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Chapter 2

Chapter 2. The Balance Sheet. PowerPoint Authors: Brandy Mackintosh Lindsay Heiser. Learning Objective 2-1. Identify financial effects of common business activities that affect the balance sheet. Building a Balance Sheet. Assets.

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Chapter 2

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  1. Chapter 2 The Balance Sheet PowerPoint Authors: Brandy Mackintosh Lindsay Heiser

  2. Learning Objective 2-1 Identify financial effects of common business activities that affect the balance sheet.

  3. Building a Balance Sheet Assets resources presently owned by a business that generate future economic benefit. = Liabilities amounts presently owed by a business to creditors. + Stockholders’ Equity the amount invested and reinvested in a company by its shareholders.

  4. Financing and Investing Activities Assets Companies rely on two sources of financing: Invest in Assets = Liabilities Debt Financing + & Stockholders’ Equity Equity Financing

  5. Financing and Investing Activities Key Features Your Goals 1. A company always documents its activities. Picture the documented activity. 2. A company always receives something and gives something. Name what’s exchanged. 3. A dollar amount is determined for each exchange. Analyzethe financial effects.

  6. Exchanges involving assets, liabilities, and stockholders’ equity that you can see between the company and someone else. External Exchanges Events occurring within the company, for example, using some assets to create an inventory product. Internal Events Transactions and Other Activities

  7. Learning Objective 2-2 Apply transaction analysis to accounting transactions.

  8. Study the Accounting Methods A systematic accounting process is used to capture and report the financial effects of a company’s transactions. Record Analyze Summarize A transaction is a business activity that affects the basic accounting equation. 1 3 A = L+ SE Assets must equal liabilities plus stockholders’ equity for every accounting transaction. Duality of Effects Every transaction has at least two effects on the basic accounting equation. 2

  9. Step 1: Analyze Transactions The chart of accounts is tailored to each company’s business, so although some account titles are common across all companies (Cash, Accounts Payable) others may be used only by that particular company (Cookware).

  10. + Stockholders’ Equity (a) Cash +$50,000 Contributed Capital +$50,000 Step 1: Analyze Transactions (a) Issue Stock to Owners. Mauricio Rosa incorporates Pizza Aroma Inc., on August 1. The company issues stock to Mauricio and his wife as evidence of their contribution of $50,000 cash, which is deposited in the company’s bank account. Liabilities Assets = • Pizza Aroma receives $50,000 Cash. • Pizza Aroma gives $50,000 Stock (Contributed Capital).

  11. + Stockholders’ Equity (b) Equipment +$42,000 Cash -$42,000 Step 1: Analyze Transactions (b) Investment in Equipment. Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. Liabilities Assets = • Pizza Aroma receives $42,000 of Equipment. • Pizza Aroma gives $42,000 Cash.

  12. + Stockholders’ Equity (c) Cash +$20,000 Note Payable +$20,000 Step 1: Analyze Transactions (c) Obtain Loan from Bank. Pizza Aroma borrows $20,000 from a bank depositing those funds in its bank account and signing a formal agreement to repay the loan in two years. Liabilities Assets = • Pizza Aroma receives $20,000 Cash. • Pizza Aroma gives a note, payable to the bank for $20,000.

  13. + Stockholders’ Equity (d) Cash -$16,000 Equipment +$18,000 Accounts Payable +$2,000 Step 1: Analyze Transactions (d) Investment in Equipment. Pizza Aroma purchases $18,000 in pizza ovens and other restaurant equipment, paying $16,000 in cash and giving an informal promise to pay $2,000 at the end of the month. Liabilities Assets = • Pizza Aroma receives $18,000 in equipment (pizza ovens). • Pizza Aroma gives a Cash of $16,000 and Accounts Payable of $2,000.

