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  • Chapter 2: Investing and Financing Decisions and the Balance Sheet.
  • End of chapter 2.

Power pointchapter2 Power pointchapter2 Presentation Transcript

  • Investing and Financing Decisions and the Balance Sheet
    Chapter 2
    McGraw-Hill/Irwin
    © 2009 The McGraw-Hill Companies, Inc.
  • Understanding the Business
    To understand amounts appearing
    on a company’s balance sheet we
    need to answer these questions:
    What
    business
    activities cause
    changes in
    the balance
    sheet?
    How do
    specific
    activities
    affect each
    balance?
    How do
    companies
    keep track of
    balance sheet
    amounts?
  • The Conceptual Framework
    Elements of Statements
    Asset
    Liability
    Stockholders’ Equity
    Revenue
    Expense
    Gain
    Loss
    Qualitative Characteristics
    Relevancy
    Reliability
    Comparability
    Consistency
    Objective of Financial Reporting
    To provide useful economic information to external users for decision making and for assessing future cash flows.
  • The Conceptual Framework
    Objective of Financial Reporting
    To provide useful economic information to external users for decision making and for assessing future cash flows.
    Primary Characteristics
    • Relevancy: predictive value,
    feedback value, and timeliness.
    • Reliability: verifiability,
    representational faithfulness,
    and neutrality.
    Secondary Characteristics
    • Comparability: across
    companies.
    • Consistency: over time.
    Qualitative Characteristics
    Relevancy
    Reliability
    Comparability
    Consistency
    Elements of Statements
    Asset
    Liability
    Stockholders’ Equity
    Revenue
    Expense
    Gain
    Loss
  • The Conceptual Framework
    Asset: economic resource with
    probable future benefits.
    Liability: probable future sacrifices of
    economic resources.
    Stockholders’ Equity: financing
    provided by owners and operations.
    Revenue: increase in assets or
    settlement of liabilities from ongoing
    operations.
    Expense: decrease in assets or
    increase in liabilities from ongoing
    operations.
    Gain: increase in assets or settlement
    of liabilities from peripheral
    activities.
    Loss: decrease in assets or
    increase in liabilities from peripheral
    activities.
    Objective of Financial Reporting
    To provide useful economic information to external users for decision making and for assessing future cash flows.
    Elements of Statements
    Asset
    Liability
    Stockholders’ Equity
    Revenue
    Expense
    Gain
    Loss
    Qualitative Characteristics
    Relevancy
    Reliability
    Comparable
    Consistent
  • The Conceptual Framework
    Assumptions
    Separate 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.).
    Principle
    Historical cost: Cash equivalent cost given up is the basis for the initial recording of elements.
  • Nature of Business Transactions
    External events: exchanges of assets
    and liabilities between the business
    and one or more other parties.
    Borrow cash
    from the bank
  • Nature of Business Transactions
    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.
  • Accounts
    Cash
    Inventory
    Notes Payable
    Equipment
    An organized format used by companies to accumulate the dollar effects of transactions.
  • Typical Account Titles
    The Balance Sheet
    AssetsCashShort-Term InvestmentAccounts ReceivableNotes ReceivableInventory (to be sold)SuppliesPrepaid ExpensesLong-Term InvestmentsEquipmentBuildingsLandIntangibles
    LiabilitiesAccounts PayableAccrued ExpensesNotes PayableTaxes PayableUnearned Revenue Bonds Payable
    Stockholders’ EquityContributed CapitalRetained Earnings
  • Typical Account Titles
    The Income Statement
    RevenuesSales RevenueFee RevenueInterest RevenueRent Revenue
    ExpensesCost of Goods SoldWages ExpenseRent ExpenseInterest ExpenseDepreciation ExpenseAdvertising ExpenseInsurance ExpenseRepair ExpenseIncome Tax Expense
  • Principles of Transaction Analysis
    • Every transaction affects at least twoaccounts (duality of effects).
    • The accounting equation must remain in balance after each transaction.
    A = L + SE
    (Assets)
    (Liabilities)
    (Stockholders’Equity)
  • Duality of Effects
    Most transactions with external parties involve an exchange where the business entity gives up something but receivessomething in return.
  • Balancing the Accounting Equation
    Step 1: Accounts and effects
    • Identify the accounts affected and classify them by type of account (A, L, SE).
    • 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.
