2+3 7 Fundamentals of Financial Accounting 3e by Phillips, Libby, and Libby. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All.

Reporting Investing and Financing Results on the Balance Sheet
Chapter 2 Reporting Investing and Financing Results on the Balance Sheet PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA Chapter 2: Reporting Investing and Financing Results on the Balance Sheet

Learning Objective 1 Identify financial effects of common financing and investing activities. Learning objective 1 is to identify financial effects of common financing and investing activities. 2-3

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. + The balance sheet is structured like the basic accounting equation: Assets = Liabilities + Stockholders’ Equity. Assets are resources presently owned by a business that generate future economic benefit; liabilities are amounts presently owned by a business to creditors; and stockholders’ equity is the amount invested and reinvested in a company by its shareholders. Stockholders’ Equity the amount invested and reinvested in a company by its shareholders. 2-4

Financing and Investing Activities
Assets Companies rely on two sources of financing: Invest in Assets = Liabilities Debt Financing + & Part I Two sources of financing are available to businesses: debt financing and equity financing. Debt financing refers to money the business obtains through loans, and equity financing refers to money a business obtains through owners’ contributions and reinvestments of profit. A business is obligated to repay debt financing, but it is not obligated to repay equity financing. Part II Using a combination of debt and equity financing, a company will start investing in business assets, such as buildings, equipment, furniture, and other assets that will be used to generate revenue. Stockholders’ Equity Equity Financing 2-5

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. Three key features of these activities provide inputs into the accounting process. 1. A company always documents its activities. Stock certificates, promissory notes, checks, and invoices indicate the nature of the underlying business activity. Try to picture these in your mind. 2. A company always receives something and gives something. This is a basic feature of all business activities. A business enters into an exchange either to earn a profit immediately or to obtain resources that will allow it to earn a profit later. This is the fundamental idea of business: to create value through exchange. Any exchange that affects the company’s assets, liabilities, or stockholders’ equity must be captured in and reported by the accounting system. You will need to name the items that are received and given for each exchange. 3. A dollar amount is determined for each exchange based on the value of items given and received. This value is called the cost and is used to measure the financial effects of the exchange, as required by the cost principle. These amounts will allow you to analyze the financial effects of each accounting transaction. 3. A dollar amount is determined for each exchange. Analyze the effects. 2-6

Transactions and Other Activities
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. Part I How do you know if a business activity is considered an accounting transaction? Look for two types of events, both of which are considered accounting transactions: External exchanges involve exchanges in assets, liabilities, and stockholders’ equity that you can see between the company and someone else. For example, when Starbucks sells you a Frappucino®, it is exchanging an icy taste of heaven for your cash, so Starbucks would record this in its accounting system. Part II Internal events occur within the company, for example, using some assets to create an inventory product. 2-7

Apply transaction analysis to financing and investing
Learning Objective 2 Apply transaction analysis to financing and investing transactions. Learning objective 2 is to apply transaction analysis to financing and investing transactions. 2-8

Study the Accounting Methods
A systematic accounting process is used to capture and report the financial effects of a company’s transactions. 1 Analyze 2 Record 3 Summarize A transaction is a business activity that affects the basic accounting equation. Part I After having analyzed each transaction, a systematic accounting process is used to capture and report their financial effects. This process encompasses three basic steps: Analyze, Record, and Summarize. Part II A transaction is an exchange or an event that has a direct economic effect on the assets, liabilities, or stockholders’ equity of a business. Business activities that do not have direct or measurable financial effects on the company are not recorded in the accounting system. When analyzing transactions, two simple ideas are used. The first idea is the duality of effects and the second is the basic accounting equation. Duality of effects means that every transaction has a least two effects on the basic accounting equation. You already know the basic accounting equation. Just remember that the dollar amount for assets must always equal the total of liabilities plus stockholders’ equity for every accounting transaction. Duality of Effects Every transaction has at least two effects on the basic accounting equation. A = L+ SE Assets must equal liabilities plus stockholders’ equity for every accounting transaction. 2-9

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. A summary of account names and corresponding account numbers is called a chart of accounts. Each company keeps a chart of accounts to ensure consistency in reporting its own financial results. Don’t try to memorize the chart of accounts. It is provided merely as a learning tool for you to see many of the common account titles you will be using in this class. The accounts listed on this slide are just accounts used on the balance sheet of Pizza Aroma, our example company. Asset accounts start with the number 1, liability accounts start with the number 2, and Stockholders’ Equity accounts start with the number 3. 2-10

(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). Part I 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. Part II Pizza Aroma receives $50,000 cash and gives $50,000 of stock (contributed capital) in the transaction. Part III For this transaction, Cash, an asset, increases by $50,000 received from the owner. Stockholders’ equity increased by $50,000 when the stock was issued to Mauricio Rosa. 2-11

(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. Part I Next, Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. Part II Pizza aroma receives $42,000 of equipment for the restaurant and gives $42,000 cash. Part III For this transaction, Equipment is increased by $42,000 and the asset, Cash, is decreased by $42,000. Notice that is no impact on the Liabilities and Stockholders’ Equity section of the balance sheet. The company exchanged one asset cash for another asset equipment. 2-12

(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. Part I 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. Part II Pizza Aroma will receive $20,000 cash that is deposited into its checking account at the bank. The company gives up of issues a note payable to the bank for $20,000. Part III For this transaction, Cash, an asset account, increases by $20,000 and Note Payable, a liability, increases by the same amount. The basic accounting equation is in balance because the same amount was added to the asset side of the equation and the liability side of the equation. 2-13

(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. Part I 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. Part II In this transaction Pizza Aroma receives $18,000 in equipment (pizza ovens). Pizza Aroma gives a Cash of $16,000 and Accounts Payable of $2,000 in payment for the equipment. Part III For this transaction, Cash, an asset account, decreases by $16,000, Equipment, also an asset, increases by $18,000, and Accounts Payable, a liability, increases by $2,000. The asset side of the basic accounting equation increases by a net amount of $2,000, and the liabilities and stockholders’ equity part of the equation increases by the same amount. The basic accounting equation stays in balance. 2-14

(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. Part I Pizza Aroma orders $630 of pans, dishes, and other cookware. None have been received yet. Part II An exchange of only promises is not a transaction. This does not affect the accounting equation. Part III This event does not impact the basic accounting equation. 2-15

(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. Part I Pizza Aroma pays $2,000 to the equipment supplier from transaction (d). Part II Pizza Aroma gives cash to settle its debt to the supplier. The company receives a release from its promise to pay an amount to the supplier. Part III Once again the basic accounting equation is in balance because the assets side of the equation is reduced by $2,000, and the liabilities side is reduced by the same amount. 2-16

(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. Part I Pizza Aroma receives $630 of the cookware ordered in (e) and promises to pay for it next month. Part II Pizza Aroma receives cookware with a cost of $630, and gives a promise to pay the $630 within one month. Part III Once again the basic accounting equation is in balance because the assets side of the equation is increased by $630, and the liabilities side is increased by the same amount. 2-17

Learning Objective 3 Use journal entries and T-accounts to show how transactions affect the balance sheet. Learning objective 3 is to use journal entries and T-accounts to show how transactions affect the balance sheet. 2-18

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. 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. A three-step analyze-record-summarize process is applied to daily transactions and then to adjustments and closing processes at the end of each accounting period. Our focus in this chapter is on applying the three-step process during the period to daily activities that affect only balance sheet accounts. The analyze step involves determining the financial effects of each transaction; the record step captures these effects in an accounting record called the journal; and the summarize step accumulates these effects in accounting records called ledger accounts or T-accounts. 2-19