  14. + Stockholders’ Equity No Impact No Impact No Impact Step 1: Analyze Transactions (e) Order Cookware. Pizza Aroma orders $630 of pans, dishes, and other cookware. None have been received yet. • An exchange of only promises is not a transaction. • 2. There is no impact on the accounting equation. Liabilities Assets =

  15. + Stockholders’ Equity (f) Cash -$2,000 Accounts Payable -$2,000 Step 1: Analyze Transactions (f) Pay Suppliers. Pizza Aroma pays $2,000 to the equipment supplier from transaction (d). Liabilities Assets = • Pizza Aroma gives cash to settle its debt to the supplier. • 2. Pizza Aroma receives a release from its promise to pay.

  16. + Stockholders’ Equity (g) Cookware +$630 Accounts Payable +$630 Step 1: Analyze Transactions (g) Receive Cookware. Pizza Aroma receives $630 of the cookware ordered in (e) and promises to pay for it next month. Liabilities Assets = • Pizza Aroma receives cookware with a cost of $630. • 2. Pizza Aroma gave a promise to pay $630 on account.

  17. Learning Objective 2-3 Use journal entries and T-accounts to show how transactions affect the balance sheet.

  18. Step 2 and 3: Record and Summarize Most companies use computerized accounting systems, which can handle a large number of transactions. These systems follow a cycle, called the accounting cycle, which is repeated day-after-day, month-after-month, and year-after-year.

  19. The Debit/Credit Framework ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY Asset accounts increase on the left or debit side and decrease on the right or credit side. Stockholders’ equity accounts increase on the right or credit side and decrease on the left or debit side. Liability accounts increase on the right or credit side and decrease on the left or debit side.

  20. The Debit/Credit Framework ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY • Take special note of two important rules: • Accounts increase on the same side as they appear in A = L + SE • Left is debit ( dr), right is credit ( cr)

  21. Steps 2 & 3: Record and Summarize General Journal Page G1 Date Account Title and Explanation Ref. Debit Credit Record Analyze Summarize 1 3 2

  22. Steps 2 & 3: Record and Summarize 2013 8/1 Cash Contributed Capital (Financing from stockholders) 101 301 50,000 50,000 General Journal Page G1 Date Account Title and Explanation Ref. Debit Credit Acct 101 Acct 301 Record Analyze Summarize 1 General Ledger General Ledger Account: Contributed Capital Account: Cash 3 Balance Balance Date Explanation Ref. Debit Credit Date Explanation Ref. Debit Credit 2 2013 8/1 2013 8/1 G1 G1 50,000 50,000 50,000 50,000

  23. Steps 2 & 3: Record and Summarize (a) dr Cash (+A) cr Contributed Capital (+SE) 50,000 50,000 Acct 301 Acct 101 Record Analyze Summarize 1 General Ledger General Ledger Account: Cash Account: Contributed Capital 3 Balance Balance Date Explanation Ref. Debit Credit Date Explanation Ref. Debit Credit 2 2013 8/1 2013 8/1 G1 G1 50,000 50,000 50,000 50,000

  24. Steps 2 & 3: Record and Summarize (a) dr Cash (+A) cr Contributed Capital (+SE) 50,000 50,000 Acct 101 Acct 301 Record Analyze Summarize 1 General Ledger General Ledger Account: Cash Account: Contributed Capital 3 Balance Balance Date Explanation Ref. Debit Credit Date Explanation Ref. Debit Credit 2 2013 8/1 2013 8/1 G1 G1 50,000 50,000 50,000 50,000

  25. + Stockholders’ Equity (a) Cash +$50,000 Contributed Capital +$50,000 Pizza Aroma’s Accounting Records (a) Issue Stock to Owners. Mauricio Rosa incorporates Pizza Aroma Inc., on August 1. The company issues stock to Mauricio and his wife as evidence of their contribution of $50,000 cash, which is deposited in the company’s bank account. (a) dr Cash (+A) cr Contributed Capital (+SE) 50,000 50,000 Record Analyze Summarize = Liabilities Assets cr + cr - dr - dr + Contributed Capital (SE) Cash (A) 1 Beg. Bal. (a) 0 50,000 Beg. Bal. (a) 0 50,000 3 2

