Chapter 2 The Balance Sheet PowerPoint Authors: Brandy Mackintosh

Chapter 2 The Balance Sheet PowerPoint Authors: Brandy Mackintosh
Lindsay Heiser Chapter 2: Reporting Investing and Financing Results on the Balance Sheet

Learning Objective 2-1 Identify financial effects of common business activities that affect the balance sheet. Learning objective 2-1 is to identify financial effects of common business activities that affect the balance sheet.

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 owed 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.

Financing and Investing Activities
Assets Invest in Assets Companies rely on two sources of financing: = 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

Financing and Investing Activities
Key Features Your Goals 1. A company always documents its activities. Picture the documented activity. 2. A company always receives something and gives something. Name what’s exchanged. 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 financial effects.

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.

Apply transaction analysis to accounting transactions.
Learning Objective 2-2 Apply transaction analysis to accounting transactions. Learning objective 2 is to apply transaction analysis to accounting transactions.

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 its 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.

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). 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.

(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. Contributed Capital, a stockholders’ equity account, increases by $50,000 when the stock was issued to Mauricio Rosa. Liabilities Assets = Stockholders’ Equity + (a) Cash +$50,000 Contributed Capital +$50,000

(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, the asset, Equipment, is increased by $42,000 and the asset, Cash, is decreased by $42,000. Notice there is no impact on the Liabilities and Stockholders’ Equity section of the balance sheet. The company exchanged one asset cash for another asset equipment. Liabilities Assets = Stockholders’ Equity + (b) Equipment +$42,000 Cash -$42,000

(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. Liabilities Assets = Stockholders’ Equity + (c) Cash +$20,000 Note Payable +$20,000

(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 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 side of the equation increases by the same amount. The basic accounting equation stays in balance. Liabilities Assets = Stockholders’ Equity + (d) Cash -$16,000 Equipment +$18,000 Accounts Payable +$2,000

(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. There is no impact on the accounting equation. Liabilities Assets = Stockholders’ Equity + No Impact 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. There is no impact on the accounting equation. Part III This event does not impact the basic accounting equation.

(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 and stockholders’ equity side is reduced by the same amount. Liabilities Assets = Stockholders’ Equity + (f) Cash -$2,000 Accounts Payable -$2,000

(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 and stockholders’ equity side is increased by the same amount. Liabilities Assets = Stockholders’ Equity + (g) Cookware +$630 Accounts Payable +$630

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

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.

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. • Assets decrease on the right side of the account. Part III • Liabilities increase on the right side of the account. • Stockholders’ equity accounts increase on the right side of the account. • Decreases are the on the left side of the account. 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).

The Debit/Credit Framework
ASSETS = LIABILITIES STOCKHOLDERS’ EQUITY Take special note of two important rules: Accounts increase on the same side as they appear in A = L + SE Left is debit ( dr ), right is credit ( cr ) Part I Accounts increase on the same side as they appear in A = L + SE. Part II Left is debit ( dr ), right is credit ( cr ).

Steps 2 & 3: Record and Summarize
1 Analyze 2 Record General Journal Page G1 Date Account Title and Explanation Ref. Debit Credit 3 Summarize 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.

1 Analyze 2 Record General Journal Page G1 Date Account Title and Explanation Ref. Debit Credit 2013 8/1 Cash Contributed Capital (Financing from stockholders) 101 301 50,000 3 Summarize General Ledger Account: Cash Balance Date Explanation Ref. Debit Credit 2013 8/1 G1 50,000 Acct 101 General Ledger Account: Contributed Capital Balance Date Explanation Ref. Debit Credit 2013 8/1 G1 50,000 Acct 301 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.

1 Analyze 2 Record (a) dr Cash (+A) cr Contributed Capital (+SE) 50,000 3 Summarize General Ledger Account: Cash Balance Date Explanation Ref. Debit Credit 2013 8/1 G1 50,000 Acct 101 General Ledger Account: Contributed Capital Balance Date Explanation Ref. Debit Credit 2013 8/1 G1 50,000 Acct 301 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.

1 Analyze 2 Record (a) dr Cash (+A) cr Contributed Capital (+SE) 50,000 3 Summarize General Ledger Account: Cash Balance Date Explanation Ref. Debit Credit 2013 8/1 G1 50,000 Acct 101 General Ledger Account: Contributed Capital Balance Date Explanation Ref. Debit Credit 2013 8/1 G1 50,000 Acct 301 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.

