© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Accounting Equation

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Previous Lecture – Objective of financial reporting – Qualitative characteristics of accounting information Relevance Faithful representation Comparability Understandability

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin – Elements of financial statements Assets Liabilities Equity Revenues Expenses – Recognition and measurement criteria – The Concept of the Business Entity – Introduction of financial statement

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Accounting Equation Assets = Liabilities + Owners’ Equity $300,000 = $80,000 + $220,000 Assets = Liabilities + Owners’ Equity $300,000 = $80,000 + $220,000

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Generally Accepted Accounting Principles (GAAP) Cost Full disclosure Revenue recognition (covered in Chapter 4) Matching (covered in Chapter 4) Chapter 2 5

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 6 Cost Principle Assets should be recorded at cost at the time of acquisition

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 7 Full Disclosure Principle Circumstances and events that make a difference to financial statement users should be disclosed

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 8 Constraints in Accounting Materiality – An item is material if it is likely to influence the decision of a user Cost-benefit – Ensures that the value of the information is greater than the cost of providing it

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 9 Classified Balance Sheet A classified balance sheet generally contains the following standard classifications: Assets Liabilities - Current assets - Current liabilities - Long-term investments - Long-term liabilities - Property, plant, and equipment - Intangible assets Shareholders’ Equity - Share capital - Retained earnings

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 10 Current Assets Assets expected to be converted to cash or used in the business within the year Listed in order of liquidity Examples include cash, short-term investments, accounts receivable, inventories and prepaid expenses

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 11 Long-Term Investments Investments in the debt or equity securities of other corporations These assets are normally not intended to be sold within the next year

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 12 Property, Plant, and Equipment Tangible assets with relatively long useful lives Assets used in operating the business Examples include land, building, machinery, delivery equipment, furniture and fixtures

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 13 Depreciation Allocation of an asset’s full purchase price to match cost to revenues over the entire estimated useful life instead of expensing full cost in the year of purchase The cost of long-lived assets with indefinite lives (e.g., land) is not depreciated

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 14 Depreciation Accumulated depreciation account shows the total amount of depreciation taken to date The difference between the cost of the asset and its accumulated depreciation is referred to as the carrying amount of the asset

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 15 Intangible Assets Noncurrent assets that do not have physical substance and represent a privilege or a right Examples include goodwill, patents, copyrights, trademarks, trade names and licenses

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 16 CSU CORPORATION Balance Sheet December 31, 2009 Assets Cash Accounts receivable Supplies Equipment Less: Accumulated depreciation Total assets $24,000 8,000 $ 2,000 4,000 1,800 16,000 $23,800

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 17 Liabilities Current liabilities – Obligations that are supposed to be paid within the coming year – Examples include accounts payable, notes payable, interest payable, etc.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 18 Liabilities Long-term liabilities – Debts expected to be paid after one year – Examples include bonds payable, mortgage payable, notes payable, lease liabilities, etc.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Shareholder’s Equity Share capital – Investment of cash (or other assets) in the business by the shareholders in exchange for preferred or common shares Retained earnings – Earnings kept for use in the business Chapter 2 19

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Let’s analyze some transactions for JJ’s Lawn Care Service.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 1, 2003, Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 2, JJ’s purchased a riding lawn mower for $2,500 cash.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 8, JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 11, JJ’s purchased some repair parts for $300 on account.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Jill realized she had purchased more repair parts than needed. On May 18, JJ’s was able to sell half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. JJ’s will receive the cash within 30 days.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 25, ABC Lawns pays JJ’s $75 as a partial settlement of its accounts receivable.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 28, JJ’s pays $150 of its accounts payable.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 29, JJ’s recorded lawn care services provided during May of $750. All clients paid in cash.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Now, let’s review how JJ’s transactions affected the accounting equation. On May 31, JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin These transactions impact the Statement of Cash Flows. These transactions impact the Income Statement. Let’s prepare the Income Statement and Statement of Cash Flows for JJ’s Lawn Care Service for the month ending May 31, 2003.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Investments by and payments to the owners are not included on the Income Statement.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Operating activities include the cash effects of revenue and expense transactions.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Investing activities include the cash effects of purchasing and selling assets.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Financing activities include the cash effects of transactions with the owners and creditors.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Relationships Among Financial Statements Beginning of period End of period Balance Sheet Time Income Statement Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Forms of Business Organizations Sole Proprietorship Partnership Corporation

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Reporting Ownership Equity in the Balance Sheet Sole Proprietorship Partnership Corporation

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Use of Financial Statements by Outsiders Creditors Investors Two concerns: Solvency Profitability Two concerns: Solvency Profitability

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Need for Adequate Disclosure Notes to the financial statements often provide facts necessary for the proper interpretation of the statements. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin End of Chapter 2