  26. + Stockholders’ Equity (b) Cash -$42,000 Equipment +$42,000 Pizza Aroma’s Accounting Records (b) Investment in Equipment. Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. (b) dr Equipment (+A) cr Cash (-A) 42,000 42,000 Record Analyze Summarize = Liabilities Assets cr - cr - dr + dr + Equipment (A) Cash (A) 1 Beg. Bal. (b) Beg. Bal. (a) (b) 0 42,000 0 50,000 42,000 3 2

  27. + Stockholders’ Equity (c) Cash +$20,000 Note Payable +$20,000 Pizza Aroma’s Accounting Records (c) Obtain Loan from Bank. Pizza Aroma borrows $20,000 from a bank depositing those funds in its bank account and signing a formal agreement to repay the loan in two years. (c) dr Cash (+A) cr Note Payable (+L) 20,000 20,000 Record Analyze Summarize = Liabilities Assets cr + cr - dr - dr + Note Payable (L) Cash (A) 1 Beg. Bal. (a) (c) 0 20,000 Beg. Bal. (c) (b) 0 50,000 20,000 42,000 3 2

  28. + Stockholders’ Equity (d) Cash -$16,000 Equipment +$18,000 Accounts Payable +$2,000 Pizza Aroma’s Accounting Records (d) Investment in Equipment. Pizza Aroma purchases $18,000 in pizza ovens and other restaurant equipment, paying $16,000 in cash and giving an informal promise to pay $2,000 at the end of the month. 16,000 2,000 (d) dr Equipment (+A) cr Cash (-A) cr Accounts Payable (+L) 18,000 Record Analyze Summarize = Liabilities Assets dr + Cash (A) cr - 1 Beg. Bal. (a) (c) (b) (d) 42,000 16,000 0 50,000 20,000 3 2 dr + cr + Equipment (A) dr - cr - Accounts Payable (L) Beg. Bal. (b) (d) 0 42,000 18,000 0 2,000 Beg. Bal. (d)

  29. + Stockholders’ Equity (f) Cash -$2,000 Accounts Payable -$2,000 Pizza Aroma’s Accounting Records (f) Pay Suppliers. Pizza Aroma pays $2,000 to the equipment supplier from the last transaction. (f) dr Accounts Payable (-L) cr Cash (-A) 2,000 2,000 Record Analyze Summarize = Liabilities Assets cr + cr - dr - dr + Accounts Payable (L) Cash (A) 1 (f) Beg. Bal. (a) (c) 0 2,000 Beg. Bal. (d) (b) (d) (f) 2,000 0 50,000 20,000 42,000 16,000 2,000 3 2

  30. + Stockholders’ Equity (g) Cookware +$630 Accounts Payable +$630 Pizza Aroma’s Accounting Records (g) Receive Cookware. Pizza Aroma receives $630 of the cookware previously ordered and promises to pay for it next month. (g) dr Cookware (+A) cr Accounts Payable (+L) 630 630 Record Analyze Summarize = Liabilities Assets cr + cr - dr - dr + Cookware (A) Accounts Payable (L) 1 Beg. Bal. (g) (f) 2,000 0 2,000 630 Beg. Bal. (d) (g) 0 630 3 2

  31. T-Accounts for Pizza Aroma Cash Contributed Capital Equipment Cookware Accounts Payable Notes Payable 42,000 16,000 2,000 (b) (d) (f) Beg. Bal. (a) (c) - 50,000 20,000 Beg. Bal. (g) - 630 - 2,000 630 Beg. Bal. (d) (g) - 20,000 Beg. Bal. (c) - 50,000 Beg. Bal. (a) Beg. Bal. (b) (d) - 42,000 18,000 (f) 2,000 End. Bal. 630 20,000 End. Bal. 50,000 End. Bal. End. Bal. 60,000 630 End. Bal. End. Bal. 10,000

  32. Learning Objective 2-4 Prepare a classified balance sheet.

  33. Preparing a Balance Sheet It’s a good idea to check that the accounting records are in balance by determining whether debits = credits. We do this by preparing a Trial Balance. Pizza Aroma, Inc. Trial Balance August 31, 2013 Credit $ 630 20,000 50,000 $70,630 Debit $10,000 630 60,000 $70,630 Cash Cookware Equipment Accounts Payable Note Payable Contributed Capital Totals

