1. Chapter 2 Establishing a Business and the Balance Sheet © 2009 The McGraw-Hill Companies, Inc.

2. Slide 2 The Nature of Business Transactions External Events Exchanges between the business and others involving the exchange of assets and services from one company for other assets or promises to pay from another company. Internal Events Certain events that are not exchanges between the business and others, but which have a direct and measurable effect on the entity.

3. Slide 3 Each company establishes a chart of accounts—a list of all the account titles and their numbers that are unique to each company.

4. Slide 4 Transaction Analysis Two simple ideas are used when analyzing transactions: Duality of Effects Every transaction affects at least two accounts. Balancing the Equation Assets = liabilities + owner’s equity must remain in balance.

5. Slide 5 Dual Effects Pay cash for supplies. Duality of Effects 1.Pizza Aroma receives Supplies. 2.Pizza Aroma gives Cash. Balancing the Equation Supplies (an asset) increases. Cash (an asset) decreases. Supplies (an asset) increases Cash (an asset) decreases

6. Slide 6 Balancing the Accounting Equation Pay cash for supplies. Duality of Effects 1.Pizza Aroma receives Supplies. 2.Pizza Aroma gives Cash. Balancing the Equation Supplies (an asset) increases. Cash (an asset) decreases.

7. Slide 7 Identify the accounts affected. Classify them by the type of account. Determine the direction of the effect. Step 1 Verify that the accounting equation remains in balance. Step2 Transaction Analysis Steps

8. Slide 8 Analysis of Pizza Aroma’s Transactions (a) Investment by Owner. The business receives $30,000 cash as an initial investment from owner-manager, Mauricio Rosa. Step 1: Identify and classify accounts and effects: Received: Cash (+A) $30,000. Given: Recognition of owner’s investment in the business. M. Rosa, Capital (+OE) $30,000. Step 2: Is the accounting equation in balance? Yes. The left side increased by $30,000 and the right side increased by $30,000.

9. Slide 9 Analysis of Pizza Aroma’s Transactions (b) Borrow from Bank. Pizza Aroma obtains a $20,000 loan from a local bank. Step 1: Identify and classify accounts and effects: Received: Cash (+A) $20,000. Given: A written promise by the business to pay the bank. Notes Payable (+L) $20,000. Step 2: Is the accounting equation in balance? Yes. The left side increased by $20,000 and the right side increased by $20,000.

10. Slide 10 Analysis of Pizza Aroma’s Transactions (c) Prepaid Rent. Pizza Aroma pays $4,800 in advance to the building owner to cover rent for the store for May through October (six months). Step 1: Identify and classify accounts and effects: Received: Prepaid Rent (+A) $4,800. Given: Cash (-A) $4,800. Step 2: Is the accounting equation in balance? Yes. The left side increased and decreased by the same amount ($4,800).

11. Slide 11 Analysis of Pizza Aroma’s Transactions (d) Purchase Equipment. A construction company renovates the store and installs equipment at a cost of $36,000; $33,000 in cash is paid and Pizza Aroma promises to pay the balance next month. Step 1: Identify and classify accounts and effects: Received: Equipment (+A) $36,000. Given: Cash (-A) $33,000, and a promise to pay, Accounts Payable (+L) $3,000. Step 2: Is the accounting equation in balance? Yes. The left side increased by $3,000 ($36,000 - $33,000) and the right side increased by $3,000.

12. Slide 12 Analysis of Pizza Aroma’s Transactions (e) Purchase Supplies. Pizza Aroma orders and receives $2,000 in supplies on account from local fresh food suppliers. Step 1: Identify and classify accounts and effects: Received: Supplies(+A) $2,000. Given: A promise to pay. Accounts Payable (+L) $2,000. Step 2: Is the accounting equation in balance? Yes. The left side increased by $2,000 and the right side increased by $2,000.

13. Slide 13 Analysis of Pizza Aroma’s Transactions (f) Pay Account Owed to Supplier. Pizza Aroma pays $1,000 cash on account to a supplier. Step 1: Identify and classify accounts and effects: Received: A reduction in the amount owed to the supplier. Accounts Payable (-L) $1,000. Given: Cash (-A) $1,000. Step 2: Is the accounting equation in balance? Yes. The left side decreased by $1,000 and the right side decreased by $1,000.