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. Liability accounts increase on the right or credit side and decrease on the left or debit side. Stockholders’ equity accounts increase on the right or credit side and decrease on the left or debit side. Part I Accounts increase on the same side as they appear in A = L + SE. Part II Accounts on the left side of the accounting equation increase on the left side of the account and accounts on the right side of the equation increase on the right. So • Assets increase on the left side of the account. Part III • Liabilities increase on the right side of the account. • Stockholders’ equity accounts increase on the right. • Decreases are the opposite. Part IV Left is debit ( dr ), right is credit ( cr ). The terms (and abbreviations) debit ( dr ) and credit ( cr ) come from Latin words that had meaning back in the day, but today they just mean left and right. When combined with how increases and decreases are entered into accounts, the following rules emerge: Use debits for increases in assets (and for decreases in liabilities and stockholders’ equity accounts). Use credits for increases in liabilities and stockholders’ equity accounts (and for decreases in assets). 2-20

Steps 2 & 3: Record and Summarize
1 Analyze 2 Record 3 Summarize The debit-credit framework is the basis As we saw earlier, first transactions are analyzed to determine their financial effects. In step 2, these financial effects are recorded in a journal using a debits-equal-credits format. The journal entries are recorded in the order transactions occur, and then their effects on each individual account are summarized in step 3, to enable preparation of financial statements. 2-21

1 Analyze 2 Record 3 Summarize Part I Notice the following aspects of journal entries in step 2. A date is included for each transaction. Debits appear first (on top). Credits are written below the debits and are indented to the right (both the words and the amounts). The order of the debited accounts or credited accounts doesn’t matter, as long as for each journal entry debits are on top and credits are on the bottom and indented. Total debits equal total credits for each transaction. Dollar signs are not used because the journal is understood to be a record of financial effects. A brief explanation of the transaction is written below the debits and credits. The line after the explanation is left blank before writing the next journal entry. By themselves, journal entries show the effects of transactions, but they do not provide account balances. That’s why ledger accounts are needed. Part II After journal entries have been recorded (in step 2), their dollar amounts are copied (“posted”) to each ledger account affected by the transaction so that account balances can be computed. This step 3 involves copying the debit part of the journal entry into the debit column of the applicable ledger account and the credit part of the journal entry into the credit column of the other applicable ledger account. The updated balance for each ledger account at the end of the accounting period will be used to prepare financial statements. 2-22

1 Analyze 2 Record 3 Summarize For classroom purposes, we use a simplified version of the journal entry. This simplified format includes a reference, such as the letter (a) shown here. The abbreviation dr is used for debit and cr is used for credit. The account name is shown, along with the effect of the journal entry on the accounting equation. In this example, a debit to cash causes an increase in assets and a credit to contributed capital causes an increase in stockholders’ equity. Finally, the amount is shown for each line of the journal entry. As shown earlier on the formal journal page, the credit line is indented to the right. 2-23

1 Analyze 2 Record 3 Summarize For classroom purposes, we will also use a simplified version of ledger accounts, called T-accounts. The name T-account comes from the appearance of the debit and credit columns represented in this simplified format. Now let’s practice following these steps, with the transactions we previously analyzed for Pizza Aroma. 2-24

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. 1 Analyze 2 Record Part I 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. Part II Analyze the transaction. In this case Cash, an asset, increased by $50,000, and Contributed Capital, a Stockholders’ Equity account increase by the same amount. Part III The general journal entry is to debit, or increase the asset Cash for $50,000, and credit, or increase, the stockholders’ equity account, Contributed Capital for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Cash accounting will increase by $50,000, and the Contributed Capital accounting will also increase by the same amount. After the transaction is posted, the balance in the Cash account is $50,000. 3 Summarize 2-25

(b) Investment in Equipment. Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. 1 Analyze 2 Record Part I Next, Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. Part II Our analysis of this transaction indicates that the asset account Equipment increased by $42,000, and the asset account Cash decreased by $42,000. Part III The general journal entry to record the transaction is to debit, or increase, the equipment account by $42,000, and credit, or decrease, the asset account Cash for $42,000. Part IV Finally, we summarize the transactions by posting them to the general ledger. The credit to cash reduces the asset account by $42,000, and the asset account Equipment is increase by $42,000. 3 Summarize 2-26

(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. 1 Analyze 2 Record Part I 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. Part II An analysis of this transaction shows that the asset account Cash increased by $20,000, and the liability account, Note Payable, increased by $20,000. Part III To record this transaction in the general journal we debit, or increase, the Cash account for $20,000, and credit, or increase, the liability account, Note Payable for the same amount. The basic accounting equation is in balance. Part IV We summarize by posting the $20,000 to the debit, or right side, of the asset account Cash, and credit, or place on the left side of the liability account, Note Payable for $20,000. 3 Summarize 2-27

(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. 1 Analyze 2 Record Part I 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. Part II In analyzing this transaction we see that the asset account cash is decreased by $16,000, and the asset account Equipment is increased by $18,000. So, there is a net $2,000 increase in the asset side of the equation. Accounts payable, a liability account, is increased by $2,000. The basic accounting equation is in balance. Part III Next, we record this transaction in the general journal with a debit, or increase, to the asset account Equipment for $20,000. We credit, or decrease, the asset account Cash for $16,000, and credit, or increase, the liability account Accounts Payable for $2,000. Part IV The transaction recorded in the general journal is posted to the general ledger. Review the posting of transaction (d). 3 Summarize 2-28

(f) Pay Suppliers. Pizza Aroma pays $2,000 to the equipment supplier from the last transaction. 1 Analyze 2 Record Part I Pizza Aroma pays $2,000 to the equipment supplier from the last transaction. Part II In analyzing this transaction we determine that the asset account Cash decreased by $2,000, and the liability account, Accounts Payable, decreased by the same amount. Part III To record the transaction in the general journal we debit, or decrease, the liability account Accounts Payable for $2,000, and credit, or decrease, the asset account Cash for the same amount. Part IV As you can see after we post the transaction for the payment to suppliers the balance in the Accounts Payable account is zero, and the Cash account houses many transactions. 3 Summarize 2-29

(g) Receive Cookware. Pizza Aroma receives $630 of the cookware previously ordered and promises to pay for it next month. 1 Analyze 2 Record Part I Pizza Aroma receives $630 of the cookware previously ordered and promises to pay for it next month. Part II When we analyze this transaction we see that the asset account Cookware increased by $630, and the liability account, Accounts Payable increased by the same amount. Part III The entry to record the transaction is to debit, or increase, the asset account Cookware for $630, and credit, or increase, the liability account Accounts Payable by $630. Part IV After posting the transaction from the general journal to the general ledger, notice that the balance in the Cookware account, an assets, is $630, and the balance in the liability accounting, Accounts Payable is also $630. 3 Summarize 2-30

T-Accounts for Pizza Aroma
Here are all the T-accounts with their individual balances. All ending balances are positive so they are shown on the plus side with a double underline. Now that we have the account balances, we can prepare a balance sheet. Let’s see it on the next slide. 2-31

Prepare a classified balance sheet.
Learning Objective 4 Prepare a classified balance sheet. Learning objective 4 is to prepare a classified balance sheet. 2-32

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. The amounts on the balance sheet come from the ending balances in the ledger accounts. 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. Notice that the total debits of $70,630 equal the total credits of $70,630. 2-33

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. A classified balance sheet contains subcategories for assets and liabilities labeled current. Current assets are assets the business will use up or turn into cash within 12 months of the balance sheet date. Current liabilities are debts and other obligations that will be paid or fulfilled within 12 months of the balance sheet date. Equipment and Note Payable accounts, and stockholders’ equity accounts are understood to be long-term in nature. Retained Earnings account in stockholders’ equity despite its zero balance because we don’t want you to forget about this account. 2-34

Learning Objective 5 Interpret the balance sheet using the current ratio and an understanding of related concepts. . Learning objective 5 is to interpret the balance sheet using the current ratio and an understanding of related concepts. 2-35

