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  • Chapter 2: Investing and Financing Decisions and the Balance Sheet.
  • End of chapter 2.
  • Power pointchapter2

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

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