14. Slide 14 Analysis of Pizza Aroma’s Transactions (g) Acquire Investments. Pizza Aroma puts $6,000 in a savings account at a bank. Step 1: Identify and classify accounts and effects: Received: Investments(+A) $6,000. Given: Cash (-A) $6,000. Step 2: Is the accounting equation in balance? Yes. The left side increased and decreased by the same amount ($6,000).

15. Slide 15 Analysis of Pizza Aroma’s Transactions

16. Slide 16 The Accounting Cycle During the Period (Chapters 2 and 3) 1.Analyze transactions 2.Record journal entries in the general journal 3.Post amounts to the general ledger At the End of the Period (Chapter 4) 4.Adjust revenues and expenses and related balance sheet accounts 5.Prepare a complete set of financial statements and disseminate it to users 6.Close revenues, gains, expenses, and losses to owner’s equity Start of New Period

17. Slide 17 Analyzing Business Transactions Withdrawals by owners decrease owner’s equity. Investments by owners and net income of business increase owner’s equity.

18. Slide 18 Analyzing Business Transactions Debit = LeftCredit = Right Withdrawals by owners decrease owner’s equity. Investments by owners and net income of business increase owner’s equity.

19. Slide 19 Recording Transaction Effects

20. Slide 20 Recording Transaction Effects

21. Slide 21 Posting Transaction Effects After journal entries have been recorded, the bookkeeper posts (transfers) the dollar amounts to each ledger page that is affected by the transaction, so that the account balances can be computed. Ledger

22. Slide 22 Posting Transaction Effects The T-account is a simplified version of a ledger page. Ledger

23. Slide 23 Pizza Aroma’s Accounting Records Using T- Accounts Ledger Pages General Journal Journal Entries Identify and classify accounts Transactions (1) Analyze(2) Record(3) Post

24. Slide 24 Pizza Aroma’s Accounting Records (a) Investment by Owner. The business receives $30,000 cash as an initial investment from owner-manager, Mauricio Rosa.

25. Slide 25 Pizza Aroma’s Accounting Records (b) Borrow from Bank. Pizza Aroma obtains a $20,000 loan from a local bank.

26. Slide 26 Pizza Aroma’s Accounting Records

27. Slide 27

28. Slide 28 Preparing a Trial Balance

29. Slide 29 Locating and Correcting Errors Possible Errors 1.Totaling the debit and credit columns in the trial balance. 2.Copying the ending balances from the T-accounts to the trial balance. 3.Computing the ending balances in the T-accounts. 4.Incorrectly posting the dollar effects of a transaction from the journal entry to the T-accounts. 5.Preparing journal entries in which the debits do not equal the credits.

30. Slide 30 Classified Balance Sheet Current assets will be used or turned into cash within one year. Noncurrent assets are expected to last for several years. Current liabilities will need to be paid or settled within the coming year. Noncurrent liabilities are owed beyond one year.

31. Slide 31 Limitations of the Balance Sheet What is (and is not) recorded? What amounts are assigned to recorded items? Cost PrincipleConservatism

32. Slide 32 Summary of the Accounting Cycle During the Period (Chapters 2 and 3) 1.Analyze transactions 2.Record journal entries in the general journal 3.Post amounts to the general ledger At the End of the Period (Chapter 4) 4.Adjust revenues and expenses and related balance sheet accounts 5.Prepare a complete set of financial statements and disseminate it to users 6.Close revenues, gains, expenses, and losses to owner’s equity Start of New Period

33. Slide 33 Supplement 2-A: Accounting Concepts Revisited Qualitative Characteristics Relevancy Reliability Comparability Consistency Qualitative Characteristics Relevancy Reliability Comparability Consistency Elements of Statements Asset Liability Owner’s Equity Revenue Expense Elements of Statements Asset Liability Owner’s Equity Revenue Expense Objective of Financial Reporting To provide useful economic information to external users for decision making. Objective of Financial Reporting To provide useful economic information to external users for decision making. Primary Characteristics Relevancy: predictive value, feedback value, and timeliness. Reliability: verifiability, representational faithfulness, and neutrality. Secondary Characteristics Comparability: across companies. Consistency: over time.

34. Slide 34 Supplement 2-A: Accounting Concepts Revisited Assumptions Separate entity Unit-of-measure Continuity Time Period Assumptions Separate entity Unit-of-measure Continuity Time Period Principles Historical cost Revenue Recognition Matching Full Disclosure Principles Historical cost Revenue Recognition Matching Full Disclosure Constraint Conservatism

35. Slide 35 End of Chapter 2