Chapter 2 The Balance Sheet PowerPoint Author: Brandy Mackintosh, CA

Chapter 2 The Balance Sheet PowerPoint Author: Brandy Mackintosh, CA

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 Economic resources presently controlled by the company that have measurable value and are expected to benefit the company by producing cash inflows or reducing cash outflows in the future. = Liabilities Measurable amounts that the company owes to creditors. + The balance sheet is structured like the basic accounting equation: Assets = Liabilities + Stockholders’ Equity. Assets are economic resources presently controlled by the company that have measurable value and are expected to benefit the company by producing cash inflows or reducing cash outflows in the future; liabilities are measurable amounts that the company owes to creditors; and stockholders’ equity is the owners’ claim to the business resources. Stockholders’ Equity Owners’ claim to the business resources.

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, invoices, and other documents 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. Because the accounting system captures both what is received and what is given, it is often referred to as a “double-entry” 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 Business activities that affect the basic accounting equation (A = L + SE) are called transactions. Transactions are of special importance because they are the only activities that enter the financial accounting system. Transactions include two types of events: 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 do not involve exchanges with others outside the business, but rather occur within the company itself. For example, when the company Red Bull combines sugar, water, taurine, and caffeine, something magical happens: these ingredients turn into Red Bull Energy Drink.

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 is called the accounting cycle because it repeats itself over and over. For now, we will focus on the first three 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
As part of transaction analysis, a name is given to each item exchanged. Accountants refer to these names as account titles. 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 unique to a particular company. Part I As part of transaction analysis, a name is given to each item exchanged. Accountants refer to these names as account titles. Part II To ensure account titles are used consistently, every company establishes a chart of accounts —a list that designates a name and reference number that the company will use when accounting for each item it exchanges. Part III A partial chart of accounts for SonicGateway is shown on this slide. 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. Scott incorporates SonicGateway Inc. on August 1. The company issues common stock to Scott and Angus as evidence of their contribution of $10,000 cash, which is deposited in the company’s bank account. SonicGateway receives $10,000 Cash. SonicGateway gives $10,000 of Common Stock. Part I Scott incorporates SonicGateway Inc. on August 1. The company issues common stock to Scott and Angus as evidence of their contribution of $10,000 cash, which is deposited in the company’s bank account. Part II SonicGateway has received $10,000 cash and gave $10,000 of common stock in the transaction. Part III For this transaction, Cash, an asset, increases by $10,000 received from the owners. Common Stock, a stockholders’ equity account, increases by $10,000 when the stock was issued to Scott and Angus. Liabilities Assets = Stockholders’ Equity + (a) Cash +$10,000 Common Stock $10,000

(b) Invest in Logo/Trademark. SonicGateway pays $300 cash to create the company’s logo. SonicGateway receives a logo costing $300. Sonic Gateway gives $300 Cash. Part I Next, SonicGateway pays $300 cash to create the company’s logo. Part II SonicGateway has received a logo costing $300 and gave $300 cash. Part III For this transaction, the asset, Logo/Trademarks, is increased by $300 and the asset, Cash, is decreased by $300. Notice that even though this transaction did not affect liabilities or stockholders’ equity, the accounting equation remained in balance because the decrease in one asset was offset by the increase in another asset. Liabilities Assets = Stockholders’ Equity + (b) Logo/ Trademark +$300 Cash -$300

(c) Obtain Loan from Bank. SonicGateway 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 (on August 3, 2017). SonicGateway receives $20,000 Cash. SonicGateway gives a note, payable to the bank for $20,000. Part I SonicGateway 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 (on August 3, 2017). Part II SonicGateway has received $20,000 cash that is deposited into its checking account at the bank and in return SonicGateway gave 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) Invest in Equipment. SonicGateway purchases and receives $9,600 in computers, printers, and desks, in exchange for its promise to pay $9,600 at the end of the month. SonicGateway receives $9,600 in equipment. SonicGateway gives a promise to pay $9,600 on account. Part I SonicGateway purchases and receives $9,600 in computers, printers, and desks, in exchange for its promise to pay $9,600 at the end of the month. Part II In this transaction SonicGateway has received $9,600 of equipment and gave a promise to pay $9,600 on account. Part III For this transaction, Equipment, an asset account, increases by $9,600, and Accounts Payable, a liability, increases by $9,600. SonicGateway would typically wait until the end of the month to pay the amount owed to the supplier. But to show you how the payment is accounted for, we will present it on the next slide. Liabilities Assets = Stockholders’ Equity + (d) Equipment +$9,600 Accounts Payable +$9,600

