1. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 2 Reporting Investing and Financing Results on the Balance Sheet

2. 2-2 Supercut’s Situation All businesses—big and small—need systems for organizing information. In this chapter, we will focus on the decisions that business managers make when starting up a single Supercuts salon and how their accounting systems track the financial results of the salon’s investing and financing activities.

3. 2-3 The Basic Accounting Equation Remember the basic accounting equation from chapter 1? In this chapter we will focus on how business activities affect this equation.

4. 2-4 Learning Objective 1 Explain and select common balance sheet account titles.

5. 2-5 Business Activities and Balance Sheet Accounts Let’s think about what’s involved in getting your Supercuts hair salon up and running: Select a rental location Renovate the space Buy furniture and salon equipment Buy a computer and software Buy shampoos and the like You and your parents only have $50,000 to contribute to these start-up costs. You determined that a $20,000 loan from a bank would provide enough cash to cover the rest of the costs. What accounts do you think would likely appear on the balance sheet of your Supercuts store?

6. 2-6 Business Activities and Balance Sheet Accounts

7. 2-7 Sample Chart of Accounts The chart of accounts is a summary of all account names (and corresponding account numbers) used to record financial results in the accounting system. The next slide provides a description of each account listed.

8. 2-8

9. 2-9 Learning Objective 2 Apply transaction analysis to business transactions.

10. 2-10 The Accounting Cycle (1) Analyze(2) Record(3) Summarize

11. 2-11 Step 1: Analyze Transaction A transaction is an exchange or an event that has a direct economic effect on the assets, liabilities, or stockholders’ equity of a business.

12. 2-12 Step 1: Analyze External Exchanges Exchanges involving assets, liabilities, and stockholders’ equity that you can see between the company and someone else. Internal Events Events occurring within the company, for example, using some assets to create an inventory product.

13. 2-13 Transaction Analysis Two simple ideas are used when analyzing transactions: Duality of Effects Every transaction has at least two effects on the basic accounting equation. A = L+ SE Remember that assets must equal liabilities plus stockholders’ equity for every accounting transaction.

14. 2-14 Transaction Analysis—Examples Pay cash for hair spray supplies. Duality of Effects 1.Supercuts gives Cash. 2.Supercuts receives Supplies. A = L+ SE Cash (an asset) decreases. Supplies (an asset) increases.

15. 2-15 Transaction Analysis—Examples Buy hair supplies on credit. Duality of Effects 1.Supercuts gives Accounts Payable. 2.Supercuts receives Supplies. A = L+ SE Accounts Payable (a liability) increases. Supplies (an asset) increases.

16. 2-16 Transaction Analysis—Examples Pay cash for amount owed. Duality of Effects 1.Supercuts gives Cash. 2.Supercuts eliminates Accounts Payable. A = L+ SE Cash (an asset) decreases. Accounts Payable (a liability) decreases.

17. 2-17 DECIDE: An Approach to Analyzing Transactions Let’s work through a few examples using the DECIDE approach.

18. 2-18 You incorporate your Supercuts salon on August 1. The company issues stock certificates to you and your parents in exchange for $50,000, which is deposited in the company’s bank account. Take a minute and think about these steps.

19. 2-19 You incorporate your Supercuts salon on August 1. The company issues stock certificates to you and your parents in exchange for $50,000, which is deposited in the company’s bank account.

20. 2-20 Your salon pays $42,000 cash for equipment. Take a minute and think about these steps.

21. 2-21 Your salon pays $42,000 cash for equipment.

22. 2-22 Your company 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. Take a minute and think about these steps.

23. 2-23 Your company 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.

24. 2-24 Your salon installs $18,000 of additional equipment, paying $16,000 in cash and giving an informal promise to pay $2,000 at the end of the month. Take a minute and think about these steps.

25. 2-25 Your salon installs $18,000 of additional equipment, paying $16,000 in cash and giving an informal promise to pay $2,000 at the end of the month.

26. 2-26 Your company orders $800 of shampoo and other operating supplies from Tigi. None have been received yet. Take a minute and think about these steps.

27. 2-27 Your company orders $800 of shampoo and other operating supplies from Tigi. None have been received yet. Did you get this one?

28. 2-28 Your company pays the $2,000 owed to the equipment supplier in (d). Take a minute and think about these steps.

29. 2-29 Your company pays the $2,000 owed to the equipment supplier in (d).

30. 2-30 Your company receives $630 of the supplies ordered in (e), and promises to pay for them next month. Take a minute and think about these steps.

31. 2-31 Your company receives $630 of the supplies ordered in (e), and promises to pay for them next month.

