Investing and Financing Decisions and the Balance

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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 (Assets) = L ( Liabilities ) + SE (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.

(a) Cash 2,000 Investments Equip.

Notes Receivable Notes Payable Contributed Capital 2,000 Retained Earnings Effect

A =

2,000

=

L

+

2,000

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

A =

8,000

=

L

+

8,000

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.

Notes Receivable Notes Payable 6,000 8,000 Contributed Capital 2,000 Retained Earnings Effect

A =

16,000

=

L

+

16,000

SE

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.

(a) (b) (c) (d) (e) (f) Effect Cash 2,000 6,000 (2,000) (3,000) (1,000) (3,000) Investments 1,000 Equip.

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?

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