(e) Pay Supplier. SonicGateway pays $5,000 to the equipment supplier in (d). SonicGateway receives a release from $5,000 of its promise to pay on account. 2. SonicGateway gives $5,000 cash. Liabilities Assets = Stockholders’ Equity + (e) Cash -$5,000 Accounts Payable $5,000 Part I SonicGateway pays $5,000 to the equipment supplier from the previous slide in transaction (d). Part II In this transaction, SonicGateway has received a release from $5,000 of its promise to pay on account and gave $5,000 cash. Part III For this transaction, Cash, an asset account, decreases by $5,000, and Accounts Payable, a liability, decreases by $5,000.

(f) Order Software for App. SonicGateway signs a contract with a programmer for program code for the Static Charge game app for $9,000. No code has been received yet. An exchange of only promises is not a transaction. 2. There is no impact on the accounting equation. Part I SonicGateway signs a contract with a programmer for program code for the Static Charge game app for $9,000. No code has been received yet. Part II Not all documented business activities are considered accounting transactions. As shown in this example, SonicGateway and the app programmer have documented the order, but it involves an exchange of only promises, so it is not an accounting transaction. Part III Seeing this is not an accounting transaction, there is no impact to the accounting equation. Liabilities Assets = Stockholders’ Equity + (f) No Change No Change

(g) Receive Software. SonicGateway receives the $9,000 of app game code ordered in (f), pays $4,000 cash, and promises to pay the remaining $5,000 next month. SonicGateway receives software with a cost of $9,000. 2. SonicGateway gives Cash of $4,000 and gives a promise to pay $5,000 on account. Part I SonicGateway receives the $9,000 of app game code ordered in(f) on the previous slide, pays $4,000 cash, and promises to pay the remaining $5,000 next month. Part II SonicGateway has received software costing $9,000, gave $4,000 cash and a promise to pay $5,000 on account. Part III For this transaction, Cash, an asset account, decreased by $4,000, Software, also an asset, increases by $9,000, and Accounts Payable, a liability, increased by $5,000. The asset side of the basic accounting equation increases by a net amount of $5,000, 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 + (g) Cash -$4,000 Software +$9,000 Accounts Payable +$5,000

(h) Receive Supplies. SonicGateway receives supplies costing $600 on account. SonicGateway receives supplies with a cost of $600. 2. SonicGateway gives a promise to pay $600 on account. Part I SonicGateway receives supplies costing $600 on account. Part II SonicGateway has received supplies costing $600 and gave a promise to pay $600 on account. Part III For this transaction, Supplies, an asset account, increases by $600, and Accounts Payable, a liability, increased by $600. The basic accounting equation stays in balance. Liabilities Assets = Stockholders’ Equity + (g) Supplies +$600 Accounts Payable +$600

Step 2 and 3: Record and Summarize
One way to record and summarize the financial effects of transactions would be to enter your understanding of their effects into a spreadsheet One way to record and summarize the financial effects of transactions would be to enter your understanding of their effects into a spreadsheet like the one shown in this slide. By summing each spreadsheet column, you could compute new balances at the end of each month and report them on a balance sheet. A spreadsheet makes it easy to see the individual impact of each transaction and how transactions combine with beginning balances to yield ending balances, but it is impractical for most large organizations to use.

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. The three-step analyze-record-summarize process is applied to daily transactions, as well as adjustments at the end of each month, before preparing a trial balance and the financial statements. The same three steps also are part of the closing process that occurs at the end of each year. Our focus in this chapter is on applying the three-step process during the period to activities that affect only balance sheet accounts. The analyze step involves determining the financial effects of each transaction; the record step captures these effects and enters them into an accounting record called a journal each day that they occur; and the summarize step accumulates these journal entries in accounting records called ledger accounts or T-accounts.