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 Liabilities Assets = Stockholders’ Equity + (a) Cash +$50,000 Contributed Capital +$50,000 2 Record (a) dr Cash (+A) cr Contributed Capital (+SE) 50,000 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 account will increase by $50,000, and the Contributed Capital account will also increase by the same amount. After the transaction is posted, the balance in the Cash account is $50,000. 3 Summarize Beg. Bal. (a) Cash (A) dr + cr - 50,000 Contributed Capital (SE) dr - cr +

(b) Investment in Equipment. Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. 1 Analyze Liabilities Assets = Stockholders’ Equity + (b) Cash -$42,000 Equipment +$42,000 2 Record (b) dr Equipment (+A) cr Cash (-A) 42,000 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 transaction by posting it to the general ledger. The credit to cash reduces the asset account by $42,000, and the asset account Equipment is increased by a debit of $42,000. 3 Summarize Beg. Bal. (a) (b) Cash (A) dr + cr - 50,000 42,000 Equipment (A)

(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 Liabilities Assets = Stockholders’ Equity + (c) Cash +$20,000 Note Payable +$20,000 2 Record (c) dr Cash (+A) cr Note Payable (+L) 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 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 left side, of the asset account Cash, and credit, or place on the right side of the liability account, Note Payable for $20,000. 3 Summarize Beg. Bal. (a) (c) (b) Cash (A) dr + cr - 50,000 20,000 42,000 Note Payable (L) dr - cr +

(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 Liabilities Assets = Stockholders’ Equity + (d) Cash -$16,000 Equipment +$18,000 Accounts Payable +$2,000 2 Record 16,000 2,000 (d) dr Equipment (+A) cr Cash (-A) cr Accounts Payable (+L) 18,000 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 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 $18,000. 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). Beg. Bal. (d) Accounts Payable (L) dr - cr + 2,000 3 Summarize (a) (c) (b) Cash (A) dr + cr - 50,000 20,000 42,000 16,000 Equipment (A) 18,000

(f) Pay Suppliers. Pizza Aroma pays $2,000 to the equipment supplier from the last transaction. 1 Analyze Liabilities Assets = Stockholders’ Equity + (f) Cash -$2,000 Accounts Payable -$2,000 2 Record (f) dr Accounts Payable (-L) cr Cash (-A) 2,000 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 Beg. Bal. (a) (c) (b) (d) (f) Cash (A) dr + cr - 50,000 20,000 42,000 16,000 2,000 Accounts Payable (L) dr - cr +

(g) Receive Cookware. Pizza Aroma receives $630 of the cookware previously ordered and promises to pay for it next month. 1 Analyze Liabilities Assets = Stockholders’ Equity + (g) Cookware +$630 Accounts Payable $630 2 Record (g) dr Cookware (+A) cr Accounts Payable (+L) 630 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 account, Accounts Payable is also $630. 3 Summarize Beg. Bal. (g) Cookware (A) dr + cr - 630 (f) (d) Accounts Payable (L) dr - cr + 2,000

T-Accounts for Pizza Aroma
Cash Beg. Bal. - (a) 50,000 (c) 20,000 42,000 (b) 16,000 (d) 2,000 (f) End. Bal. 10,000 Cookware Beg. Bal. - (g) 630 End. Bal. Accounts Payable (f) 2,000 - Beg. Bal. (d) 630 (g) End. Bal. Equipment Beg. Bal. - (b) 42,000 (d) 18,000 End. Bal. 60,000 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. Notes Payable - Beg. Bal. 20,000 (c) End. Bal. Contributed Capital - Beg. Bal. 50,000 (a) End. Bal.

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

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. Pizza Aroma, Inc. Trial Balance August 31, 2013 Cash Cookware Equipment Accounts Payable Note Payable Contributed Capital Totals Debit $10,000 630 60,000 $70,630 Credit $ 20,000 50,000 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.

Classified Balance Sheet
Pizza Aroma, Inc. Balance Sheet At August 31, 2013 Current Assets: Cash Cookware Total Current Assets Property, Plant, and Equipment: Equipment Total Assets: Liabilities and Stockholders’ Equity: Current Liabilities: Accounts Payable Long-Term Liabilities: Note Payable Total Liabilities: Stockholders’ Equity Contributed Capital Total Liabilities and Stockholders’ Equity $10,000 630 10,630 60,000 $70,630 $ 20,000 20,630 50,000 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 converted 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.

