ACCT Chap 2 1

Chapter 2: Investing and Financing Decisions and the Balance Sheet

Understanding amounts on a company's balance sheet
1. What business activities cause changes in the balance sheet?
2. Ho do speci!c activities a"ect each balance?
#. Ho do companies $eep trac$ o% balance sheet amounts?
Primary objective of external fnancial reporting: to provide use%ul
economic in%ormation to e&ternal users %or decision ma$ing and assessing
%uture cash 'os
(mportant )e!nitions
asset: economic resource ith probable %uture bene!ts
liability: probable %uture sacri!ces o% economic resources
stockholders' equity: !nancing provided by oners and business
operations
revenue: increase in assets or settlement o% liabilities %rom ongoing
operations
expense: decrease in assets or settlement o% liabilities %rom ongoing
operations
gain: increase in assets or settlement o% liabilities %rom peripheral operations
loss: decrease in assets or settlement o% liabilities %rom peripheral operations
*evie o% +lements o% the ,alance -heet. in more detail
assets: economic resource ith probable %uture bene!ts oned or controlled
by the entity. /easured by historic cost principle
liabilities: probable debts or obligations that result %rom a compay's past
transactions and ill be paid ith assets or services.
stockholders' equity: !nancing provided by oners and business
operations.
oner provided cash is called contributed capital
Three ,asic Assumptions
1. separate entity assumption0 business transactions are accounted %or separately
%rom oner transactions
2. unit1o%1measure assumption0 accountin in%o measured and reported in national
monetary unit
#. continuity assumption0 businesses assumed to continue to operate into the
%oreseeable %uture
historic cost principle: re2uires assets to be recorded at historical cost1
cash paid plus current dollar value o% all noncash considerations given on
date o% e&change
current assets: resources that a company ill use or turn into cash ithin a
year. all other assets are considered long1term
current liabilities: obligations that ill be settled ithin a year
retained earnings: earnings that are reinvested in the company and not
distributed to stoc$holders
o generally. stoc$holders hope to ma$e money either through dividends
or capital gains
ACCT Chap 2 2
materiality: small amounts that are not lie$ly to in'uence user's decision
are accounted %or in most cost1bene!cial manner. usually this means this
item is simply recorded as an e&pense hen purchased
conservatism: care should be ta$en not to overstate assets and revenues or
understate liabilities and e&penses
3ature o% ,usiness Transactions
/ost transactions ith e&ternal parties involve an e&change here the
business entity gives up something but receives something in return
signing a contract is not a transaction because it is an e&change o% promises
and not o% assets
4rinciples o% Transaction Analysis
Transaction analysis: process o% studying a transaction to determine its
economic e"ects on the entity in terms o% the accounting e2uation
Exchange: business both receives something and gives up something in
return.
every transaction a"ects at least to accounts
1. The accounting e2uation must remain in balance a%ter each transaction
2. Debits and credits do not describe negatives or positives. rather
debit is on the le%t and credit is on the right. The total dollar amounts o%
the to should e2ual a%ter a transaction
ACCT Chap 2 #
The 5ournal +ntry
1. Account titles0 debited accounts on top. Credited accounts on bottom. usually
indented
2. )ebited amounts on le%t. credited accounts on the right.
3. Credits and debits should have same amount
The T account
1. -tart ith a beginning balance
2. )ra a line across the T 6assets on one side. liabilities on other side o% T7
3. 4ut ending balance amount on the side o% the T account that it represents
Classi!ed ,alance -heet
urrent: those to be used or turned into cash ithin the upcoming year
!oncurrent: those that ill last longer than one year