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.

The Debit/Credit Framework
Take special note of three important rules: Accounts increase on the same side as they appear in A = L + SE. Left is debit ( dr ), right is credit ( cr ). 3. The normal balance for an account is the side on which it increases. Part I Think of the accounting equation (A + L = SE) as an old-fashioned weight scale that tips at the equals sign. Assets—like Cash and Equipment—are put on the left side of the scale and liabilities and stockholders’ equity accounts are put on the right. Part II Likewise, each individual account has two sides, with one side used for increases and the other for decreases. Part III Take special note of three important rules illustrated on this slide: Part IV 1. Accounts increase on the same side as they appear in A = L + SE. 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. • Liabilities increase on the right side of the account. • Stockholders’ equity accounts increase on the right side of the account. • Decreases are the opposite, as shown in this slide. Part V 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). Part VI 3. The normal balance for an account is the side on which it increases. Assets normally have debit balances, whereas liabilities and stockholders’ equity accounts normally have credit balances.

Step 2: Recording Journal Entries
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 as shown here on this slide. When looking at these journal entries, as they are called, notice the following: • A date is included for each transaction. • Debits appear first (on top). Credits are shown below the debits and are indented to the right (both the words and the amounts). If more than one account is debited or credited, their order 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 (for example, see the entry on August 29 where $9,000 = $4,000 + $5,000). • Dollar signs are not used because the journal is understood to be a record of financial effects. • The reference column (Ref.) will be used later (in step 3) to indicate when the journal entry has been summarized in the ledger accounts. • A brief explanation of the transaction is shown below the debits and credits. • The line after the explanation is left blank before showing the next journal entry.

Step 2: Recording Journal Entries
Part I For classroom purposes, we use a simplified version of a journal entry which should make it easier for you to learn the most important aspects of recording journal entries. The way you would show the journal entry for August 29 is: Part II The main differences between your simplified format and a formal journal entry are: • When a date is not given, use some form of reference for each transaction, such as ( d ),to identify the event. • Omit the reference column and transaction explanation to simplify the entry. • Include the appropriate account type (A, L, or SE) along with the direction of the effect ( + or - ) next to each account title to clarify the effects of the transaction on each account. This parenthetical note will reinforce the debit/credit framework and help you ensure the accounting equation remains in balance.

Step 3: Summarizing in Ledger Accounts
By themselves, journal entries show the effects of transactions, but they do not provide account balances. That’s why ledger accounts are needed. After journal entries have been recorded (in step 2), their dollar amounts are copied (“posted”) in 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.

Step 3: Summarizing in Ledger Accounts
For classroom purposes we will use a simplified format for ledger accounts to make it easier to focus on their main features. The simplified version of a ledger account is called a T-account. Each T-account represents the debit and credit columns of a ledger account. This slide shows the T-accounts for SonicGateway ’s Software, Cash, and Accounts Payable, based on transactions (a) through (g) that we looked at on the previous slides. It also shows how an individual journal entry’s effects would be summarized in these T-accounts. The debit to Software in the journal entry is copied into the debit (left) side of its T-account. The credits to Cash and Accounts Payable are copied into the credit (right) side of those T-accounts. Notice the following in this slide: 1. Every account starts with a beginning balance, normally on the side where increases are summarized. For balance sheet accounts, the ending balance from the prior period is the beginning balance for the current period. Because SonicGateway is in its first month of business, the beginning balance in each account is zero in this example. 2. Each amount is accompanied by a reference to the related journal entry, which makes it easy to trace back to the original transaction should errors occur. 3. To calculate the ending balance in each account, you must start with the beginning balance, add the amounts on the “+” side of the T-account, and then subtract the amounts on the “-” side of the T-account. The ending balance is double underlined to distinguish it from transactions and symbolize the final result of a computation. The ending balance is shown on the side that has the greater total dollar amount. Now let’s practice following these steps, with the transactions we previously analyzed for SonicGateway.

