Chapter 2: Reporting Investing and Financing Results on the Balance Sheet Learning Objective 1

1. Chapter 2: Reporting Investing and Financing Results on the Balance SheetLearning Objective 1 Identify financial effects of common financing and investing activities. 2-1

2. 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. 2-2

3. Financing and Investing Activities Assets Companies rely on two sources of financing: Invest in Assets = Liabilities Debt Financing + & Stockholders’ Equity Equity Financing 2-3

4. Financing and Investing Activities Key Features Your Goals 1. A company always documents its activities. Picture each activity. 2. A company always receives something and gives something. Name the items. 3. A dollar amount is determined for each exchange. Analyzethe effects. 2-4

5. 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 2-5

6. Learning Objective 2 Apply transaction analysis to financing and investing transactions. 2-6

7. 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 2-7

8. 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). Depending on the company, you may see a liability for a bank loan called a Note Payable or a Loan Payable. 2-8

9. 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. • Pizza Aroma receives $50,000 Cash. • Pizza Aroma gives $50,000 Stock (Contributed Capital). 2-9

10. Step 1: Analyze Transactions (b) Investment in Equipment. Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. • Pizza Aroma receives $42,000 of Equipment. • Pizza Aroma gives $42,000 Cash. 2-10

11. 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. • Pizza Aroma receives $20,000 Cash. • Pizza Aroma gives a note, payable to the bank for $20,000. 2-11

12. 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. • Pizza Aroma receives $18,000 in equipment (pizza ovens). • Pizza Aroma gives a Cash of $16,000 and Accounts Payable of $2,000. 2-12

13. 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. This does not affect the accounting equation. 2-13

14. Step 1: Analyze Transactions (f) Pay Suppliers. Pizza Aroma pays $2,000 to the equipment supplier from transaction (d). • Pizza Aroma gives cash to settle its debt to the supplier. • 2. Pizza Aroma receives a release from its promise to pay. 2-14

15. 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. • Pizza Aroma receives cookware with a cost of $630. • 2. Pizza Aroma gave a promise to pay $630 on account. 2-15

16. Learning Objective 3 Use journal entries and T-accounts to show how transactions affect the balance sheet. 2-16

17. 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. 2-17

18. 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. 2-18

19. Steps 2 & 3: Record and Summarize Record Analyze Summarize 1 3 2 2-19

20. Steps 2 & 3: Record and Summarize Record Analyze Summarize 1 3 2 2-20

21. Steps 2 & 3: Record and Summarize Record Analyze Summarize 1 3 2 2-21

22. Steps 2 & 3: Record and Summarize Record Analyze Summarize 1 3 2 2-22

23. 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. Record Analyze Summarize 1 3 2 2-23

24. Pizza Aroma’s Accounting Records (b) Investment in Equipment. Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. Record Analyze Summarize 1 3 2 2-24

25. 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. Record Analyze Summarize 1 3 2 2-25

26. 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. Record Analyze Summarize 1 3 2 2-26

27. Pizza Aroma’s Accounting Records (f) Pay Suppliers. Pizza Aroma pays $2,000 to the equipment supplier from the last transaction. Record Analyze Summarize 1 3 2 2-27

28. 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. Record Analyze Summarize 1 3 2 2-28

29. T-Accounts for Pizza Aroma 2-29

30. Learning Objective 4 Prepare a classified balance sheet. 2-30

31. 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. 2-31

32. Classified Balance Sheet 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 turned into cash more than 12 months after the balance sheet date. 2-32

33. Learning Objective 5 Interpret the balance sheet using the current ratio and an understanding of related concepts. . 2-33

34. Assessing the Ability to Pay 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. 2-34

35. Balance Sheet Concepts and Values • What is (is not) recorded? • Includes items acquired through exchange. • Excludes other items (such as secret recipes). • What amounts? • Initially recorded at cost. • Conservatism leads to recording decreases in asset value but generally not increases. 2-35