Assessing the Ability to Pay
Current Ratio = Current Assets Current Liabilities 16.9 = $ 10,630 $ 630 = Part I The classified balance sheet format makes it easy to see whether current assets are sufficient to pay current liabilities. One way to determine this is to compare the total dollar amounts of current assets and current liabilities. It is much easier to express the relationship as a ratio, by dividing current assets by current liabilities. This calculation is known as the current ratio, which is used to evaluate the ability to pay liabilities as they come due in the short run. Part II Pizza Aroma’s ratio is calculated by dividing total current assets of $10,630 by total current liabilities of $630. The result is a current ratio of A higher current ratio generally means a better ability to pay. Pizza Aroma’s current ratio is unusually high. Current ratios typically vary from 1.0 to 2.0. A higher current ratio generally means a better ability to pay. Pizza Aroma’s current ratio is unusually high. 2-36

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. We know that accounting is based on recording and reporting transactions. This focus on transactions does two things to the balance sheet: (1) it affects what is (and is not) recorded, and (2) it affects the amounts assigned to recorded items. The balance sheet includes items acquired through exchange but it excludes other items, such as the secret recipes that Pizza Aroma has developed internally rather than acquired through exchange. The amount at which items are initially recorded is their cost, but may be changed later as a result of applying the conservatism concept. Conservatism generally requires recording decreases in asset values but not increases in their values (until sold). Consequently, the values reported on the balance sheet may not correspond to current values. 2-37

Chapter 2 Solved Exercises
M2-13, M2-14, M2-15, M2-16, E2-4, E2-6 Chapter 2 Solved Exercises: M2-13, M2-14, M2-15, M2-16, E2-4, E2-6

M2-13 Identifying Transactions and Preparing Journal Entries
J.K. Builders was incorporated on July 1, Prepare journal entries for the following events from the first month of business. If the event is not a transactions, write “no transaction.” Received $55,000 cash invested by owners and issued stock. Bought an unused field from a local farmer by paying $45,000 cash. As a construction site for smaller projects it is estimated to be worth $50,000 to J.K. Builders. A lumber supplier delivered lumber to J.K. Builders for future use. The lumber would have normally sold for $10,000, but the supplier gave J.K. Builders a 10% discount. J.K. Builders has not received a bill from the suppliers. dr Cash (+A) ,000 cr Contributed Capital (+SE) 55,000 Part I J.K. Builders was incorporated on July 1, Prepare journal entries for the following events from the first month of business. If the event is not a transactions, write “no transaction.” Received $55,000 cash invested by owners and issued stock. Bought an unused field from a local farmer by paying $45,000 cash. As a construction site for smaller projects it is estimated to be worth $50,000 to J.K. Builders. A lumber supplier delivered lumber to J.K. Builders for future use. The lumber would have normally sold for $10,000, but the supplier gave J.K. Builders a 10% discount. J.K. Builders has not received a bill from the suppliers. Part II For part (a) we begin by debiting, or increasing the asset account Cash for $55,000. Part III The second part of the entry is to credit, or increase, the stockholders’ equity account Contributed Capital for $55,000. Part IV For part (b) or the problem, we begin with a debit, or increase, in the asset account Inventory for $45,000. Part V The final part of the entry is to credit, or decrease, the asset accounting Cash for $45,000. Part VI For part (c) of the problem, we begin with a debit, or increase, in the asset account Supplies for $9,000. Part VII We complete the entry with a credit, or decrease, in the asset account Cash for $9,000. You can see that the $9,000 is calculated by subtracting the $1,000 discount from the gross amount of $10,000, to arrive at the net amount due of $9,000. b. dr Inventory (+A) 45,000 cr Cash (-A) ,000 c. dr Supplies (+A) ,000 cr Cash (-A) ,000 $10,000 × 10% = $1,000; $10,000 - $1,000 = $9,000 2-39

Borrowed $25,000 from the bank with a plan to use the funds to build a small workshop in August. The loan must be report in two years. One of the owners sold $10,000 worth of his stock to another shareholder for $11,000 cash. dr Cash (+A) ,000 cr Notes Payable (+L) 25,000 e. No transaction Event (e) is a transaction between two independent individuals and does not involve the company, J.K. Builders. Part I This is a continuation of the problem we started on the previous screen. Borrowed $25,000 from the bank with a plan to use the funds to build a small workshop in August. The loan must be report in two years. One of the owners sold $10,000 worth of his stock to another shareholder for $11,000 cash. Part II We begin recording transaction (d) with a debit, or increase, in the asset account Cash for $25,000. Part III We complete the recording with a credit, or increase, to the liability account Notes Payable for $25,000. Part IV Section (e) of the problem is really not a transaction between the company and an outside party. Rather it is a transaction between two individuals and does not impact the records of J. K. Builders. 2-40

Joel Henry founded bookmart.com at the beginning of August, which sells new and used books online. He is passionate about books but does not have a lot of accounting experience. Help Joel by preparing journal entries for the following events. If the event is not a transaction, write “no transaction.” The company purchased bookshelves for $2,000 cash. The bookshelves are expected to be used for ten or more years. Joel’s business bought $8,000 worth of books from a publisher. The company will pay the publisher within days. dr Equipment (+A) 2,000 cr Cash (-A) 2,000 Part I Joel Henry founded bookmart.com at the beginning of August, which sells new and used books online. He is passionate about books but does not have a lot of accounting experience. Help Joel by preparing journal entries for the following events. If the event is not a transaction, write “no transaction.” The company purchased bookshelves for $2,000 cash. The bookshelves are expected to be used for ten or more years. Joel’s business bought $8,000 worth of books from a publisher. The company will pay the publisher within days. Part II Let’s begin by recording transaction (a). We begin with a debit, or increase, in the asset account Equipment for $2,000. Part III The entry is completed with a credit, or decrease, to the asset Cash in the amount of $2,000. Part IV For transaction (b), we begin with a debit, or increase, in the asset account Inventory for $8,000. Remember that inventory represents items purchased for resale. Part V We complete transaction (b) with a credit, or increase, in the liability account Accounts Payable for $8,000. b. dr Inventory (+A) 8,000 cr Accounts Payable (+L) 8,000 2-41

Joel’s friend Sam lent $4,000 to the business. Sam had Joel write a note promising that bookmart.com would repay the $4,000 in four months. Because they are good friends, Sam is not going to charge Joel interest. The company paid $1,500 cash, for books purchased on account earlier in the month. Bookmart.com repaid the $4,000 loan established in c. c. dr Cash (+A) 4,000 cr Notes Payable (+L) 4,000 d. dr Accounts Payable (-L) 1,500 cr Cash (-A) 1,500 Part I This is a continuation of the problem we started on the previous slide. Joel’s friend Sam lent $4,000 to the business. Sam had Joel write a note promising that bookmart.com would repay the $4,000 in four months. Because they are good friends, Sam is not going to charge Joel interest. The company paid $1,500 cash, for books purchased on account earlier in the month. Bookmart.com repaid the $4,000 loan established in c. Part II For transaction (c) we begin with a debit, or increase, to the asset account Cash for $4,000. Part III We complete the entry with a credit, or increase in the liability account Notes Payable for $4,000. Part IV For transaction (d) we begin with a debit, or decrease in the liability account Accounts Payable for $1,500. Part V Transaction (d) is completed with a credit, or decrease in the asset account Cash for $1,500. Part VI Finally, on transaction (e), we begin with a debit, or decrease, to the liability account Accounts Payable for $4,000. Part VII The entry is completed with a credit, or decrease, in the asset account Cash for $4,000. e. dr Accounts Payable (-L) 4,000 cr Cash (-A) 4,000 2-42

