Investing and Financing Decisions and the Balance Sheet Irwin/McGraw-Hill

Transcription

1 Chapter 2 Investing and Financing Decisions and the Balance Sheet

2 Business Background To understand amounts appearing on a company s balance sheet we need to answer these questions: What business activities cause changes in the balance sheet? How do specific activities affect each balance? How do companies keep track of balance sheet amounts?

3 The Conceptual Framework Objective of of External Financial Reporting To To provide useful useful economic information to to external users users for for decision making and and for for assessing future future cash cash flows. flows. Qualitative Characteristics Relevancy Reliability Comparable Consistent Elements of of Statements Asset Liability Stockholders Equity Revenue Expense Gain Loss

4 The Conceptual Framework Qualitative Characteristics Relevancy Reliability Comparable Consistent Objective of of External Financial Reporting To To provide useful useful economic information to to external users users for for decision making and and for for assessing future future cash cash flows. flows. Primary Characteristics Elements of of Statements Relevancy: predictive value, feedback value, Asset and timeliness. Reliability: verifiability, Liability representational faithfulness, and Stockholders Equity neutrality. Revenue Secondary Expense Characteristics Comparability: across Gain companies. Consistency: over time. Loss

5 The Conceptual Framework Asset: economic resource with probable future benefit. Liability: probable future sacrifices of economic resources. Stockholders Equity: financing provided by owners and operations. Revenue: Qualitative increase Characteristics in assets or settlement of liabilities from ongoing operations. Relevancy Expense: decrease Reliability in assets or increase in liabilities from ongoing operations. Comparable Gain: increase Consistent in assets or settlement of liabilities from peripheral transactions. Loss: decrease in assets or increase in liabilities from peripheral transactions. Objective of of External Financial Reporting To To provide useful useful economic information to to external users users for for decision making and and for for assessing future future cash cash flows. flows. Elements of of Statements Asset Liability Stockholders Equity Revenue Expense Gain Loss

6 The Conceptual Framework Assumptions Separate entity: Transactions of of the business are separate from transactions of of owners. Continuity: The entity will not go go out of of business in in the near future. Unit-of-measure: Accounting measures are in in the national monetary unit ($). Time period: The long life of of a company can be be reported over a series of of shorter time periods.

7 The Conceptual Framework Principles Historical cost: Cash equivalent cost given up up is is the basis for for initial recording of of elements. Revenue recognition: Record revenues when earned and measurable (exchange complete, earnings complete and collection probable). Matching: Record expenses when incurred in in earning revenue. Full disclosure: Disclose relevant economic information.

8 The Conceptual Framework Constraints Cost-benefit: Benefits of of recording and reporting information should outweigh costs. Materiality: Relatively small amounts not likely to to influence decisions are to to be be recorded in in most cost/beneficial way. Industry peculiarities: Differences in in accounting and reporting for for certain items are permitted if if there is is a clear precedent in in the industry. Conservatism: Exercise care not to to overstate assets and revenues or or understate liabilities and expenses.

9 Nature of Business Transactions External events: exchanges of assets and liabilities between the business and one or more other parties. Borrow money from the bank

10 Nature of Business Transactions Internal events: not an exchange between the business and other parties, but have a direct effect on the accounting entity. Loss due to fire damage.

11 Accounts An organized format used by companies to accumulate the dollar effects of transactions. Equipment Cash Inventory Notes Payable

12 Transaction Analysis ➊Every transaction affects at least two accounts (duality of effects). ➋The accounting equation must remain in balance after each transaction. A = L + SE

13 Duality of Effects Most transactions with external parties involve an exchange where the business entity both gives up something and receives something in return.

14 Balancing the Accounting Equation!Accounts and effects "Identify the accounts affected. "Classify each as an asset, liability or equity account. "Determine the direction of the effect (increase or decrease) on each account. #Determine that the accounting equation remains in balance.

15 Balancing the Accounting Equation Let s see how we keep the accounting equation in balance for Papa John s. All amounts are in thousands of dollars.

16 Papa John s issues $1,300 of additional common stock to new investors for cash. Identify & Classify the Accounts Cash (asset) Contributed Capital (equity) Determine the Direction of of the Effect Cash increases Contributed Capital increases.

17 Papa John s issues $1,300 of additional common stock to new investors for cash. Assets = Liabilities + Stockholders' Equity Cash Investments Equip. Notes Rec. Notes Pay. Contributed Capital (a) 1,300 1,300 Effect 1,300 = 1,300 A = L + SE

18 The company borrows $1,000 from the local bank, signing a one-year note. Identify & Classify the Accounts Cash (asset) Notes Payable (liability) Determine the Direction of of the Effect Cash increases Notes Payable increases.

19 The company borrows $1,000 from the local bank, signing a one-year note. Assets = Liabilities + Stockholders' Equity Cash Investments Equip. Notes Rec. Notes Pay. Contributed Capital (a) 1,300 1,300 (b) 1,000 1,000 Effect 2,300 = 2,300 A = L + SE

20 Papa John s purchases $5,700 of new equipment, paying $1,500 in cash and the rest on a note payable. Identify & Classify the Accounts Equipment (asset) Cash (asset) Notes Payable (liability) Determine the Direction of of the Effect Equipment increases Cash decreases Notes Payable increases.