32. 2-32 Learning Objective 3 Use journal entries and T-accounts to show how business transactions affect the balance sheet.

33. 2-33 Steps 2 & 3: Record and Summarize Transactions Journal Ledger Posted to Financial Statements Used to prepare Entered in

34. 2-34 The Journal and Ledger Journal A journal is a record of each day’s transactions. A ledger is a collection of records that summarize the effects of transactions entered in the journal. Ledger

35. 2-35 The Debit/Credit Framework Take a moment to see how the increase symbol + appears on the left side of the T-account for accounts on the left side of the accounting equation and on the right side of the T-account for accounts on the right side of the equation. The same balancing logic applies to decreases, which are on the side of the T- account closest to the equals sign.

36. 2-36 The Debit/Credit Framework Debit = LeftCredit = Right DebitCredit increase debit decrease credit Asset accounts increase on the left or debit side and decrease on the right or credit side. DebitCredit increase creditdecrease debit Liability accounts increase on the right or credit side and decrease on the left or debit side. DebitCredit increase credit decrease debit Stockholders’ equity accounts increase on the right or credit side and decrease on the left or debit side. In every transaction, the total dollar value of all debits equals the total dollar value of all credits.

37. 2-37 Step 2: Recording Journal Entries Formal Journal Entries

38. 2-38 Step 2: Recording Journal Entries Simplified Journal Entries

39. 2-39 Steps 3: Summarizing in Ledger Accounts Journal Ledger By themselves, journal entries show the effects of transactions, but do not indicate the balance in each account. That is why we need ledger accounts. After journal entries have been recorded, their dollar amounts are copied (“posted”) to each ledger account affected by the transaction so that account balances can be computed.

40. 2-40 The T-Account The T-account is a simplified version of a ledger. Ledger

41. 2-41 T-Accounts In Ledgers Journal Entries In Journals DECIDE Transactions A Review of The Accounting Cycle (1) Analyze(2) Record(3) Summarize

42. 2-42 You incorporate your Supercuts salon on August 1. The company issues stock certificates to you and your parents in exchange for $50,000, which is deposited in the company’s bank account.

43. 2-43 Your salon pays $42,000 cash for equipment.

44. 2-44 Your company 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.

45. 2-45 Your salon installs $18,000 of additional equipment, paying $16,000 in cash and giving an informal promise to pay $2,000 at the end of the month.

46. 2-46 Your company orders $800 of shampoo and other operating supplies from Tigi. None have been received yet. Because this event involves the exchange of only promises, it is not considered a transaction. No journal entry is needed.

47. 2-47 Your company pays the $2,000 owed to the equipment supplier in (d).

48. 2-48 Your company receives $630 of the supplies ordered in (e), and promises to pay for them next month.

49. 2-49 T-Account Balances To compute the balance in T-accounts, draw a single line through each T- account below the amounts you wish to total. Then, calculate the ending balance by converting each T-account into equation form, as shown here for Cash and Accounts Payable.

50. 2-50 T-Accounts All ending balances are positive so they are shown on the “+” side with a double underline.

51. 2-51 Learning Objective 4 Prepare a classified balance sheet.

52. 2-52 Preparing a Balance Sheet The amounts on the balance sheet come from the ending balances in the ledger accounts.

53. 2-53 Preparing a 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.

54. 2-54 Preparing a Balance Sheet Current liabilities are debts or obligations that will be paid, settled, or fulfilled within one year. Long-term liabilities are debts or obligations that will be paid, settled, or fulfilled more than 12 months after the balance sheet date.

55. 2-55 Learning Objective 5 Explain the concepts that determine whether an items is reported on the balance sheet and at what amount.

56. 2-56 What is (and is not) recorded? An item will only be recorded if it comes from an identifiable transaction. Some very valuable assets are not recorded on the balance sheet because they were not acquired in an identifiable transaction. For example, one of Regis Corporations most valuable assets, the name “Regis Salons”, is not reported on the balance sheet because it wasn’t acquired in an identifiable transaction.

57. 2-57 Amounts Assigned to Recorded Items Assets and liabilities are initially recorded at their original cost to the company. This cost principle is one of the main principles of accounting. While these amounts are accurate at the time of purchase, there is no guarantee that they will continue to represent the “value” of an asset or liability. Conservatism requires the use of the least optimistic measures when uncertainty exists about the value of an asset or liability.

58. 2-58 Ethical Insights Financial statements are used by outsiders to make decisions and accountants don’t want to mislead them.

59. 2-59 End of Chapter 2