The employee has yet to provide any services to the company
M2-15 Identifying Transactions and Preparing Journal Entries Katy Williams is the manager of Blue Light Arcade. The company provides entertainment for parties and special events. Prepare journal entries for the following events relating to the year ended December 31. If the event is not a transaction, write “no transaction.” Blue Light Arcade received $50 cash on account for a birthday party held two months ago. Agreed to hire a new employee at a monthly salary of $3,000. The employee starts work next month. Paid $2,000 for a table top hockey game purchased last month on account. a. dr Cash (+A) cr Accounts Receivable (-A) 50 Part I Katy Williams is the manager of Blue Light Arcade. The company provides entertainment for parties and special events. Prepare journal entries for the following events relating to the year ended December 31. If the event is not a transaction, write “no transaction.” Blue Light Arcade received $50 cash on account for a birthday party held two months ago. Agreed to hire a new employee at a monthly salary of $3,000. The employee starts work next month. Paid $2,000 for a table top hockey game purchased last month on account. Part II Transaction (a) begins with a debit, or increase, in the asset account Cash for $50. Part III The entry is completed with a credit, or decrease, in the asset account Accounts Receivable for $50. Part IV Event (b) is not a recordable transaction. We merely hired an employee and no work was performs. Until the employee renders a service to the company, not transactions has taken place. Part V In transaction (c), we begin with a debit, or increase, in the asset account Equipment for $2,000. Part VI We complete the entry with a credit, or decrease, in the asset account Cash for $2,000. b. No Transaction The employee has yet to provide any services to the company c. dr Equipment (+A) ,000 cr Cash (-A) ,000 2-43

Katy Williams is the manager of Blue Light Arcade continuation. Prepare journal entries for the following events relating to the year ended December 31. If the event is not a transaction, write “no transaction.” d. Repaid a $5,000 bank loan. (Ignore interest). e. The company purchased an air hockey table for $2,200, paying $1,000 cash and signing short-term note for $1,200. d. dr Notes Payable (-L) 5,000 cr Cash (-A) 5,000 Part I This is a continuation of the Blue Light Arcade problem with added parts (d) and (e). Prepare journal entries for the following events relating to the year ended December 31. If the event is not a transaction, write “no transaction.” Repaid a $5,000 bank loan (Ignore interest.) The company purchased an air hockey table for $4,400, paying $1,000 cash and signing short-term note for $1,200. Part II Transaction (d) begins with a debit, or decrease, in the liability account Notes Payable for $5,000. Part III The entry is completed with a credit, or decrease, in the asset account Cash for $5,000. Part IV Event (e) begins with a debit, or increase, to the asset account Equipment for $2,200. Part V Next, we credit, or decrease, the asset account Cash for $1,000. Part VI We complete the entry with a credit, or increase, in the liability account Notes Payable for $1,200. e. dr Equipment (+A) 2,200 cr Cash (-A) 1,000 cr Notes Payable (+L) 1,200 2-44

Sweet Shop Co. Is a chain of candy stores that has been in operation for the past ten years. Prepare journal entries for the following events, which occurred at the end of the most recent year. If the event is not a transaction, write “no transaction.” Ordered and received $12,000 worth of cotton candy machines from Candy Makers, Inc., which Sweet Shop Co. Will pay for in 45 days. Sent a check for $6,000 to Candy Makers, Inc. For the cotton candy machines from (a) Received $400 from customers who bought candy on account in previous months. a. dr Equipment (+A) 12,000 cr Accounts Payable (+L) 12,000 Part I Sweet Shop Co. Is a chain of candy stores that has been in operation for the past ten years. Prepare journal entries for the following events, which occurred at the end of the most recent year. If the event is not a transaction, write “no transaction.” Ordered and received $12,000 worth of cotton candy machines from Candy Makers, Inc., which Sweet Shop Co. Will pay for in 45 days. Sent a check for $6,000 to Candy Makers, Inc. For the cotton candy machines from (a) Received $400 from customers who bought candy on account in previous months. Part II We record transaction (a) with a debit, or increase, to the asset account Equipment for $12,000. Part III The entry is completed with a credit, or increase, in the liability account Accounts Payable for $12,000. Part IV For transaction (b) we begin with a credit, or decrease, in the liability account Accounts Payable for $6,000. Part V Finally, we complete the entry with a credit, or decrease, in the asset account Cash for $6,000. Part VI For transaction (c) we begin with a debit, or increase, in the asset account Cash for $400. Part VII We complete the entry with a credit, or decrease, in the asset account Accounts Receivable for $400. b. dr Accounts Payable (-L) 6,000 cr Cash (-A) ,000 c. dr Cash (+A) cr Accounts Receivable (-A) 2-45

To help raise funds for store upgrades estimated to cost $20,000, Sweet Shop Co. Issued 1,000 shares of $15 each to existing stockholders. Sweet Shop Co. bought ice cream trucks for $50,000 total, paying $10,000 cash and signing a long-term note for $40,000. d. dr Cash (+A) 15,000 cr Contributed Capital (+SE) 15,000 1,000 shares × $15 each = $15,000 Part I This is a continuation of the problem started on the previous slide. To help raise funds for store upgrades estimated to cost $20,000, Sweet Shop Co. Issued 1,000 shares of $15 each to existing stockholders. Sweet Shop Co. bought ice cream trucks for $50,000 total, paying $10,000 cash and signing a long-term note for $40,000. Part II For transaction (d), we begin with a debit, or increase, to the asset account Cash for $15,000. Part III The entry is completed with a credit, or increase, in the stockholders’ equity account Contributed Capital for $15,000. As you can see, the $15,000 is determine by multiplying the number of shares issued, 1,000, times the selling price of each share, $15. Part IV For the last transaction, we begin with a debit, or increase, in the asset account Equipment for $50,000. Part V Next, we credit, or increase, the liability account Notes Payable for $40,000, the amount of money borrowed. Part VI The last part of the entry is to credit, or decrease, the asset account Cash for $10,000, the amount of the cash paid to acquire the truck. e. dr Equipment (+A) ,000 cr Notes Payable (+L) ,000 cr Cash (-A) 10,000 2-46

E2-4 Determining Financial Statement Effects of Several Transactions
The following events occurred for Favata Company: a. Received $10,000 cash from owners and issued stock to them. b. Borrowed $7,000 cash from a bank and signed a note. c. Purchased land for $12,000; paid $1,000 in cash and signed a note for the balance. d. Bought $800 of equipment on account. e. Purchased $3,000 of equipment, paying $1,000 in cash and signing a note for the rest. Required: For each of the events ( a) through ( e), perform transaction analysis and indicate the account amount, and direction of the effect ( for increase and for decrease) on the accounting equation. Check that the accounting equation remains in balance after each transaction. Part I E2-4 The following events occurred for Favata Company: a. Received $10,000 cash from owners and issued stock to them. b. Borrowed $7,000 cash from a bank and signed a note. c. Purchased land for $12,000; paid $1,000 in cash and signed a note for the balance. d. Bought $800 of equipment on account. e. Purchased $3,000 of equipment, paying $1,000 in cash and signing a note for the rest. Required: For each of the events ( a) through ( e), perform transaction analysis and indicate the account amount, and direction of the effect ( for increase and for decrease) on the accounting equation. Check that the accounting equation remains in balance after each transaction. Use the following Headings of Assets = Liabilities Stockholders’ Equity In transaction (a) we have an increase in the asset Cash for $10,000, and an increase in Contributed Capital for the same amount. Part II In transaction (b) we have an increase in the asset Cash for $7,000, and an increase in the liability Notes Payable for the same amount. Part III For transaction (c) we have an increase in the asset Land for $12,000, a decrease in the asset Cash for $1,000, and an increase in Notes Payable for $11,000. Part IV In transaction (d) we have an increase in the asset account Equipment for $800, and an increase in the liability account, Accounts Payable for the same amount. Part V Finally, in transaction (e) we have an increase in the asset Equipment for $3,000, a decrease in the asset Cash for $1,000, and an increase in the liability account Notes Payable for $2,000. 2-47