SonicGateway’s Accounting Records
(a) Issue Stock to Owners. Scott incorporates SonicGateway Inc. on August 1. The company issues common stock to Scott and Angus as evidence of their contribution of $10,000 cash, which is deposited in the company’s bank account. 1 Analyze Liabilities Assets = Stockholders’ Equity + (a) Cash +$10,000 Common Stock +$10,000 2 Record (a) Cash (+A) Common Stock (+SE) 10,000 Part I Scott incorporates SonicGateway Inc. on August 1. The company issues common stock to Scott and Angus as evidence of their contribution of $10,000 cash, which is deposited in the company’s bank account. Part II Analyze the transaction. In this case Cash, an asset, increased by $10,000, and Common Stock, a stockholders’ equity account increase by the same amount. The basic accounting equation is in balance. Part III The general journal entry is to debit, or increase the asset Cash for $10,000, and credit, or increase, the stockholders’ equity account, Common Stock 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 $10,000, and the Common Stock account will also increase by the same amount. After the transaction is posted, the balance in the Cash account is $10,000. 3 Summarize Beg. Bal. (a) Cash (A) dr + cr - 10,000 Common Stock (SE) dr - cr +

(b) Invest in Logo and Trademarks.
SonicGateway’s Accounting Records (b) Invest in Logo and Trademarks. SonicGateway pays $300 cash to create the company’s logo. 1 Analyze Liabilities Assets = Stockholders’ Equity + (b) Cash -$300 Logo/trademarks+$300 2 Record (b) Logo and Trademarks (+A) Cash (-A) 300 Part I Next, SonicGateway pays $300 cash to create the company’s logo. Part II Our analysis of this transaction indicates that the asset account Cash decreased by $300 and the asset account Logo and Trademarks increased by $300. The basic accounting equation is in balance. Part III The general journal entry to record the transaction is to debit, or increase, the Logo and Trademarks account by $300, and credit, or decrease, the asset account Cash for $300. Part IV Finally, we summarize the transaction by posting it to the general ledger. The credit to cash reduces the asset account by $300, and the asset account Logo and Trademarks is increased by a debit of $300. 3 Summarize Beg. Bal. (a) (b) Cash (A) dr + cr - 10,000 300 Logo and Trademarks (A)

(c) Obtain Loan from Bank.
SonicGateway’s Accounting Records (c) Obtain Loan from Bank. SonicGateway 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 (on August 3, 2017). 1 Analyze Liabilities Assets = Stockholders’ Equity + (c) Cash +$20,000 Note Payable (long-term) +$20,000 2 Record (c) Cash (+A) Note Payable (long-term) (+L) 20,000 Part I SonicGateway 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 (on August 3, 2017). Part II An analysis of this transaction shows that the asset account Cash increased by $20,000, and the liability account, Note Payable (long-term), increased by $20,000. The basic accounting equation is in balance. 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 (long-term) 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 post on the right side of the liability account, Note Payable (long-term) for $20,000. 3 Summarize Beg. Bal. (a) (c) (b) Cash (A) dr + cr - 10,000 20,000 300 Note Payable (long-term) (L) dr - cr +

(d) Invest in Equipment.
SonicGateway’s Accounting Records (d) Invest in Equipment. SonicGateway purchases and receives $9,600 in computers, printers, and desks, in exchange for its promise to pay $9,600 at the end of the month. 1 Analyze Liabilities Assets = Stockholders’ Equity + Equipment+$9,600 Accounts Payable +$9,600 2 Record 9,600 (d) Equipment (+A) Accounts Payable (+L) Part I SonicGateway purchases and receives $9,600 in computers, printers, and desks, in exchange for its promise to pay $9,600 at the end of the month. Part II In analyzing this transaction we see that the asset account Equipment is increased by $9,600. Accounts payable, a liability account, is increased by $9,600. 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 $9,600 and we credit, or increase, the liability account Accounts Payable for $9,600. Part IV We summarize by posting the $9,600 to the debit, or left side, of the asset account Equipment, and credit, or post on the right side of the liability account, Accounts Payable for $9,600. Beg. Bal. (d) Accounts Payable (L) dr - cr + 9,600 3 Summarize Equipment (A) dr + cr -

