3rd session : Balance Sheet Recording the Effects of Transactions and Events Goals of Today’s Class 1. Develop a better understanding of Balance Sheet Concepts 2. Understand the Accounting Process and Transactional Analysis 3. Understand Debits, Credits, and the use of T-accounts 2 Exercise II – Fill in the Gaps 2009 Current Assets Non-current Assets Total Assets Current Liabilities Non-current Liabilities m l Total L and E 2006 9,975 e 9,366 15,547 14,960 f 14,659 b 12,033 24,935 24,025 h n 8,040 8,287 p 8,663 9,207 1,399 o 2007 9,988 25,535 Contributed Capital Retained Earnings 2008 7,433 25,535 8,435 a 7,642 g 20,468 6,733 7,312 5,999 c k 1,292 1,149 j 6,149 7,922 6,719 i 24,935 24,025 20,468 d e. Current Assets – Current Liabilities = $1,724 j. Net loss = $656 and Dividends = $1,117 n. Current Assets – Current Liabilities = $1,948 o. Net income = $2,524 and Dividends = $1,240 1,017 3 How do we get the numbers in the balance sheet? 1. Record financial effects of transactions in accounts 2. Calculate the ending balance 3. Report the ending balance on the balance sheet • Note: Balance sheet accounts are cumulative 4 Accounting Process • Transaction analysis • Recording transactions • Deriving account balances • Prepare financial statements 5 Dual Effects of Transactions on the Accounting Equation Assets = Liabilities + Equity Example #1: Receive $100 from bank loan + Increase Cash (an asset) + Increase Bank Loan (a liability) Assets = Liabilities + Equity 100 = 100 + 0 6 Dual Effects of Transactions on the Accounting Equation Assets = Liabilities + Equity Example #2: Repay $20 of bank loan + Decrease Cash (an asset) + Decrease Bank Loan (a liability) Assets = Liabilities + Equity 100 = 100 + 0 (20) = (20) + 0 7 Dual Effects of Transactions on the Accounting Equation Assets = Liabilities + Equity Example #3: Purchase $10 of inventory with cash + Decrease Cash (an asset) + Increase Inventory (an asset) Assets = Liabilities + Equity 100 = 100 + 0 (20) = (20) + 0 +10 - 10 = 0 + 0 8 Dual Effects of Transactions on the Accounting Equation Assets = Liabilities + Equity Example #4: Issue $50 of common stock to repay portion of bank loan + Increase Common Stock (equity) + Decrase Bank Loan (a liability) Assets = Liabilities + Equity 100 = 100 + 0 (20) = (20) + 0 +10 - 10 = 0 + 0 0 = (50) + 50 80 = 30 + 50 9 All transactions will fit into one or a combination of two or more of the below This change will be accompanied by This change +A +A +A -A +L +E -L -L -L -A +L +E +E +E +E +A -L -E Or vice versa! 10 Transaction Analysis Indicate the effects of the following transactions on the balance sheet equation using this format: Trans. # Assets = Liabilities + Equity 1. The firm issues 3,000 share of $10 par value common stock at par for cash Trans. 1 30,000 = 0 + 30,000 Subtotal 30,000 = 0 + 30,000 2. The firm purchases merchandise costing $18,900 on account. Trans. 2 18,900 = 18,900 + 0 Subtotal 48,900 = 18,900 + 30,000 11 Transaction Analysis 3. The firm acquires store equipment costing $12,700. It issues a check for $2,000 with the balance payable over 3 years under an installment contract. Trans. 3 12,700 -2,000 = 10,700 + 0 Subtotal 59,600 = 29,600 + 30,000 4. The firm issues a check for $1,800 covering two months’ rent in advance. Trans. 4 1,800 -1,800 = 0 + 0 Subtotal 59,600 = 29,600 + 30,000 12 Transaction Analysis 5. Refer to transaction (3) above. The firm issues common stock with a market value of $10,700 in full settlement of the installment contract. Trans. 5 0 = -10,700 + 10,700 Subtotal 59,600 = 18,900 + 40,700 6. The firm pays the merchandise supplier in transaction (2) the amount due. Trans. 