E2-6 Recording Investing and Financing Activities
The following events occurred for Favata Company: a. Received $10,000 cash from owners and issued stock to them. b. Borrowed $7,000 cash from a bank and signed a note. c. Purchased land for $12,000; paid $1,000 in cash and signed a note for the balance. d. Bought $800 of equipment on account. e. Purchased $3,000 of equipment, paying $1,000 in cash and signing a note for the rest. Required: For each of the events, prepare journal entries, checking that debits equal credits. a. dr Cash (+A) 10,000 cr Contributed Capital (+SE) 10,000 b. dr Cash (+A) ,000 cr Notes Payable (+L) ,000 Part I E2-6 The following events occurred for Favata Company: a. Received $10,000 cash from owners and issued stock to them. b. Borrowed $7,000 cash from a bank and signed a note. c. Purchased land for $12,000; paid $1,000 in cash and signed a note for the balance. d. Bought $800 of equipment on account. e. Purchased $3,000 of equipment, paying $1,000 in cash and signing a note for the rest. Required: For each of the events, prepare journal entries, checking that debits equal credits. Part II The general journal entry for part (a) begin with a debit, or increase, in the asset account Cash for $10,000 Part III Next, we credit, or increase, the stockholders’ equity account Contributed Capital for $10,000. Part IV. The general journal entry for part (b) begins with a debit, or increase, in the asset account Cash for $7,000. Part V Next, we credit, or increase, the liability account Notes Payable for $7,000. Part VI For part c, we begin with a debit, or increase, in the asset account Land for $12,000 Part VII Finally, we credit, or increase, the liability account Notes Payable for $11,000, and credit, or decrease, the asset account Cash for $1,000, and the entry is in balance. c. dr Land (+A) ,000 cr Notes Payable (+L) ,000 cr Cash (-A) ,000 2-48

E2-6 Recording Investing and Financing Activities
The following events occurred for Favata Company: a. Received $10,000 cash from owners and issued stock to them. b. Borrowed $7,000 cash from a bank and signed a note. c. Purchased land for $12,000; paid $1,000 in cash and signed a note for the balance. d. Bought $800 of equipment on account. e. Purchased $3,000 of equipment, paying $1,000 in cash and signing a note for the rest. Required: For each of the events, prepare journal entries, checking that debits equal credits. d. dr Equipment (+A) cr Accounts Payable (+L) Part I This is a continuation of the exercise we started on the previous slide. We need to complete parts (d) and (e). Part II For transaction d, we will begin with a debit, or increase, in the asset account Equipment for $800. Part III Next, we credit, or increase the liability account Accounts Payable for $800. Part IV For transaction e, our final transaction, we begin with a debit, or increase, the asset account Equipment for $3,000. Part V Next, we credit, or increase, the liability account Notes Payable for $2,000, and credit, or decrease the asset account Cash for $1,000. Now the exercise is complete. e. dr Equipment (+A) cr Notes Payable (+L) ,000 cr Cash (-A) 1,000 2-49

End of Chapter 2 End of chapter 2.

Fundamentals of Financial Accounting 3e by Phillips, Libby, and Libby.
McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Reporting Operating Results on the Income Statement
Chapter 3 Reporting Operating Results on the Income Statement PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA Chapter 3: Reporting Operating Results on the Income Statement

Learning Objective 1 Describe common operating transactions and select appropriate income statement account titles. Learning objective 1 is to describe common operating transactions and select appropriate income statement account titles. . 3-53

Operating Activities Operating activities include buying goods and services from suppliers and employees and selling goods and services to customers and then collecting cash from them. Part I Operating activities are the day-to-day functions involved in running a business. Unlike the investing and financing activities in Chapter 2 that occur infrequently and typically produce long-lasting effects, operating activities occur regularly and often have a shorter duration of effect. Operating activities include buying goods and services from suppliers and employees and selling goods and services to customers and then collecting cash from them. Part II The period from buying goods and services through to collecting cash from customers is known as the operating cycle. This graphic illustrates the operating cycle for Pizza Aroma. Although most businesses have the same steps in their operating cycles, the length of time for each step varies from company to company. For example, Pizza Aroma usually collects cash from restaurant customers within minutes of making a sale, whereas a company like Kellogg’s might wait several weeks to collect on sales it makes to grocery stores. Operating activities are the primary source of revenues and expenses and, thus, can determine whether a company earns a profit (or incurs a loss). 3-54

Income Statement Accounts
Part I Although a manager or owner may intuitively sense how the business is doing, a more reliable management approach is to evaluate the revenues and expenses reported on the income statement. This slide illustrates the income statement based on the operating activities that were expected for Pizza Aroma as discussed in Chapter 1. This projected income statement will provide a benchmark to evaluate Pizza Aroma’s actual results. Part II Revenues are the amounts a business charges its customers for goods or services. If Pizza Aroma sells 1,100 pizzas in September and charges $10 per pizza, Pizza Revenue would total $11,000. The amount of revenues earned during the period is the first thing reported in the body of the income statement. Part III Expenses are any costs of operating the business, incurred to generate revenues in the period covered by the income statement. Anything a business uses up to generate revenues during the period is an expense, regardless of when it was or will be paid for. Expenses are reported in the body of the income statement after revenues. Part IV Net income is a total that is calculated by subtracting expenses from revenues; it is not an account like Pizza Revenue or Wages Expense. This total summarizes the overall impact of revenues and expenses in a single number. It is called a net loss if expenses are greater than revenues, and net income if revenues are greater than expenses. Net income indicates the amount by which stockholders’ equity increases as a result of a company’s profitable operations. For this reason, net income (or loss) is a closely watched measure of a company’s success. 3-55

Cash Basis Accounting Cash basis accounting records revenues when cash is received and expenses when cash is paid. Like most people, you probably look at the balance in your bank account to gauge your financial performance. If the overall balance increased this month, you likely take that as a sign that you’ve done a good job of managing your finances. If it has gone down, that is a clue that you need to tame yourself a little more next month. Because the cash inflows and outflows occur close in time to the activities that cause those cash flows, using your bank balance tends to give a decent measure of financial performance. This is a cash basis of accounting. The cash basis of accounting records revenues when cash is received and expenses when cash is paid. However, the cash basis of accounting doesn’t measure financial performance very well when transactions are conducted using credit rather than cash. The problem is that credit often introduces a significant delay between the time an activity occurs and the time it impacts the bank account balance. So, what accounting method is preferred? 3-56

Explain and apply the revenue and matching principles.
Learning Objective 2 Explain and apply the revenue and matching principles. Learning objective 2 is to explain and apply the revenue and matching principles. 3-57

Accrual Basis Accounting
GAAP Records revenues when they are earned and expenses when they are incurred, regardless of the timing of cash receipts or payments. Generally accepted accounting principles require the use of the accrual basis of accounting. The cash basis can be used internally by some small companies, but GAAP do not allow it to be used for external reporting. The “rule of accrual” is that the financial effects of business activities are measured and reported when the activities actually occur, not when the cash related to them is received or paid. That is, revenues are recognized when they are earned and expenses when they are incurred. The two basic accounting principles that determine when revenues and expenses are recognized under accrual basis accounting are called the revenue principle and the matching principle. 3-58

