance20108/1 G1 50,000 50,000

General Ledger

(a) dr Cash (+A) 50,000 cr Contributed Capital (+SE) 50,000

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Account: Cash Acct. 101

Date Explanation Ref. Debit Credit Balance20108/1 G1 50,000 50,000

General Ledger

Steps 2 & 3: Record and SummarizeSteps 2 & 3: Record and Summarize1 Analyze

2 Record

3 Summarize

Account: Contributed Capital Acct. 301

Date Explanation Ref. Debit Credit Balance20108/1 G1 50,000 50,000

General Ledger

(a) dr Cash (+A) 50,000 cr Contributed Capital (+SE) 50,000

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Pizza Aroma’s Accounting Pizza Aroma’s Accounting RecordsRecords(a) Issue Stock to Owners.

Mauricio Rosa incorporates Pizza Aroma Inc., on August 1. The company issues stock to Mauricio and his wife as evidence of their contribution of $50,000 cash,

which is deposited in the company’s bank account.

Assets = Liabilities + Stockholders' Equity(a) Cash +$50,000 Contributed

Capital + $50,000

1 Analyze

(a) dr Cash (+A) 50,000 cr Contributed Capital (+SE) 50,000

2 Record

3 Summarize

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Pizza Aroma’s Accounting Pizza Aroma’s Accounting RecordsRecords(b) Investment in Equipment.

Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment.

Assets = Liabilities + Stockholders' Equity(b) Cash -$42,000Equipment + $42.000

1 Analyze

3 Summarize

2 Record

(b) dr Cash (+A)Equipment (+A) 42,000 cr Cash (-A) 42,000

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Pizza Aroma’s Accounting Pizza Aroma’s Accounting RecordsRecords

(c) Obtain Loan from Bank.

Pizza Aroma borrows $20,000 from a bank depositing those funds in its bank account and signing a formal agreement to repay the loan in two years.

Assets = Liabilities + Stockholders' Equity(c) Cash +$20,000 Note Payable +$20,000

1 Analyze

(c) dr Cash (+A)Cash (+A) 20,000 cr Note Payable (+L) 20,000

2 Record

3 Summarize

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Pizza Aroma’s Accounting Pizza Aroma’s Accounting RecordsRecords(d) Investment in Equipment.

Pizza Aroma purchases $18,000 in pizza ovens and other restaurant equipment, paying $16,000 in cash and giving an informal promise to pay

$2,000 at the end of the month.

Assets = Liabilities + Stockholders' Equity(d) Cash -$16,000 Accounts Payable +$2,000

Equipment +$20,000

1 Analyze

3 Summarize

2 Record (d) dr Equipment (+A) 18,000 cr Cash (-A) 16,000 cr Accounts Payable (+L) 2,000

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Pizza Aroma’s Accounting Pizza Aroma’s Accounting RecordsRecords

(f) Pay Suppliers.

Pizza Aroma pays $2,000 to the equipment supplier from the last transaction.

Assets = Liabilities + Stockholders' Equity(f) Cash -$2,000 Accounts Payable - $2,000

1 Analyze

3 Summarize

2 Record

(f) dr Cash (+A)Accounts Payable (-L) 2,000 cr Cash (-A) 2,000

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Pizza Aroma’s Accounting Pizza Aroma’s Accounting RecordsRecords

(g) Receive Cookware.

Pizza Aroma receives $630 of the cookware previously ordered and promises to pay for it next month.

Assets = Liabilities + Stockholders' Equity(g) Cookware +$630 Accounts Payable + $630

1 Analyze

(g) dr Cookware (+A) 630 cr Accounts Payable (+L) 630

2 Record

3 Summarize

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T-Accounts for Pizza AromaT-Accounts for Pizza Aroma

Beg. Bal. - (a) 50,000 42,000 (b) (c) 20,000 16,000 (d)

2,000 (f) End. Bal. 10,000

CashBeg. Bal. -

(g) 630 End. Bal. 630

Supplies

- Beg. Bal.(f) 2,000 2,000 (d)

630 (g)630 End. Bal.

Accounts Payable

- Beg. Bal.20,000 (c)20,000 End. Bal.

Notes Payable

- Beg. Bal.50,000 (a)50,000 End. Bal.

Contributed Capital

Beg. Bal. - (b) 42,000 (d) 18,000

End. Bal. 60,000

Equipment

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Learning Objective 4Learning Objective 4

Prepare a classified balance sheet.

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Preparing a Balance SheetPreparing a Balance Sheet

It’s a good idea to check that the

accounting records are in balance by

determining whether debits = credits. We

do this by preparing a Trial Balance.

Debit CreditCash 10,000$ Cookware 630 Equipment 60,000 Accounts Payable 630$ Note Payable 20,000 Contributed Capital 50,000 Totals 70,630$ 70,630$

Pizza Aroma, Inc.Trial Balance

August 31, 2010

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Classified Balance SheetClassified Balance Sheet

Current assets will be used up or converted into cash within

the next 12 months.

Long-term assets include resources that will be used or turned into cash more than 12 months after the balance sheet

date.

Current Assets: Cash 10,000$ Cookware 630 Total Current Assets 10,630 Property, Plant, and Equipment: Equipment 60,000 Total Assets: 70,630$ Liabilities and Stockholders' Equity:Current Liabilities: Accounts Payable 630$ Long-Term Liabilities: Note Payable 20,000 Total Liabilities: 20,630 Stockholders' Equity Contributed Capital 50,000 Total Liabilities and Stockholders' Equity 70,630$

Pizza Aroma, Inc.Balance

At August 31, 2010

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Learning Objective 5Learning Objective 5

Interpret the balance sheet using the current ratio and an

understanding of related concepts.

.

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Assessing the Ability to PayAssessing the Ability to Pay

CurrentRatio

=Current Assets

Current Liabilities

A higher current ratio generally means a better ability to pay. Pizza Aroma’s current ratio is unusually high.

Current Assets: Cash 10,000$ Cookware 630 Total Current Assets 10,630 Property, Plant, and Equipment: Equipment 60,000 Total Assets: 70,630$ Liabilities and Stockholders' Equity:Current Liabilities: Accounts Payable 630$ Long-Term Liabilities: Note Payable 20,000 Total Liabilities: 20,630 Stockholders' Equity Contributed Capital 50,000 Total Liabilities and Stockholders' Equity 70,630$

Pizza Aroma, Inc.Balance SheetAt 8/31/2010

16.9

=$ 10,630

$ 630

=

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Balance Sheet Concepts and Balance Sheet Concepts and ValuesValues

What is (is not) recorded?•Includes items acquired through exchange.•Excludes other items (such as secret recipes).

What is (is not) recorded?•Includes items acquired through exchange.•Excludes other items (such as secret recipes).

Current Assets: Cash 10,000$ Cookware 630 Total Current Assets 10,630 Property, Plant, and Equipment: Equipment 60,000 Total Assets: 70,630$ Liabilities and Stockholders' Equity:Current Liabilities: Accounts Payable 630$ Long-Term Liabilities: Note Payable 20,000 Total Liabilities: 20,630 Stockholders' Equity Contributed Capital 50,000 Total Liabilities and Stockholders' Equity 70,630$

Pizza Aroma, Inc.Balance SheetAt 8/31/2010

What amounts?•Initially recorded at cost.•Conservatism leads to recording decreases in asset value but generally not increases.

What amounts?•Initially recorded at cost.•Conservatism leads to recording decreases in asset value but generally not increases.

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