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

Assessing the Ability to Pay
Pizza Aroma, Inc. Balance Sheet At August 31, 2013 Current Assets: Cash Cookware Total Current Assets Property, Plant, and Equipment: Equipment Total Assets: Liabilities and Stockholders’ Equity: Current Liabilities: Accounts Payable Long-Term Liabilities: Note Payable Total Liabilities: Stockholders’ Equity Contributed Capital Total Liabilities and Stockholders’ Equity $10,000 630 10,630 60,000 $70,630 $ 20,000 20,630 50,000 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.

Balance Sheet Concepts and Values
Pizza Aroma, Inc. Balance Sheet At August 31, 2013 Current Assets: Cash Cookware Total Current Assets Property, Plant, and Equipment: Equipment Total Assets: Liabilities and Stockholders’ Equity: Current Liabilities: Accounts Payable Long-Term Liabilities: Note Payable Total Liabilities: Stockholders’ Equity Contributed Capital Total Liabilities and Stockholders’ Equity $10,000 630 10,630 60,000 $70,630 $ 20,000 20,630 50,000 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.

Chapter 2 Solved Exercises
M2-13, M2-15, M2-17, M2-19, 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 $70,000 cash invested by owners and issued stock. Bought an unused field from a local farmer by paying $60,000 cash. As a construction site for smaller projects it is estimated to be worth $65,000 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) 70,000 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 $70,000 cash invested by owners and issued stock. Bought an unused field from a local farmer by paying $60,000 cash. As a construction site for smaller projects it is estimated to be worth $65,000 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 $70,000. Part III The second part of the entry is to credit, or increase, the stockholders’ equity account Contributed Capital for $70,000. Part IV For part (b) or the problem, we begin with a debit, or increase, in the asset account Inventory for $60,000. Part V The final part of the entry is to credit, or decrease, the asset account Cash for $60,000. 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) 60,000 cr Cash (-A) ,000 c. dr Supplies (+A) ,000 cr Cash (-A) ,000 $10,000 × 10% = $1,000; $10,000 - $1,000 = $9,000

Borrowed $25,000 from the bank with a plan to use the funds to build a small workshop in August. The loan must be repaid in two years. One of the owners sold $10,000 worth of his stock to another shareholder for $11,000. 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 repaid in two years. One of the owners sold $10,000 worth of his stock to another shareholder for $11,000. 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.

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 equipment for $4,000 cash. The equipment is expected to be used for ten or more years. Joel’s business bought $7,000 worth of books from a publisher. The company will pay the publisher within days. dr Equipment (+A) 4,000 cr Cash (-A) 4,000 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 equipment for $4,000 cash. The equipment is expected to be used for ten or more years. Joel’s business bought $7,000 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 $4,000. Part III The entry is completed with a credit, or decrease, to the asset account Cash in the amount of $4,000. Part IV For transaction (b), we begin with a debit, or increase, in the asset account Inventory for $7,000. Inventory represents items purchased for resale. Part V We complete transaction (b) with a credit, or increase, in the liability account Accounts Payable for $7,000. b. dr Inventory (+A) 7,000 cr Accounts Payable (+L) 7,000

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 Notes 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 Notes Payable (-L) 4,000 cr Cash (-A) 4,000

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 partial payment of 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 debit, 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)

To help raise funds for store upgrades estimated to cost $20,000, Sweet Shop Co. Issued 1,000 shares for $15 each to existing stockholders. Sweet Shop Co. bought ice cream trucks for $60,000 total, paying $10,000 cash and signing a long-term note for $50,000. 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 for $15 each to existing stockholders. Sweet Shop Co. bought ice cream trucks for $60,000 total, paying $10,000 cash and signing a long-term note for $50,000. 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 $60,000. Part V Next, we credit, or increase, the liability account Notes Payable for $50,000, 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

The employee has yet to provide any services to the company
M2-19 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, no transaction has taken place. Part V In transaction (c), we begin with a debit, or decrease, in the liability account Accounts Payable 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 Accounts Payable (-L) ,000 cr Cash (-A) ,000

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 that had been outstanding for 6 months. (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 that had been outstanding for 6 months. (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

End of Chapter 2 End of chapter 2.

Chapter 2 The Balance Sheet PowerPoint Authors: Brandy Mackintosh

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Chapter 2 The Balance Sheet PowerPoint Authors: Brandy Mackintosh

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