Revenue Principle—Revenue Recognition
Timing of Reporting Revenue versus Cash Receipts Part I All companies expect to receive cash in exchange for providing goods and services, but the timing of cash receipts does not dictate when revenues are recognized. Instead, the key factor in determining when to recognize revenue is whether the company has done what it promised during the accounting period. Regardless of the length of the period (month, quarter, or year), cash can be received (1) in the same period as the goods or services are provided, (2) in a period before the goods or services are provided, or (3) in a period after the goods or services are provided, as shown on the timeline on this slide. Part II Receiving cash in the same period as the promised acts are performed is a common occurrence for Pizza Aroma because customers pay within a few minutes of receiving their pizza. Pizza Aroma delivers the pizza to the customer as ordered, earning revenue in the process. In exchange, Pizza Aroma receives cash from the customer. Part III Receiving cash in a period before the promised acts are performed can occur when Pizza Aroma receives cash for gift cards that customers can use to pay for pizza in the future. Pizza Aroma will record the cash received, but since it hasn’t delivered pizza for these customers, no revenue is recorded yet. Instead, Pizza Aroma has an obligation to accept the gift card as payment for pizza in the future. This obligation is a liability called Unearned Revenue. Part IV Receiving cash in a period after the promised acts are performed typically arises when a company sells to a customer on account. Selling on account means that the company provides goods or services to a customer not for cash, but instead for the right to collect cash in the future. This right is an asset called Accounts Receivable. Thus, if Pizza Aroma delivers pizza sold on account to a college organization in September, it will report Pizza Revenue on the income statement and Accounts Receivable on the balance sheet in September. Cash is received in the same period as the goods or services are provided. 1 Revenue Principle Revenues are recognized when they are earned. Cash is received in a period before goods or services are provided. 2 Cash is received in a period after goods or services are provided. 3 3-59

Matching Principle—Expense Recognition
Timing of Reporting Expenses versus Cash Payments Part I The business activities that generate revenues also create expenses. Under accrual basis accounting, expenses are recognized in the same period as the revenues to which they relate, not necessarily the period in which cash is paid for them. This is what accountants call the matching principle: record expenses in the same period as the revenues with which they can be reasonably associated. It is the timing of the underlying business activities, not the cash payments, that dictates when expenses are recognized. Cash payments may occur (1) at the same time as, (2) before, or (3) after the related expenses are incurred to generate revenue, as shown on this graphic. Part II Expenses are sometimes paid for in the period that they arise. For example, Pizza Aroma could spend $50 cash for balloons to celebrate its grand opening this month. It would report this cost on this month’s income statement because the balloons were used for an activity occurring this month. In other words, the benefits of incurring the cost are entirely used up within the current accounting period. Part III It is common for businesses to pay for something that provides benefits only in future periods. For example, Pizza Aroma might buy paper napkins now but does not use them until next month. The asset Supplies is increased and Cash is decreased. Given the matching principle, the expense from using these supplies is reported next month when the supplies are used to earn revenue, not now when purchased. Part IV Many costs are paid after receiving and using goods or services. For example, Pizza Aroma uses electricity to heat the ovens and light the restaurant this month but does not pay for its electricity usage until next month. Because the cost of the electricity relates to revenues earned now, it represents an expense that will be reported on this month’s income statement. Because the cost has not yet been paid at the end of the month, a liability called Accounts Payable is created. Similar situations arise when employees work in the current period but are not paid their wages until the following period. Cash is paid at the same time as the cost is incurred to generate revenue. 1 Matching Principle Record expenses in the same period as the revenues with which they can be reasonably associated. Cash is paid before the expense is incurred to generate revenue. 2 Cash is paid after the cost is incurred to generate revenue. 3 3-60

Learning Objective 3 Analyze, record, and summarize the effects of operating transactions, using the accounting equation, journal entries, and T-accounts. Learning objective 3 is to analyze, record, and summarize the effects of operating transactions, using the accounting equation, journal entries, and T-accounts. 3-61

The Expanded Accounting Equation
Exhibit 3.7 Part I Remember the basic accounting equation from Chapter 2? That is, assets equals liabilities plus stockholders’ equity, or A = L + SE. Part II Remember that asset accounts increase on the left or debit side and decrease on the right or credit side. Liability accounts increase on the right or credit side and decrease on the left or debit side. This is just opposite of the way assets increase and decrease. And, like liability accounts, stockholders’ equity accounts also increase on the right or credit side and decrease on the left or debit side. Part III Stockholders’ equity represents the stockholders’ investment in the company, which comes from either (1) contributed capital, given to the company by stockholders in exchange for stock or (2) retained earnings, generated by the company itself through profitable operations. Part IV Retained earnings is the part that expands to include revenues and expenses. Remember that revenue minus expenses equals net income (or net loss). Part V Think of revenues and expenses as subcategories within retained earnings, which is part of stockholders’ equity. Because revenue and expense accounts are subcategories of retained earnings, they are affected by debits and credits in the same way as all stockholders’ equity accounts. You already know that increases in stockholders’ equity are recorded on the right side. You also know that revenues increase net income, which increases the stockholders’ equity account called Retained Earnings. So putting these ideas together should lead to the conclusion that revenues are recorded on the right (credit). Decreases in stockholders’ equity are recorded on the left side, so to show that expenses decrease net income and retained earnings, expenses are recorded on the left (debit). Revenues are recorded with credits. Expenses are recorded with debits. Revenues - Expenses 3-62

(a) Provided services for cash. In September, Pizza Aroma delivered pizza to customers for $15,000 cash. 1 Analyze 2 Record Part I In September, Pizza Aroma delivered pizza to customers for $15,000 cash. Part II Analyze the transaction. In this case Cash, an asset, increased by $15,000, and Pizza Revenue, a subcategory of Stockholders’ Equity, increased by the same amount. Part III The general journal entry is to debit, or increase, the asset Cash for $15,000, and credit, or increase, Pizza Revenue for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Cash account will increase by $15,000, and the Pizza Revenue account will also increase by $15,000. 3 Summarize 3-63

(b) Receive cash for future services. Pizza Aroma sold three $100 gift cards at the beginning of September. 1 Analyze 2 Record Part I Pizza Aroma sold three $100 gift cards at the beginning of September. Part II Analyze the transaction. In this case Cash, an asset, increased by $300, and Unearned Revenue, a liability, increased by the same amount. Part III The general journal entry is to debit, or increase, the asset Cash for $300, and credit, or increase, Unearned Revenue, a liability, for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Cash accounting will increase by $300, and the Unearned Revenue account will also increase by the same amount. 3 Summarize 3-64

(c) Provide services on credit. Pizza Aroma delivers $500 of pizza to a college organization, billing this customer on account. 1 Analyze 2 Record Part I Pizza Aroma delivers $500 of pizza to a college organization, billing this customer on account. Part II Analyze the transaction. In this case Accounts Receivable, an asset, increased by $500, and Pizza Revenue, a subcategory of stockholders’ equity, increased by the same amount. Part III The general journal entry is to debit, or increase, the asset Accounts Receivable for $500, and credit, or increase, Pizza Revenue for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Accounts Receivable account will increase by $500, and the Pizza Revenue account will increase by the same amount. 3 Summarize 3-65

(d) Receive payment on account. Pizza Aroma received a $300 check from the college organization, as partial payment of its account balance. 1 Analyze 2 Record Part I Pizza Aroma received a $300 check from the college organization, as partial payment of its account balance. Part II Analyze the transaction. In this case Cash, an asset, increased by $300, and Accounts Receivable, an asset, decreased by the same amount. Part III The general journal entry is to debit, or increase, the asset Cash for $300, and credit, or decrease, Accounts Receivable, an asset, for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Cash accounting will increase by $300, and the Accounts Receivable account will decrease by the same amount. 3 Summarize 3-66

(e) Pay cash to employees. Pizza Aroma wrote checks to employees, totaling $8,100 for wages related to hours worked in September. 1 Analyze 2 Record Part I Pizza Aroma wrote checks to employees, totaling $8,100 for wages related to hours worked in September. Part II Analyze the transaction. In this case Cash, an asset, decreased by $8,100, and Wages Expense, a subcategory of stockholders’ equity, increased by $8,100, which causes stockholders’ equity to decrease. Part III The general journal entry is to debit, or increase, Wages Expense for $8,100, and credit, or decrease, Cash, an asset, for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Cash accounting will decrease by $8,100, and the Wages Expense account will increase by the same amount. 3 Summarize 3-67