SonicGateway pays $5,000 to the equipment supplier in (d).
SonicGateway’s Accounting Records (e) Pay Supplier. SonicGateway pays $5,000 to the equipment supplier in (d). 1 Analyze Liabilities Assets = Stockholders’ Equity + (f) Cash -$5,000 Accounts Payable -$5,000 2 Record (f) Accounts Payable (-L) Cash (-A) 5,000 Part I SonicGateway pays $5,000 to the equipment supplier in (d). Part II In analyzing this transaction we determine that the asset account Cash decreased by $5,000, and the liability account, Accounts Payable, decreased by the same amount. The basic accounting equation is in balance. Part III To record the transaction in the general journal we debit, or decrease, the liability account Accounts Payable for $5,000, 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 supplier the balance in the Accounts Payable account is $4,600 which is the remaining amount owing to the supplier, and the Cash account houses many transactions. 3 Summarize Beg. Bal. (a) (c) (b) (e) Cash (A) dr + cr - 10,000 20,000 300 5,000 (d) Accounts Payable (L) dr - cr + 9,600

(f) Order Software. SonicGateway signs a contract for program code for a game app for $9,000. No code has been received yet. 1 Analyze Liabilities Assets = Stockholders’ Equity + (f) No Change No Change 2 Record Because this event involves the exchange of only promises, it is not considered a transaction. No journal entry is needed. Part I SonicGateway signs a contract for program code for a game app for $9,000. No code has been received yet. Part II Because this event involves the exchange of only promises, it is not considered a transaction. No journal entry is needed.

(g) Receive Software. SonicGateway receives the $9,000 of app game code ordered in (f), pays $4,000 cash, and promises to pay the remaining $5,000 next month. 1 Analyze Liabilities Assets = Stockholders’ Equity + (d) Cash -$4,000 Software +$9,000 Accounts Payable +$5,000 2 Record 4,000 5,000 (d) Software (+A) Cash (-A) Accounts Payable (+L) 9,000 Part I SonicGateway receives the $9,000 of app game code ordered in (f), pays $4,000 cash, and promises to pay the remaining $5,000 next month. Part II In analyzing this transaction we see that the asset account Cash is decreased by $4,000, and the asset account Software is increased by $9,000. So, there is a net $5,000 increase in the asset side of the equation. Accounts Payable, a liability account, is increased by $5,000. 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 Software for $9,000. We credit, or decrease, the asset account Cash for $4,000, and credit, or increase, the liability account Accounts Payable for $5,000. Part IV We summarize by posting the $9,000 to the debit, or left side, of the asset account Software, we credit, or post on the right side of the asset account, Cash for $4,000, and credit, or post on the right side of the liability account, Accounts Payable for $5,000. Beg. Bal. (d) (g) Accounts Payable (L) dr - cr + (e) 9,600 5,000 3 Summarize (a) (c) (b) Cash (A) dr + cr - 10,000 20,000 300 4,000 Software (A) 9,000

SonicGateway receives supplies costing $600 on account.
SonicGateway’s Accounting Records (h) Receive Supplies. SonicGateway receives supplies costing $600 on account. 1 Analyze Liabilities Assets = Stockholders’ Equity + (f) Supplies +$600 Accounts Payable +$600 2 Record (f) Supplies (+A) Accounts Payable (+L) 600 Part I SonicGateway receives supplies costing $600 on account. Part II In analyzing this transaction we determine that the asset account Supplies increased by $600, and the liability account, Accounts Payable, increased by the same amount. The basic accounting equation is in balance. Part III To record the transaction in the general journal we debit, or increase, the asset account Supplies for $600, and credit, or increase, the liability account Accounts Payable for the same amount. Part IV We summarize by posting the $600 to the debit, or left side, of the asset account Supplies, and credit, or post on the right side of the liability account, Accounts Payable for $600. 3 Summarize Beg. Bal. (h) Supplies (A) dr + cr - 600 (e) (d) (g) Accounts Payable (L) dr - cr + 5,000 9,600

T-Accounts for SonicGateway
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 trial balance and a balance sheet.