  34. Classified Balance Sheet Pizza Aroma, Inc. Balance Sheet At August 31, 2013 Current assets will be used up or converted into cash within the next 12 months.Long-term assets include resources that will be used or converted into cash more than 12 months after the balance sheet date. $10,000 630 10,630 60,000 $70,630 $ 630 20,000 20,630 50,000 $70,630 Current Assets: Cash Cookware Total Current Assets Property, Plant, and Equipment: Equipment Total Assets: Liabilities and Stockholders’ Equity: Current Liabilities: Accounts Payable Long-Term Liabilities: Note Payable Total Liabilities: Stockholders’ Equity Contributed Capital Total Liabilities and Stockholders’ Equity

  35. Learning Objective 2-5 Interpret the balance sheet using the current ratio and an understanding of related concepts. .

  36. Assessing the Ability to Pay Pizza Aroma, Inc. Balance Sheet At August 31, 2013 $10,000 630 10,630 60,000 $70,630 $ 630 20,000 20,630 50,000 $70,630 Current Assets: Cash Cookware Total Current Assets Property, Plant, and Equipment: Equipment Total Assets: Liabilities and Stockholders’ Equity: Current Liabilities: Accounts Payable Long-Term Liabilities: Note Payable Total Liabilities: Stockholders’ Equity Contributed Capital Total Liabilities and Stockholders’ Equity CurrentRatio Current AssetsCurrent Liabilities $ 10,630$ 630 = = = 16.9 A higher current ratio generally means a better ability to pay. Pizza Aroma’s current ratio is unusually high.

  37. Balance Sheet Concepts and Values Pizza Aroma, Inc. Balance Sheet At August 31, 2013 • What is (is not) recorded? • Includes items acquired through exchange. • Excludes other items (such as secret recipes). $10,000 630 10,630 60,000 $70,630 $ 630 20,000 20,630 50,000 $70,630 Current Assets: Cash Cookware Total Current Assets Property, Plant, and Equipment: Equipment Total Assets: Liabilities and Stockholders’ Equity: Current Liabilities: Accounts Payable Long-Term Liabilities: Note Payable Total Liabilities: Stockholders’ Equity Contributed Capital Total Liabilities and Stockholders’ Equity • What amounts? • Initially recorded at cost. • Conservatism leads to recording decreases in asset value but generally not increases.

  38. Chapter 2Solved Exercises M2-13, M2-15, M2-17, M2-19, E2-4, E2-6

  39. M2-13 Identifying Transactions and Preparing Journal Entries • J.K. Builders was incorporated on July 1, 2013. Prepare journal entries for the following events from the first month of business. If the event is not a transactions, write “no transaction.” • Received $70,000 cash invested by owners and issued stock. • Bought an unused field from a local farmer by paying $60,000 cash. As a construction site for smaller projects it is estimated to be worth $65,000 to J.K. Builders. • A lumber supplier delivered lumber to J.K. Builders for future use. The lumber would have normally sold for $10,000, but the supplier gave J.K. Builders a 10% discount. J.K. Builders has not received a bill from the suppliers. • dr Cash (+A) 70,000 • cr Contributed Capital (+SE) 70,000 b. dr Inventory (+A) 60,000 cr Cash (-A) 60,000 c. dr Supplies (+A) 9,000 cr Cash (-A) 9,000 $10,000 × 10% = $1,000; $10,000 - $1,000 = $9,000

  40. M2-13 Identifying Transactions and Preparing Journal Entries • Borrowed $25,000 from the bank with a plan to use the funds to build a small workshop in August. The loan must be repaid in two years. • One of the owners sold $10,000 worth of his stock to another shareholder for $11,000. dr Cash (+A) 25,000 cr Notes Payable (+L) 25,000 e. No transaction Event (e) is a transaction between two independent individuals and does not involve the company, J.K. Builders.