(f) Pay cash in advance. On September 1, Pizza Aroma paid $7,200 in advance for September, October, and November rent. 1 Analyze 2 Record Part I On September 1, Pizza Aroma paid $7,200 in advance for September, October, and November rent. Part II Analyze the transaction. In this case Cash, an asset, decreased by $7,200, and Prepaid Rent, an asset, increased by the same amount. Part III The general journal entry is to debit, or increase, the asset Prepaid Rent for $7,200, and credit, or decrease, Cash, an asset, for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Cash account will decrease by $7,200, and the Prepaid Rent account will increase by the same amount. Prepayments for insurance and other time-based services would be analyzed and recorded in a similar manner. 3 Summarize 3-68

(g) Pay cash in advance. On September 2, Pizza Aroma wrote a check for $1,600 for pizza sauce, dough, cheese, and paper products. 1 Analyze 2 Record Part I On September 2, Pizza Aroma wrote a check for $1,600 for pizza sauce, dough, cheese, and paper products. Part II Analyze the transaction. In this case Cash, an asset, decreased by $1,600, and Supplies, an asset, increased by the same amount. Part III The general journal entry is to debit, or increase, the asset Supplies for $1,600, and credit, or decrease, Cash, an asset, for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Cash account will decrease by $1,600, and the Supplies account will increase by the same amount. 3 Summarize 3-69

(h) Incur cost to be paid later. Pizza Aroma received a bill for $400 for running a newspaper ad in September. The bill will be paid in October. 1 Analyze 2 Record Part I Pizza Aroma received a bill for $400 for running a newspaper ad in September. The bill will be paid in October. Part II Analyze the transaction. In this case Accounts Payable, a liability, increased by $400, and Advertising Expense, a subcategory of stockholders’ equity, increased by $400, which causes stockholders’ equity to decrease. Part III The general journal entry is to debit, or increase, Advertising Expense for $400, and credit, or increase, Accounts Payable, a liability, for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Accounts Payable account will increase by $400, and the Advertising Expense account will increase by the same amount. 3 Summarize 3-70

(i) Pay cash for expenses. Pizza Aroma received and paid bills totaling $600 for September utilities services. 1 Analyze 2 Record Part I Pizza Aroma received and paid bills totaling $600 for September utilities services. Part II Analyze the transaction. In this case Cash, an asset, decreased by $600, and Utilities Expense, a subcategory of stockholders’ equity, increased by $600, which causes stockholders’ equity to decrease. Part III The general journal entry is to debit, or increase, Utilities Expense for $600, and credit, or decrease, Cash, an asset, for the same amount. Part IV We summarize the transaction by posting the amount to the general ledger accounts. The Cash account will decrease by $600, and the Utilities Expense account will increase by the same amount. 3 Summarize 3-71

Prepare an unadjusted trial balance.
Learning Objective 4 Prepare an unadjusted trial balance. Learning objective 4 is to prepare an unadjusted trial balance. 3-72

Unadjusted Trial Balance
Cash Ledger Account Part I After summarizing journal entries in the various accounts and then calculating ending balances for each account, you should check that the total recorded debits equal the total recorded credits. The best way to ensure your accounts are “in balance” is to prepare a trial balance , like the one on this slide. Typically, a trial balance lists every account name in one column (usually in the order of assets, liabilities, stockholders’ equity; revenues, and then expenses). Part II The ending balances obtained from the ledgers (T-accounts) are listed in the appropriate debit or credit column. For example, on the Unadjusted Trial Balance, the Cash listing for $8,100 comes from the balance in the Cash ledger account. 3-73

Review of Revenues and Expenses
(1) Cash is received before the company earns revenue. dr. Cash cr. Unearned Rev. dr. Unearned Rev. cr. _______ Revenue $ Earn Revenue (3) Cash is received after the company earns revenue. dr. Cash cr. Accounts Rec. dr. Accounts Rec. cr. ________ Revenue $ Earn Revenue (2) Cash is received in the same period the company earns revenue. dr. Cash cr. ________ Revenue $ Earn Revenue Part I Remember that revenues are recorded when the business fulfills its promise to provide goods or services to customers, which is not necessarily the same time that cash is received. Here is a summary of the three cases we discussed earlier. First, cash is received before revenue is earned by delivering goods or services. The journal entry to record the cash receipt is a debit to Cash and a credit to Unearned Revenue. Later when the services or goods are delivered, the journal entry is a debit to Unearned Revenue and a credit to Service Revenue. Part II Second, cash is received at the same time as revenue is earned by delivering goods or services. The journal entry to record this transaction is a debit to Cash and a credit to Service Revenue. Part III Third, cash is received after revenue is earned by delivering goods or services. The journal entry to record the delivery of the goods or services is a debit to Accounts Receivable and a credit to Service Revenue. Later when the cash is collected, the journal entry is a debit to Cash and a credit to Accounts Receivable. 3-74

Review of Revenues and Expenses
(1) Cash is paid before the expense is incurred. dr. Prepaid Expense cr. Cash dr. Business Expense cr. Prepaid Expense $ Use-up Benefits (3) Cash is paid after the expense is incurred. dr. Accounts Payable cr. Cash dr. Business Expense cr. Accounts Payable $ Use-up Benefits (2) Cash is paid in the same period the expense is incurred. dr. Business Expense cr. Cash $ Use-up Benefits Part I Remember that expenses are recorded when they are incurred, which is not necessarily the same time that cash is paid. Here is a summary of the three cases we discussed earlier. First, cash is paid before the expense is incurred. The journal entry to record the cash payment is a debit to Prepaid Expense and a credit to Cash. Later when the expense is incurred, the journal entry is a debit to the appropriate Expense account and a credit to Prepaid Expense. Prepaid Expenses are assets such as Prepaid Rent and Prepaid Insurance. Part II Second, cash is paid at the same time the expense is incurred. The journal entry to record this transaction is a debit to the Expense account and a credit to Cash. Part III Third, cash is paid after the expense is incurred. The journal entry to record the incurrence of the expense is a debit to the Expense account and a credit to Accounts Payable. Later when the cash is paid, the journal entry is a debit to Accounts Payable and a credit to Cash. 3-75

Describe limitations of the income statement.
Learning Objective 5 Describe limitations of the income statement. Learning objective 5 is to describe limitations of the income statement. 3-76

Income Statement Limitations
NI  Cash NI   Value One of the most common misconceptions is that some people think that net income equals the amount of cash generated by the business during the period. Following the rules of accrual accounting, revenues are recorded when earned and expenses are recorded when incurred, regardless of when cash is received or paid. A second limitation is that net income does not measure the change in the value of a company during a period. Many other factors can cause the value of a company to change without affecting net income. A good example is the increase in the value of Pizza Aroma’s name as its reputation for making great pizza grows. So, net income measures many of the most important events that affect a business’s value, but it does not include all events that potentially affect a company’s value. A third common misconception is that measuring net income just involves counting. Estimation also plays a key role when measuring income. We will learn more about this in chapter 4. For now, just note that net income is not always a precise measure. NI  Exact 3-77

Chapter 3 Solved Exercises
M3-2, M3-3, M3-4, M3-5, M3-13, M3-14 Chapter 3 Solved Exercises: M3-3, M3-4, M3-5, M3-13, M3-14