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

Preparing a Trial Balance
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. Part I The next step in the accounting cycle is to prepare an internal accounting report called a trial balance. It checks that the accounting records are in balance by determining whether debits = credits. If total debits don’t equal total credits, the balance sheet will not balance. The trial balance lists the ending balance in every T-account and then computes total debits and total credits, as shown in this slide. Part II Because the column totals are equal, SonicGateway’s balance sheet can be prepared.

Preparing a Classified Balance Sheet
Current assets will be used up or turned into cash within the next 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. Part I The balance sheet is prepared by taking the ending balances for each account and grouping them as assets, liabilities, and stockholders’ equity in balance sheet format. This slide uses a balance sheet format called the classified balance sheet. Part II 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. In our example, Accounts Payable is the only current liability. The other liability—Note Payable—is expected to be paid in two years, so it is considered noncurrent. Companies list assets in order of liquidity (how soon they will be used up or turned into cash) and liabilities in order of maturity (how soon they will be paid in cash or fulfilled by providing a service).

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
Current Ratio = Current Assets Current Liabilities 2.09 = $ 21,300 $ 10,200 = Part I The classified balance sheet format makes it easy to see whether current assets are sufficient to pay current liabilities. In SonicGateway’s case, $21,300 of current assets is greater than the $10,200 of current liabilities, making it obvious that the company’s current assets are sufficient to cover its current liabilities. Part II The only problem with looking at total dollar amounts is the difficulty in comparing across companies. It’s far easier to express the relationship as a ratio, by dividing current assets by current liabilities. This calculation is known as the current ratio. It is used to evaluate liquidity, which is the ability to pay liabilities as they come due in the short run. Generally speaking, a high current ratio suggests good liquidity. Part III SonicGateway’s current ratio ($21,300 /$10,200 = 2.09) is in line with many other tech companies. Current ratios typically vary from 1.0 to 2.0. A higher current ratio generally means a better ability to pay.

Balance Sheet Concepts and Values
What is (is not) recorded? Includes items acquired through exchange. Excludes other items (such as creativity and vision). What amounts are assigned? Initially recorded at cost. Decreases in asset value are recorded but generally not increases. The purpose of a balance sheet is to report what a company owns and owes, but not necessarily what the company is worth. So why is it wrong to think that the balance sheet reports a company’s current value? The answer comes from knowing that accounting is based on recording and reporting transactions, which affects (1) what is (and is not) recorded, and (2) the amounts assigned to recorded items. The balance sheet includes items acquired through exchange but items not acquired through exchange, such as Scott’s creativity and vision, are not listed on the balance sheet. Following the cost principle, assets and liabilities are first recorded at cost, which is their cash-equivalent value on the date of the transaction. Later, if an asset’s value increases, the increase is generally not recorded under GAAP unless it is a particular type of financial investment. However, if an asset’s value falls, it is generally reported at that lower value. Thus, the amount reported on the balance sheet may not be the asset’s current value.

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 transaction, 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 supplies to J.K. Builders for future use. The lumber supplies would have normally sold for $10,000, but the supplier gave J.K. Builders a 10% discount. J.K. Builders has not received the $9,000 bill from the supplier. Cash (+A) ,000 Common Stock (+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 transaction, 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 supplies to J.K. Builders for future use. The lumber supplies would have normally sold for $10,000, but the supplier gave J.K. Builders a 10% discount. J.K. Builders has not received the $9,000 bill from the supplier. 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 Common Stock for $70,000. Part IV For part (b) or the problem, we begin with a debit, or increase, in the asset account Land 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 increase, in the liability account Accounts Payable 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. Land (+A) ,000 Cash (-A) ,000 c. Supplies (+A) ,000 Accounts Payable (+L) ,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 common stock to another shareholder for $11,000. Cash (+A) ,000 Notes Payable (long-term) (+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 common 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 (long-term) 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. Equipment (+A) 4,000 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. Inventory (+A) 7,000 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. Cash (+A) 4,000 Notes Payable (short-term) (+L) 4,000 d. Accounts Payable (-L) 1,500 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 (short-term) 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 (short-term) for $4,000. Part VII The entry is completed with a credit, or decrease, in the asset account Cash for $4,000. e. Notes Payable (short-term) (-L) 4,000 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. Equipment (+A) 12,000 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. Accounts Payable (-L) ,000 Cash (-A) ,000 c. Cash (+A) Accounts Receivable (-A)

