investing and financing decisions and the balance sheet chapter 2 mcgraw-hill/irwin © 2009 the...
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Investing and Financing Decisions Investing and Financing Decisions and the Balance Sheetand the Balance Sheet
Chapter 2
McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.
The Conceptual Framework
AssumptionsSeparate entity: Activities of the business are separate from activities of owners.Continuity: The entity will not go out of business in the near future.Unit-of-measure: Accounting measurements will be in the national monetary unit (i.e., $ in the U.S.).
AssumptionsSeparate entity: Activities of the business are separate from activities of owners.Continuity: The entity will not go out of business in the near future.Unit-of-measure: Accounting measurements will be in the national monetary unit (i.e., $ in the U.S.).
PrincipleHistorical cost: Cash equivalent cost given up
is the basis for the initial recording of elements.
PrincipleHistorical cost: Cash equivalent cost given up
is the basis for the initial recording of elements.
The Conceptual FrameworkExceptions
Materiality: Account for small amounts in the most cost effective way, even if not technically correct.
Conservatism: Do not overstate assets or revenue and do not understate liabilities or expenses.
Nature of Business Transactions
Most transactions with external parties involve an
exchange exchange where the business entity gives up gives up something but receivesreceives
something in return.
Principles of Transaction Analysis
Every transaction affects at least two accounts (duality of effects).
The accounting equation must remain in balance after each transaction.
AA = = LL + + SESE(Assets) (Liabilities) (Stockholders’ Equity)
Double-Entry Accounting
Double-entry bookkeeping means to recordthe dual effects of each business transaction.
Accounting for Business Transactions
The Lyons invest $50,000 to beginthe business, and Air & Sea Travel
issues common stock.
Stockholders’ Assets = Liabilities + Equity
(1) Cash + 50,000 = + 50,000*
*Common stock
Accounting for Business Transactions
Air & Sea purchases land for anoffice location, paying $40,000 in cash.
Balance + 50,000 = + 50,000*
*Common stock
(2) Cash – 40,000 Land + 40,000
50,000 = + 50,000*
Stockholders’ Assets = Liabilities + Equity
Analytical Tool: The T-Account
Account Title
Debit
LEFT SIDE RIGHT SIDE
Credit
Rules of Debit and Credit
AccountingEquation: Assets = Liabilities +
Stockholders’Equity
Rules ofDebit andCredit: Debit
+Debit
–Debit
–Credit
–Credit
+Credit
+
Rules of Debit and Credit
Air & Sea received $50,000 and issued stock.
Assets = Liabilities +Stockholders’
Equity
Debitfor
Increase,50,000
Creditfor
Increase,50,000
Cash Common Stock
Rules of Debit and Credit
Air & Sea purchased land for $40,000 cash.
Common Stock
Bal. 50,000
CashCredit
forDecrease,
40,000
Bal. 50,000
LandDebit
forIncrease,
40,000
Assets = Liabilities +Stockholders’
Equity
The Journal Entry
A journal entry might look like this:(c) Property and Equipment (+A) 10,000
Cash (-A) 2,000 Notes Payable (+L) 8,000
To record purchase of P+E for cash and notes
Reference:Reference:Letter, Letter, number, or number, or date.date.
Reference:Reference:Letter, Letter, number, or number, or date.date.
Account Titles:Account Titles:Debited accounts on top.Debited accounts on top.Credited accounts on bottom Credited accounts on bottom usually indented.usually indented.
Account Titles:Account Titles:Debited accounts on top.Debited accounts on top.Credited accounts on bottom Credited accounts on bottom usually indented.usually indented.
Amounts:Amounts:Debited amounts on left.Debited amounts on left.Credited amounts on right.Credited amounts on right.
Amounts:Amounts:Debited amounts on left.Debited amounts on left.Credited amounts on right.Credited amounts on right.
Recording Transactionsin the Journal
Identify the transaction andspecify each account affected.
Determine whether each account is increased or decreased by the transaction.
Use the rules of debits and credits.
Enter the transaction in the journal, including a brief explanation for the entry.
How Do Companies Keep Track of Account Balances?
General JournalGeneral JournalGeneral JournalGeneral Journal
General LedgerGeneral Ledger
PostLedger
Posting from GJ to GL
After journal entries are prepared, the accountant posts (transfers) the dollar amounts to each account affected by
the transaction.
Debit Credit(c) Property and Equipment (+A) 10,000
Cash (-A) 2,000 Notes Payable (+L) 8,000
Key Ratio Analysis
CurrentRatio
Current AssetsCurrent Liabilities
=
The 2011 current ratio for Chipotle:The 2011 current ratio for Chipotle:
The current ratio for Chipotle shows a high level of liquidity, well above 1.0, and the ratio has varied slightly around the 3.1 level since 2009. Chipotle has high growth strategies requiring cash to fund expansion.
$501,200$157,500
= 3.182
Classified Balance Sheet
In a classified balance sheet assets and liabilities are classified into two categories – current and
noncurrent.
Current assets are those to be used or
turned into cash within the upcoming year, whereas noncurrent assets are those that will last longer than
one year.
Current liabilities are those obligations to be paid or settled within the next 12 months with current assets.
k
The Accounting Cycle
During the Period(Chapters 2 and 3)
•Analyze transactions•Record journal entries in the general journal•Post amounts to the general ledger
During the Period(Chapters 2 and 3)
•Analyze transactions•Record journal entries in the general journal•Post amounts to the general ledger
Start of new period
At the End of the Period(Chapter 4)
•Prepare a trial balance to determine if debits equal credits•Adjust revenues and expenses and related balance sheet accounts (record in journal and post to ledger) •Prepare a complete set of financial statements and disseminate it to users•Close revenues, gains, expenses, and losses to Retained Earnings (record in journal and post to ledger)
At the End of the Period(Chapter 4)
•Prepare a trial balance to determine if debits equal credits•Adjust revenues and expenses and related balance sheet accounts (record in journal and post to ledger) •Prepare a complete set of financial statements and disseminate it to users•Close revenues, gains, expenses, and losses to Retained Earnings (record in journal and post to ledger)
Focus on Cash Flows
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 –
Companies report cash inflows and outflows over a period in their statement of cash flows.
End of Chapter 2