6 -18,900 = -18,900 + 0 Total 40,700 = 0 + 40,700 13 Recording Transactions Using Ledger Accounts • Maintaining accounts using balance sheet equation is inefficient, especially as the number of accounts grow. Use Journal Entries and ledger accounts instead. • The increases and decreases in each asset, liability and equity item is tracked through its “T-account” Account Title Left Debit (Dr.) Right Credit (Cr.) • There can be no negative entries in T-Accounts • Note: Debit only means “left” and Credit only means “right” • One side of the T-account is used for increases and one for decrease. There is a beginning balance and an ending balance that appear on the financial statements (e.g., balance sheet). 14 T-Accounts Credit = Right Debit = Left Assets Dr. Cr. = Liabilities Dr. BB Incr. EB Cr. + Equity Dr. BB Decr. Decr. Incr. EB Cr. BB Decr. Incr. EB 15 T-Accounts • For Asset accounts: debit = left = increase credit = right = decrease • For Liability and Equity accounts: debit = left = decrease credit = right = increase 16 T-Accounts Handy Trick of the Day: Whether debit (left) means increase or decrease depends on what side of the Balance Sheet equation the account sits. Assets = Liabilities + Equity That is, Assets are on the left side of the equation, thus debit (left) is an increase for assets [and credits are therefore decreases]. Liabilities and Equity are on the right side of the equation, thus credit (right) is an increase [and debits are therefore decreases]. 17 T- Accounts, Dual Effects of Transactions, and the Balance Sheet Equation • In our prior examples we used the equation to make sure that each transaction had two effects on the balance sheet and thus the equation always held. • Now that we have T-accounts, we can also make sure that: Debits = Credits This will also ensure that the Balance Sheet equation holds! Let’s check this… 18 Debits = Credits Assets = Liabilities + Equity Recall the 4 possible combinations of the dual effects of transactions: 1) Increase an asset and Increase a liability or equity Debit Credit 2) Decrease an asset and Decrease a liability or equity Credit Debit 3) Increase an asset and Decrease an asset Debit Credit 4) Increase a liab. or eq. and Decrease another liab or eq. Credit Debit 19 Debits and Credits Retained Earnings Liability or Owners’ Equity Asset (Debit) + Remember RE is an Owners’ Equity Account (Credit) - Memorize this for Assets (Debit) (Credit) - + Flip it for Liabs + OE Expenses/Losses An increase in an Expense is a decrease in Retained Earnings. (We decrease Owners’ Equity accounts with a debit.) (Debit) + Revenues/Gains An increase in a Revenue is an increase in Retained Earnings. (We increase Owners’ Equity accounts with a credit.) (Credit) + 20 Debits and Credits, Some Intuition “Debit” card Suppose I open a checking account with BOA with $1,000. Assets Cash Bank of America Liabilities credit debit Accounts Payable (Chris) $1,000 $1,000 $150 $850 $150 $850 I use my debit card to buy an iPod at Best Buy for $150. Using a debit card reduces the bank’s liability to you. The word “debit” in the term “debit card” is intuitive from the bank’s point of view. 21 Debits and Credits, Some Intuition “Credit” card Suppose I sign up for a Visa credit card. My Finances debit Assets iPod $150 Liabilities Accounts Payable (Visa) credit $150 I use my credit card to buy an iPod at Best Buy for $150. Using a credit card increases your liability to your credit card company (i.e., Visa) The word “credit” in the term “credit card” is intuitive from your point of view. 22 Balance Sheet