Chapter 2 Investing and Financing Decisions and the Balance Sheet Zining Li ACCT 2301 FALL 2009 Cox School of Business, SMU ACCT 2301 Zining Li Cox, SMU Fall 2009

Acct 2301 Li Fall 091 What do we hope to learn Characteristics of Financial Accounting Information How does a company record business transactions (Transactional Analysis) How does a company keep track of accounting records

Acct 2301 Li Fall 092 Accounting – Who Sets the Rules? Securities and Exchange Commission (SEC) Legal authority to set accounting rules for publicly traded companies Delegated responsibility to the accounting profession Financial Accounting Standards Board (FASB) Currently the standards setting body GAAP

Acct 2301 Li Fall 093 Qualitative Characteristics of Financial Accounting Information Relevant Specific / Timely Reliable Representational faithfulness Verifiable Comparable For same company Across different company Consistent Same rules over time

Acct 2301 Li Fall 094 Elements Assets: economic resources that are measurable; owned or controlled by the company that will bring future benefits Liabilities: economic obligations Stockholders’ equity (contributed capital + retained earnings) Revenues: inflow of assets or settlement of liabilities from on-going business Expenses: decreases (increases) in assets (liabilities) from on-going business Gains (Losses): from peripheral activities

Acct 2301 Li Fall 095 Assumptions Separate-entity assumption Unit-of-measure Continuity (going-concern) Time period

Acct 2301 Li Fall 096 Principles Historical Cost (the Balance Sheet) Revenue Recognition (the Income Statement) Matching(the Income Statement) Full disclosure

Acct 2301 Li Fall 097 Constraints Cost benefit Materiality Conservatism Industry practice

Acct 2301 Li Fall 098 How does a Company Record Business Transactions? (1) Definition of Transaction Economic events that impact a business entity External v.s. Internal NOT all economic events are reflected in financial statements!

Acct 2301 Li Fall 099 How does a Company Record Business Transactions? (2) Let’s start with A= L + SE Duality of Effects Each transaction affects at least two items (accounts) The accounting equation always remains in balance after each transaction

Acct 2301 Li Fall 0910 Determining the Financial Statement Effects of Following Transactions Received investment of $24,000 cash by organizers and distributed stock to them Purchased $8,000 of equipment, paying $1,000 in cash and signing a note for the rest Loaned $500 to an employee who signed a note Borrowed $7,000 cash from a bank by signing a note Purchased $15,000 of land; paid $4,000 in cash and signed a mortgage note for the balance

Acct 2301 Li Fall 0911 Assets = Liabilities + Stockholders’ Equity $49,000 $25,000 $24,000

Acct 2301 Li Fall 0912 Debits, Credits and T- accounts? T-account: We can use a “T” to represent an account Debit (Dr) Means the left side of an account Numbers put on the left side of an account are debits Credit (Cr) Means the right side of an account Numbers put on the right side of an account are credits What do we mean when we say “to credit (debit) an account”?

Acct 2301 Li Fall 0913 Debits, Credits, &Accounting Equation Assets = Liabilities + Shareholders’ Equity + Dr. - Dr. + Cr. - Cr. + Cr. - Dr. (Contr. Cap. + R/E)

Acct 2301 Li Fall 0914 Record Journal Entries Information recorded in a journal entry: Date of transaction Accounts affected Dollar amounts of debits and credits A brief explanation of the transaction (can be skipped for our purposes) Remember: Assets = Liabilities + Owner’s Equity Debits = Credits In every journal entry there are equal dollar amounts of debits and credits.

Acct 2301 Li Fall 0915 Received investment of $24,000 cash by organizers and distributed stock to them Transaction Account TitlesDebitsCredits #1Dr. Cash24,000 Cr. Contributed Capital 24,000

Acct 2301 Li Fall 0916 Purchased $8,000 of equipment, paying $1,000 in cash and signing a note for the rest Transaction Account TitlesDebitsCredits #2Dr. Equipment8,000 Cr. Notes Payable Cr. Cash 7,000 1,000

Acct 2301 Li Fall 0917 Loaned $500 to an employee who signed a note Transaction Account TitlesDebitsCredits #3Dr. Notes Receivable500 Cr. Cash 500

Acct 2301 Li Fall 0918 Borrowed $7,000 cash from a bank by signing a note Transaction Account TitlesDebitsCredits #4Dr. Cash7,000 Cr. Notes Payable 7,000

Acct 2301 Li Fall 0919 Purchased $15,000 of land; paid $4,000 in cash and signed a mortgage note for the balance Transaction Account TitlesDebitsCredits #5Dr. Land15,000 Cr. Mortgage notes payable Cr. Cash 11,000 4,000

Acct 2301 Li Fall 0920 T-account CashNotes Receivable 00 24, , ,0004,000 25,500

Acct 2301 Li Fall 0921 LandEquipment 00 15,0008,000 15,000 8,000

Acct 2301 Li Fall 0922 Notes Payable Mortgage Notes Payable 0 0 7,000 11,000 7,000 11,000 14,000

Acct 2301 Li Fall 0923 Contributed Capital 0 24,000

Acct 2301 Li Fall 0924 Record Transactions: Summary To record a transaction, Identify items (accounts) that are affected Determine the direction of impact on each account (increase or decrease) Verify that the accounting equation (A=L+SE) remains in balance Example To start, focus on investing and financing activities

Acct 2301 Li Fall 0925 How is the Cash Flow Statement affected by Investing and Financing Activities? Investing Cash Flows Outflows: cash paid for acquisition of long-term assets Inflows: cash proceeds from sale of long-term assets Financing Cash Flows Inflows: cash received from issues of common stock and long-term debts Outflows: cash paid directly related to issues of common stock and long-term debts. E.g. retirement of long-term debts, repurchase of common stock, and cash dividend