  41. M2-15 Identifying Transactions and Preparing Journal Entries • Joel Henry founded bookmart.com at the beginning of August, which sells new and used books online. He is passionate about books but does not have a lot of accounting experience. Help Joel by preparing journal entries for the following events. If the event is not a transaction, write “no transaction.” • The company purchased equipment for $4,000 cash. The equipment is expected to be used for ten or more years. • Joel’s business bought $7,000 worth of books from a publisher. The company will pay the publisher within 45-60 days. • dr Equipment (+A) 4,000 • cr Cash (-A) 4,000 b. dr Inventory (+A) 7,000 cr Accounts Payable (+L) 7,000

  42. M2-15 Identifying Transactions and Preparing Journal Entries • Joel’s friend Sam lent $4,000 to the business. Sam had Joel write a note promising that bookmart.com would repay the $4,000 in four months. Because they are good friends, Sam is not going to charge Joel interest. • The company paid $1,500 cash, for books purchased on account earlier in the month. • Bookmart.com repaid the $4,000 loan established in c. c. dr Cash (+A) 4,000 cr Notes Payable (+L) 4,000 d. dr Accounts Payable (-L) 1,500 cr Cash (-A) 1,500 e. dr Notes Payable (-L) 4,000 cr Cash (-A) 4,000

  43. M2-17 Identifying Transactions and Preparing Journal Entries • Sweet Shop Co. Is a chain of candy stores that has been in operation for the past ten years. Prepare journal entries for the following events, which occurred at the end of the most recent year. If the event is not a transaction, write “no transaction.” • Ordered and received $12,000 worth of cotton candy machines from Candy Makers, Inc., which Sweet Shop Co. Will pay for in 45 days. • Sent a check for $6,000 to Candy Makers, Inc. for partial payment of the cotton candy machines from (a) • Received $400 from customers who bought candy on account in previous months. a. dr Equipment (+A) 12,000 cr Accounts Payable (+L) 12,000 b. dr Accounts Payable (-L) 6,000 cr Cash (-A) 6,000 c. dr Cash (+A) 400 cr Accounts Receivable (-A) 400

  44. M2-17 Identifying Transactions and Preparing Journal Entries • To help raise funds for store upgrades estimated to cost $20,000, Sweet Shop Co. Issued 1,000 shares for $15 each to existing stockholders. • Sweet Shop Co. bought ice cream trucks for $60,000 total, paying $10,000 cash and signing a long-term note for $50,000. d. dr Cash (+A) 15,000 cr Contributed Capital (+SE) 15,000 1,000 shares × $15 each = $15,000 e. dr Equipment (+A) 60,000 cr Notes Payable (+L) 50,000 cr Cash (-A) 10,000

  45. M2-19 Identifying Transactions and Preparing Journal Entries • Katy Williams is the manager of Blue Light Arcade. The company provides entertainment for parties and special events. Prepare journal entries for the following events relating to the year ended December 31. If the event is not a transaction, write “no transaction.” • Blue Light Arcade received $50 cash on account for a birthday party held two months ago. • Agreed to hire a new employee at a monthly salary of $3,000. The employee starts work next month. • Paid $2,000 for a table top hockey game purchased last month on account. a. dr Cash (+A) 50 cr Accounts Receivable (-A) 50 b. No Transaction The employee has yet to provide any services to the company c. dr Accounts Payable (-L) 2,000 cr Cash (-A) 2,000

  46. M2-19 Identifying Transactions and Preparing Journal Entries Prepare journal entries for the following events relating to the year ended December 31. If the event is not a transaction, write “no transaction.” d. Repaid a $5,000 bank loan that had been outstanding for 6 months. (Ignore interest). e. The company purchased an air hockey table for $2,200, paying $1,000 cash and signing short-term note for $1,200. d. dr Notes Payable (-L) 5,000 cr Cash (-A) 5,000 e. dr Equipment (+A) 2,200 cr Cash (-A) 1,000 cr Notes Payable (+L) 1,200

  47. End of Chapter 2

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