Chapter 2
Investing and Financing Decisions and
the Balance Sheet
ACCT 2301
Zining Li
Cox, SMU
Fall 2009
Zining Li
ACCT 2301 FALL 2009
Cox School of Business, SMU
What do we hope to learn



Characteristics of Financial Accounting
Information
How does a company record business
transactions (Transactional Analysis)
How does a company keep track of
accounting records
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Accounting – Who Sets the
Rules?

Securities and Exchange Commission (SEC)



Legal authority to set accounting rules for publicly traded
companies
Delegated responsibility to the accounting profession
Financial Accounting Standards Board (FASB)


Currently the standards setting body
GAAP
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Qualitative Characteristics of
Financial Accounting Information

Relevant


Reliable

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Representational faithfulness
Verifiable
Comparable



Specific / Timely
For same company
Across different company
Consistent

Same rules over time
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Elements

Assets: economic resources that are measurable;
owned or controlled by the company that will bring
future benefits

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Liabilities: economic obligations
Stockholders’ equity (contributed capital +
retained earnings)

Revenues: inflow of assets or settlement of liabilities from
on-going business

Expenses: decreases (increases) in assets (liabilities) from
on-going business

Gains (Losses): from peripheral activities
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Assumptions



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Separate-entity assumption
Unit-of-measure
Continuity (going-concern)
Time period
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Principles



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Historical Cost (the Balance Sheet)
Revenue Recognition (the Income
Statement)
Matching(the Income Statement)
Full disclosure
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Constraints


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Cost benefit
Materiality
Conservatism
Industry practice
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How does a Company Record
Business Transactions? (1)

Definition of Transaction


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Economic events that impact a business entity
External v.s. Internal
NOT all economic events are reflected in
financial statements!
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How does a Company Record
Business Transactions? (2)


Let’s start with A= L + SE
Duality of Effects


Each transaction affects at least two items
(accounts)
The accounting equation always remains in
balance after each transaction
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Determining the Financial Statement Effects of
Following Transactions
• Received investment of $24,000 cash by
organizers and distributed stock to them
• Purchased $8,000 of equipment, paying $1,000
in cash and signing a note for the rest
• Loaned $500 to an employee who signed a note
• Borrowed $7,000 cash from a bank by signing a
note
• Purchased $15,000 of land; paid $4,000 in cash
and signed a mortgage note for the balance
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Event
a.
b.
c.
Assets
1)Cash (F)
=
+8,000
2)Cash (I)
–1,000
+500
3)Cash (I)
–500
e.
5)Land
+7,000
+15,000
5)Cash (I)
–4,000
Assets
$49,000
=
Stockholders’
Equity
1)Contri.
capital
3)Note
receivable
4)Cash (F)
+
+24,000
2)Equipment
d.
Liabilities
2)Notes
payable
+7,000
4)Notes
payable
+7,000
5)Mortgage
note
payable
Liabilities
$25,000
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+24,000
+11,000
+ Stockholders’ Equity
$24,000
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Debits, Credits and Taccounts?


T-account: We can use a “T” to represent an account
Debit (Dr)
 Means the left side of an account
Numbers put on the left side of an account are debits
Credit (Cr)
 Means the right side of an account
 Numbers put on the right side of an account are credits
What do we mean when we say “to credit (debit) an
account”?



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Debits, Credits, &Accounting Equation
Assets
+
Dr.
Cr.
=
Liabilities + Shareholders’ Equity
(Contr. Cap. + R/E)
Dr.
+
Cr.
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Dr.
+
Cr.
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Record Journal Entries

Information recorded in a journal entry:

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Date of transaction
Accounts affected
Dollar amounts of debits and credits
A brief explanation of the transaction (can be
skipped for our purposes)
Remember:


Assets = Liabilities + Owner’s Equity
Debits = Credits
In every journal entry there are equal dollar amounts
of debits and credits.
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Received investment of $24,000 cash by
organizers and distributed stock to them
Transaction
Account Titles
#1
Dr. Cash
Debits
Credits
24,000
Cr. Contributed Capital
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24,000
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Purchased $8,000 of equipment, paying $1,000 in
cash and signing a note for the rest
Transaction
Account Titles
Debits
#2
Dr. Equipment
Cr. Notes Payable
Cr. Cash
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Credits
8,000
7,000
1,000
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Loaned $500 to an employee who signed a note
Transaction
Account Titles
Debits
#3
Dr. Notes Receivable
Cr. Cash
Credits
500
500
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Borrowed $7,000 cash from a bank by signing a note
Transaction
Account Titles
#4
Dr. Cash
Debits
Credits
7,000
Cr. Notes Payable
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7,000
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Purchased $15,000 of land; paid $4,000 in cash
and signed a mortgage note for the balance
Transaction
Account Titles
Debits
#5
Dr. Land
Cr. Mortgage notes payable
Cr. Cash
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Credits
15,000
11,000
4,000
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T-account
Cash
Notes Receivable
0
0
24,000
500
1,000
500
500
7,000
4,000
25,500
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Land
Equipment
0
0
15,000
8,000
15,000
8,000
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Notes Payable
Mortgage Notes
Payable
0
7,000
0
11,000
7,000
14,000
11,000
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Contributed Capital
0
24,000
24,000
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Record Transactions:
Summary

To record a transaction,

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Identify items (accounts) that are affected
Determine the direction of impact on each account
(increase or decrease)
Verify that the accounting equation (A=L+SE) remains
in balance
Example

To start, focus on investing and financing activities
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How is the Cash Flow Statement affected by
Investing and Financing Activities?

Investing Cash Flows



Outflows: cash paid for acquisition of long-term assets
Inflows: cash proceeds from sale of long-term assets
Financing Cash Flows


Inflows: cash received from issues of common stock
and long-term debts
Outflows: cash paid directly related to issues of
common stock and long-term debts. E.g. retirement of
long-term debts, repurchase of common stock, and
cash dividend
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