at the beginning of 2010 Injection Plastics Company Balance Sheet As of Dec. 31, 2010 Cash $21,000 Accounts Payable $15,000 Investments (short-term) 2,000 Accrued liabilities payable 2,000 Accounts receivable 3,000 Notes payable (short-term) 7,000 Inventory Notes receivable (long-term) 24,000 Long-term notes payable 48,000 1,000 Equipment 48,000 Contributed capital 90,000 Factory building 90,000 Retained earnings 30,000 Intangibles 3,000 $192,000 $192,000 23 P2-3 Assets Cash $21,000 Liabilities Intangible Assets $3,000 Accounts Payable Accrued Liabs. Payable $15,000 Short Term Inv $2,000 $2,000 Accts Receivable $3,000 Short Term Note Pybl $7,000 Inventory $24,000 Long Term Note Pybl $48,000 Long Term Note Recv $1,000 Equity Equipment $48,000 Factory Bldg $90,000 Contributed Capital $90,000 Retained Earnings $30,000 24 P2-3 a. Lent $7,000 to a supplier who signed a two-year note Assets Cash $21,000 $7,000 Long-term note rec $1,000 $7,000 Journal Entry Long-term note receivable Cash 7,000 7,000 25 P2-3 b. Purchased Equipment that cost $18,000. Paid $6,000 cash and signed a one-year note for the balance. Assets Liabilities Equipment $48,000 $18,000 Cash $21,000 Short Term Note Payable $7,000 $7,000 $12,000 $6,000 Journal Entry Equipment 18,000 Cash 6,000 Short-term Note Payable 12,000 26 P2-3 c. Issued an additional 2,000 shares of capital stock for $12,000 cash. Assets Equity Cash Contributed Capital $21,000 $7,000 $12,000 $6,000 $90,000 $12,000 Journal Entry Cash 12,000 Contributed Capital 12,000 27 P2-3 d. Borrowed $12,000 cash from a local bank, payable in three months. Assets Liabilities Short-term note payable Cash $21,000 $7,000 $12,000 $6,000 $7,000 $12,000 $12,000 $12,000 Journal Entry Cash 12,000 Short-term note payable 12,000 28 P2-3 e. Purchased short-term investments for $9,000 cash Assets Cash $21,000 Short-term investments $7,000 $9,000 $12,000 $12,000 $2,000 $6,000 $9,000 Journal Entry Short-term investments Cash 9,000 9,000 29 P2-3 f. Hired a new president at the end of the year. The contract was for $85,000 per year plus options to purchase company stock at a set price based on company performance. No Recordable Economic Effect Journal Entry No Journal Entry 30 P2-3 g. Purchased a patent (an intangible asset) for $3,000 cash. Assets Cash Intangibles $21,000 $7,000 $20,000 $6,000 $3,000 $3,000 $9,000 $3,000 Journal Entry Intangibles (patent) Cash 3,000 3,000 31 P2-3 h. Returned defective equipment to the manufacturer and received a (full) refund of $1,000. Assets Cash Equipment $21,000 $7,000 $12,000 $6,000 $12,000 $9,000 $1,000 $48,000 $18,000 $1,000 $3,000 Journal Entry Cash 1,000 Equipment 1,000 32 P2-3 i. Built an addition to the factory for $25,000; paid $9,000 cash and signed a three-year note for the balance Assets Cash $21,000 $12,000 $12,000 $1,000 $46,000 Liabilities Long Term Note Payable Factory Building $7,000 $6,000 $9,000 $48,000 $90,000 $16,000 $25,000 $3,000 $9,000 $34,000 $12,000 How much cash is left? Journal Entry Factory Building 25,000 Cash 9,000 Long-term Note Payable 16,000 33 Balance Sheet at the beginning of 2010 Injection Plastics Company Balance Sheet As of Dec. 31, 2011 Cash Investments (short-term) Accounts receivable Inventory Notes receivable (long-term) Equipment Factory building Intangibles $12,000 Accounts Payable 11,000 Accrued liabilities payable 3,000 Notes payable (short-term) 24,000 Long-term notes payable $15,000 2,000 31,000 64,000 8,000 65,000 Contributed capital 115,000 Retained earnings 102,000 30,000 6,000 $244,000 $244,000 34 Next Class • Income Statement • Cash versus Accrual Basis Accounting 35