  • Identify & Classify the Accounts
    1. Cash (asset).
    2. Contributed Capital (equity).
    Determine the Direction of the Effect
    1. Cash increases.
    2. Contributed Capital increases.
    Papa John’s issues $2,000 of additional common stock to new investors for cash.
    Analyzing Transactions
  • A= L + SE
    Analyzing Transactions
    Papa John’s issues $2,000 of additional common stock to new investors for cash.
  • Identify & Classify the Accounts
    1. Cash (asset).
    2. Notes Payable (liability).
    Determine the Direction of the Effect
    1. Cash increases.
    2. Notes Payable increases.
    The company borrows $6,000 from the local bank, signing a three-year note.
    Analyzing Transactions
  • A= L + SE
    Analyzing Transactions
    The company borrows $6,000 from the local bank, signing a three-year note.
  • Identify & Classify the Accounts
    1. Equipment (asset).
    2. Cash (asset).
    3. Notes Payable (liability).
    Determine the Direction of the Effect
    1. Equipment increases.
    2. Cash decreases.
    3. Notes Payable increases.
    Papa John’s purchases $10,000 of new equipment, paying $2,000 in cash and signing a two-year note payablefor the rest.
    Analyzing Transactions
  • A = L + SE
    Analyzing Transactions
    Papa John’s purchases $10,000 of new equipment, paying $2,000 in cash and signing a two-year note payablefor the rest.
  • Analyzing Transactions
    Papa John’s board of directors declares andpays $3,000 in dividends to shareholders.
    Identify & Classify the Accounts
    Identify & Classify the Accounts
    1. Cash (asset).
    2. Retained Earnings (equity).
    Determine the Direction of the Effect
    Determine the Direction of the Effect
    1. Cash decreases.
    2. Retained Earnings decreases.
  • Papa John’s board of directors declares andpays $3,000 in dividends to shareholders.
    A = L + SE
    Analyzing Transactions
  • The Accounting Cycle
    Closerevenues, gains,expenses and lossesto retained earnings.
    Preparea completeset of financial statements.Disseminatestatementsto users.
    End of the period:Adjustrevenues and expensesand related balance sheet accounts.
    During the period:Analyzetransactions.Record journal entries in the general journal.Post amounts to the general ledger.
  • How Do Companies Keep Track of Account Balances?
    T-accounts
    Journal entries
  • Direction of Transaction Effects
    The left side of the
    T-account is always the debit side.
    The rightside of the
    T-account is always the credit side.
    Account Name
    Right
    Left
    Debit
    Credit
  • Transaction Analysis Model
    ASSETS
    EQUITIES
    LIABILITIES
    Debit for Increase
    Credit for Decrease
    Debit for Decrease
    Credit for Increase
    Debit for Decrease
    Credit for Increase
    Debits and credits affect the Balance Sheet Model as follows:
    A = L + SE
  • ASSETS
    EQUITIES
    LIABILITIES
    Debit for Increase
    Credit for Decrease
    Debit for Decrease
    Credit for Increase
    Debit for Decrease
    Credit for Increase
    Remember that Stockholders’ Equity includes Contributed Capital and Retained Earnings.
    A = L + SE
    The Debit-Credit Framework
  • Analytical Tool: The Journal Entry
    A journal entry might look like this:
    Account Titles:
    Debited accounts on top.Credited accounts on bottom.
    Reference:
    Letter, number, or date.
    Amounts:
    Debited amounts on left.
    Credited amounts on right.
  • After journal entries are prepared, the accountant posts (transfers) the dollar amounts to each account affected by the transaction.
    Ledger
    Post
    The T-Account
  • (a)
    Papa John’s issues $2,000 of additional common stock to new investors for cash.
  • The company borrows $6,000 from the local bank, signing a three-year note.
  • Balance Sheet Preparation
    It is possible to prepare a balance sheet at any point in time from the balances in the accounts.
    Balance Sheet
  • The Asset Section of a Classified Balance Sheet
  • Liabilities and Stockholders’ Equity Section of the Balance Sheet
  • Key Ratio Analysis
    FinancialLeverageRatio
    Average Total AssetsAverage Stockholders’ Equity
    =
    The 2006 financial leverage ratio for Papa John’s was:
    ($351,000 + $380,000) ÷ 2($161,000 + $148,000) ÷ 2
    =
    2.37
    The ratio tells us how well management is using debt toincrease assets the company employs to earn income.
    (Beginning Balance + Ending Balance) ÷ 2
  • Focus on Cash Flows
  • Investing and Financing Activities
  • End of Chapter 2