McGraw-Hill/Irwin
Chapter 2
© 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
Sales Revenue
Fee Revenue
Interest Revenue
Rent Revenue
Expenses
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)

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
–
+
–
+
+
–
–
+
–

 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.
 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.
(a)
Cash
2,000
Investments Equip.
Notes
Receivable
Notes
Payable
Contributed
Capital
2,000
Retained
Earnings
2,000
=
2,000 Effect A = L + SE

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)
Cash
2,000
6,000
Investments Equip.
Notes
Receivable
Notes
Payable
6,000
Contributed
Capital
2,000
Retained
Earnings
Effect 8,000 8,000
=
A = L + SE

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.
(a)
(b)
(c)
Cash
2,000
6,000
(2,000)
Investments Equip.
10,000
Notes
Receivable
Notes
Payable
6,000
8,000
Contributed
Capital
2,000
Retained
Earnings
Effect 16,000 16,000
=
A = L + SE

Papa John’s board of directors declares and pays $3,000 in dividends to shareholders.
1. _______________
2. ____________________
1. _________________
2. _________________________

Papa John’s board of directors declares and pays $3,000 in dividends to shareholders.
(a)
(b)
(c)
(d)
(e)
(f)
Effect
Cash
2,000
6,000
(2,000)
(3,000)
(1,000)
(3,000)
Investments Equip.
1,000
10,000
13,000
Notes
Receivable
3,000
Notes
Payable
6,000
8,000
Contributed
Capital
2,000
Retained
Earnings
13,000
=
A = L + SE
(3,000)

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.
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.
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.
Amount
Transaction Type: Operating/Investing/Financing?