1,000 common shares × $15 each = $15,000
M2-17 Identifying Transactions and Preparing Journal Entries To help raise funds for store upgrades estimated to cost $20,000, Sweet Shop Co. issued 1,000 common 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. Cash (+A) 15,000 Common Stock (+SE) 15,000 1,000 common 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 common 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 Common Stock for $15,000. As you can see, the $15,000 is determine by multiplying the number of common 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 decrease, or credit, the asset account Cash for $10,000, the amount of the cash paid to acquire the truck. Part VI The last part of the entry is to credit, or increase, the liability account Notes Payable (long-term) for $50,000, the amount of money borrowed. e. Equipment (+A) ,000 Cash (-A) ,000 Notes Payable (long-term) (+L) 50,000

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. Cash (+A) 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. Accounts Payable (-L) ,000 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. Notes Payable (short-term) (-L) 5,000 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 (short-term) 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 (short-term) for $1,200. e. Equipment (+A) 2,200 Cash (-A) 1,000 Notes Payable (short-term) (+L) 1,200

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 due later this year. c. Bought and received $800 of equipment on account. d. Purchased land for $12,000; paid $1,000 in cash and signed a long-term note for $11,000. e. Purchased $3,000 of equipment, paying $1,000 in cash and charged the rest on account. 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 due later this year. c. Bought and received $800 of equipment on account. d. Purchased land for $12,000; paid $1,000 in cash and signed a long-term note for $11,000. e. Purchased $3,000 of equipment, paying $1,000 in cash and charged the rest on account. 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 Common Stock 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 (short-term) for the same amount. Part III For transaction (c) 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 IV In transaction (d) we have an increase in the asset account Land for $12,000, a decrease in the asset account Cash for $1,000, and an increase in the liability account Notes Payable (long-term) for $11,000. Part V Finally, in transaction (e) we have an increase in the asset account Equipment for $3,000, a decrease in the asset account Cash for $1,000, and an increase in the liability account accounts payable for $2,000.

E2-6 Recording Journal Entries
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 due later this year. c. Bought and received $800 of equipment on account. d. Purchased land for $12,000; paid $1,000 in cash and signed a long-term note for $11,000. e. Purchased $3,000 of equipment, paying $1,000 in cash and charged the rest on account. Required: For each of the events, prepare journal entries, checking that debits equal credits. a. Cash (+A) 10,000 Common Stock (+SE) 10,000 b. Cash (+A) ,000 Notes Payable (short-term) (+L) 7,000 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 due later this year. 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 Common Stock 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 (short-term) for $7,000. Part VI For part c, we will begin with a debit, or increase, in the asset account Equipment for $800. Part VII Finally, we credit, or increase the liability account Accounts Payable for $800. c. Equipment (+A) Accounts Payable (+L)

E2-6 Recording Journal Entries
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. Bought and received $800 of equipment on account. d. Purchased land for $12,000; paid $1,000 in cash and signed a long-term note for $11,000. e. Purchased $3,000 of equipment, paying $1,000 in cash and charged the rest on account. Required: For each of the events, prepare journal entries, checking that debits equal credits. d. Land (+A) ,000 Cash (-A) ,000 Notes Payable (long-term) (+L) 11,000 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 begin with a debit, or increase, in the asset account Land for $12,000 Part III Next, we credit, or decrease, the asset account Cash for $1,000, and credit, or increase, the liability account Notes Payable (long-term) for $11,000, and the entry is in balance. 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 decrease, the asset account Cash for $1,000, and credit, or increase the liability account Accounts Payable for $2,000. Now the exercise is complete. e. Equipment (+A) ,000 Cash (-A) 1,000 Accounts Payable (+L) 2,000

End of Chapter 2 End of chapter 2.

Chapter 2 The Balance Sheet PowerPoint Author: Brandy Mackintosh, CA

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Chapter 2 The Balance Sheet PowerPoint Author: Brandy Mackintosh, CA

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