M3-2 Identifying Revenues
The following transactions are July 2010 activities of Bill’s Extreme Bowling Inc., which operates several bowling centers. If revenue is to be recognized in July, indicate the amount. If revenue is not to be recognized in July, explain why. Part I M3-2 Identifying Revenues The following transactions are July 2010 activities of Bill’s Extreme Bowling Inc., which operates several bowling centers. If revenue is to be recognized in July, indicate the amount. If revenue is not to be recognized in July, explain why. Part II Bill’s collected $12,000 from customers for games played in July. The amount of revenue recognized in July is $12,000. Part III Bill’s billed a customer for $250 for a party held at the center on the last day of July. The bill is to be paid in August. The amount of revenue recognized in July is $250. Part IV Bill’s received $1,000 from credit sales made to customers last month (in June). No revenue is earned in July. The cash collections in July related to revenues earned in June. Part V The men’s and women’s bowling leagues gave Bill’s advance payments totaling $1,500 for the fall season that starts in September. No revenue is earned in July. The revenues will be earned when fall bowling service is provided (i.e., when the games are played). 3-79

M3-3 Identifying Expenses
The following transactions are July 2010 activities of Bill’s Extreme Bowling, Inc., which operates several bowling centers. If an expense is to be recognized in July, indicate the amount. If an expense is not to be recognized in July, explain why. Part I M3-3 Identifying Expenses The following transactions are July 2010 activities of Bill’s Extreme Bowling, Inc., which operates several bowling centers. If an expense is to be recognized in July, indicate the amount. If an expense is not to be recognized in July, explain why. Part II Bill’s paid $1,500 to plumbers for repairing a broken pipe in the restrooms. The amount of July expense is $1,500. Part III Bill’s paid $2,000 for the June electricity bill and received the July bill for $2,500, which will be paid in August. Two thousand five hundred dollars was incurred as an expense in July. The $2,000 was an expense in June and is not an expense in July. Part IV Bill’s paid $5,475 to employees for work in July. The amount of July expense is $5,475. 3-80

M3-4 Recording Revenues For each of the transactions in M3-2, write the journal entry using the format shown in the chapter. dr Cash (+A) 12,000 cr Games Fee Revenue (+R, +SE) 12,000 dr Accounts Receivable (+A) cr Service Revenue (+R, +SE) dr Cash (+A) ,000 cr Accounts Receivable (A) 1,000 dr Cash (+A) ,500 cr Unearned Revenue (+L) 1,500 Part I M3-4 Recording Revenues For each of the transactions in M3-2, write the journal entry using the format shown in the chapter. Part II Debit Cash and credit Games Fee Revenue for $12,000. Part III Debit Accounts Receivable and credit Service Revenue for $250. Part IV Debit Cash and credit Accounts Receivable for $1,000. Part V Debit Cash and credit Unearned Revenue for $1,500. 3-81

M3-5 Recording Expenses For each of the transactions in M3-3, write the journal entry using the format shown in the chapter. dr Repairs and Maintenance Expense (+E, SE) 1,500 cr Cash (A) 1,500 dr Accounts Payable (–L) ,000 cr Cash (A) ,000 dr Utilities Expense (+E, SE) ,500 cr Accounts Payable (+L) 2,500 dr Wages Expense (+E, SE) ,475 cr Cash (A) ,475 Part I M3-5 Recording Expenses For each of the transactions in M3-3, write the journal entry using the format shown in the chapter. Part II Debit Repairs and Maintenance Expense and credit Cash for $1,500. Part III Debit Accounts Payable and credit Cash for $2,000. Part IV Debit Utilities Expense and credit Accounts Payable for $2,500. Part V Debit Wages Expense and credit Cash for $5,475. 3-82

M3-13 Preparing Journal Entries for Business Activities
Quick Cleaners, Inc. (QCI) has been in business for several years. It specializes in cleaning houses but has some small business clients as well. Prepare journal entries for the following transactions, which occurred during a recent month: Incurred $600 of heating and electrical costs this month and will pay them next month. Issued $25,000 of QCI stock for cash. dr Utilities (or Heating/Electrical) Expense (+E -SE) 600 cr Accounts (or Utilities) Payable (+L) dr Cash (+A) ,000 cr Contributed Capital (+SE) ,000 (or Capital/Common Stock) Part I M3-13 Preparing Journal Entries for Business Activities Quick Cleaners, Inc. (QCI) has been in business for several years. It specializes in cleaning houses but has some small business clients as well. Prepare journal entries for the following transactions, which occurred during a recent month: Incurred $600 of heating and electrical costs this month and will pay them next month. Part II Debit Utilities (or Heating/Electrical) Expense and credit Accounts (or Utilities) Payable for $600. Issued $25,000 of QCI stock for cash. Part III Debit Cash and credit Contributed Capital (or Capital/Commons Stock) for $25,000. 3-83

Paid wages for the current month, totaling $2,000. Performed cleaning services on account worth $2,800. Some of Quick Cleaners’ equipment was repaired at a total cost of $150. The company paid the full amount immediately. c. dr Wages Expense (+E -SE) ,000 cr Cash (-A) ,000 d. dr Accounts Receivable (+A) ,800 cr Services/Cleaning Revenue (+R +SE) ,800 dr Repairs and Maintenance Expense (+E -SE) cr Cash (-A) Part I Paid wages for the current month, totaling $2,000. Part II Debit Wages Expense and credit Cash for $2,000. Performed cleaning services on account worth $2,800. Part III Debit Accounts Receivable and credit Services/Cleaning Revenue for $2,800. Some of Quick Cleaners’ equipment was repaired at a total cost of $150. The company paid the full amount immediately. Part IV Debit Repairs and Maintenance Expense and credit Cash for $150. 3-84

Junktrader is an online company that specializes in matching buyers and sellers of used items. Buyers and sellers can purchase a membership with Junktrader, which provides them advance notice of potentially attractive offers. Prepare journal entries for the following transactions, which occurred during a recent month. Junktrader provided online advertising services for another company for $200 on account. On the last day of the month, Junktrader paid $50 cash to run an ad promoting the company’s services. The ad ran that day in the local newspaper. Part I M3-14 Preparing Journal Entries for Business Activities Junktrader is an online company that specializes in matching buyers and sellers of used items. Buyers and sellers can purchase a membership with Junktrader, which provides them advance notice of potentially attractive offers. Prepare journal entries for the following transactions, which occurred during a recent month. Junktrader provided online advertising services for another company for $200 on account. Part II Debit Accounts Receivable and credit Advertising (or Service) Revenue for $200. On the last day of the month, Junktrader paid $50 cash to run an ad promoting the company’s services. The ad ran that day in the local newspaper. Part III Debit Advertising Expense and credit Cash for $50. dr Accounts Receivable (+A) cr Advertising (or Service) Revenue (+R +SE) dr Advertising Expense (+E -SE) cr Cash (-A) 3-85

Received $200 cash in membership fees for the month from new members. Received an electricity bill for $85, for usage this month. The bill will be paid next month. Billed a customer $180 for helping them sell their junk. The customer is expected to pay by the end of next month. dr Cash (+A) cr Membership (or Fees) Revenue (+R +SE) d. dr Utilities (or Electricity) Expense (+E -SE) cr Accounts (or Utilities) Payable (+L) dr Accounts Receivable (+A) cr Services (or Sales) Revenue (+R +SE) Part I Received $200 cash in membership fees for the month from new members. Part II Debit Cash and credit Membership (or Fees) Revenue for $200. Received an electricity bill for $85, for usage this month. The bill will be paid next month. Part III Debit Utilities (or Electricity) Expense and credit Accounts (or Utilities) Payable for $85. Billed a customer $180 for helping them sell their junk. The customer is expected to pay by the end of next month. Part IV Debit Accounts Receivable and credit Services (or Sales) Revenue for $180. 3-86

End of Chapter 3 End of chapter 3.

2+3 7 Fundamentals of Financial Accounting 3e by Phillips, Libby, and Libby. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All.

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2+3 7 Fundamentals of Financial Accounting 3e by Phillips, Libby, and Libby. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All.

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