21 Papa John s purchases $5,700 of new equipment, paying $1,500 in cash and the rest on a note payable. Assets = Liabilities + Stockholders' Equity Cash Investments Equip. Notes Rec. Notes Pay. Contributed Capital (a) 1,300 1,300 (b) 1,000 1,000 (c) (1,500) 5,700 4,200 Effect 6,500 = 6,500 A = L + SE

22 Papa John s lends $450 to new franchises who sign notes. Identify & Classify the Accounts Cash (asset) Notes Receivable (asset) Determine the Direction of of the Effect Cash decreases Notes Receivable increases.

23 Papa John s lends $450 to new franchises who sign notes. Assets = Liabilities + Stockholders' Equity Cash Investments Equip. Notes Rec. Notes Pay. Contributed Capital (a) 1,300 1,300 (b) 1,000 1,000 (c) (1,500) 5,700 4,200 (d) (450) 450 Effect 6,500 = 6,500 A = L + SE

24 Papa John s purchases $3,000 of stock in other companies as an investment. Identify & Classify the Accounts Cash (asset) Investments (asset) Determine the Direction of of the Effect Cash decreases Investments increase.

25 Papa John s purchases $3,000 of stock in other companies as an investment. Assets = Liabilities + Stockholders' Equity Cash Investments Equip. Notes Rec. Notes Pay. Contributed Capital (a) 1,300 1,300 (b) 1,000 1,000 (c) (1,500) 5,700 4,200 (d) (450) 450 (e) (3,000) 3,000 Effect 6,500 = 6,500 A = L + SE

26 How Do Companies Keep Track of Account Balances? Journal entries T-accounts

27 Direction of Transaction Effects A T-account T is a tool used to represent an account. Account Name Left Right

28 Direction of Transaction Effects The left side of the T-account is always the debit side. The right side of the T-account is always the credit side. Account Name Left Right Debit Credit

29 The Debit-Credit Framework Debits and credits affect the Balance Sheet Model as follows: A = L + SE Debit for Increase ASSETS Credit for Decrease LIABILITIES Debit for Decrease Credit for Increase EQUITIES Debit for Decrease Credit for Increase

30 Analytical Tool: The Journal Entry A typical journal looks like this: GENERAL JOURNAL Page 1 Date Description Debit Credit

31 Analytical Tool: The Journal Entry A journal entry might look like this: GENERAL JOURNAL Page 1 Date Description Debit Credit Jan. 1 Cash 20,000 Contributed Capital 20,000

32 Analytical Tool: The Journal Entry Provide a reference date for each transaction. Debits are written first. GENERAL JOURNAL Page 1 Date Description Debit Credit Jan. 1 Cash 20,000 Contributed Capital 20,000 Credits are indented and written after debits. Total debits must equal total credits.

33 Analytical Tool: The T-Account After journal entries are prepared, the accountant posts (transfers) the dollar amounts to each account that was affected by the transaction. GENERAL JOURNAL Page 1 Date Description Debit Credit Jan. 1 Cash 20,000 Contributed Capital 20,000 Post Ledger

34 Transaction Analysis Illustrated Let s prepare some journal entries for Papa John s and post them to the ledger.

35 Papa John s issues $1,300 of additional common stock to new investors for cash. GENERAL JOURNAL Page 1 Date Description Debit Credit Cash 1,300 Contributed Capital 1,300 Cash Beg. Bal. 34,000 (a) 1,300 Contributed Capital 164,500 Beg. Bal. 1,300 (a) 35, ,800

36 The company borrows $1,000 from the local bank, signing a one-year note. GENERAL JOURNAL Page 1 Date Description Debit Credit Cash 1,000 Notes Payable 1,000 Cash Beg. Bal. 34,000 (a) 1,300 (b) 1,000 Notes Payable - Beg. Bal. 1,000 (b) 36,300 1,000

37 Papa John s purchases $5,700 of new equipment, paying $1,500 in cash and the rest on a note payable. GENERAL JOURNAL Page 1 Date Description Debit Credit Equipment 5,700 Cash 1,500 Notes Payable 4,200 Let s see how to post this entry...

38 Papa John s purchases $5,700 of new equipment, paying $1,500 in cash and the rest on a note payable. Equipment Beg. Bal. 169,200 (c) 5, ,900 Cash Beg. Bal. 34,000 (a) 1,300 1,500 (c) (b) 1,000 Notes Payable - Beg. Bal. 1,000 (b) 4,200 (c) 34,800 5,200

39 Balance Sheet Preparation It is possible to prepare a balance sheet at any point in time from the balances in the accounts.

40 These balances come from Papa John s ledger accounts on January 31, PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Balance Sheets January 31, 1999 (Dollars in thousands) Assets Current assets: Cash and cash equivalents $ 31,250 Accounts receivable 17,300 Inventories 9,700 Prepaid expenses 4,800 Other current assets 2,100 Total current assets 65,150 Investments 50,300 Net property and equipment 174,900 Notes receivable 12,450 Other assets 22,400 Total assets $ 325,200 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 18,100 Accrued expenses payable 25,500 Total current liabilities $ 43,600 Unearned franchise and development fees 6,600 Other long-term liabilities 11,200 Stockholders' equity: Contributed capital 165,800 Retained earnings 98,000 Total stockholders' equity 263,800 Total liabilities and stockholders' The McGraw-Hill equity Companies, $ Inc., 325,

41 Some Misconceptions Don t confuse bookkeeping with accounting. Bookkeeping involves the routine, clerical part of accounting and requires only minimal knowledge of accounting, but... An accountant is a trained professional who can design information systems, analyze complex transactions, and interpret financial data.

42 Some Misconceptions Are all transactions subject to precise and objective measurement? Almost all accounting numbers are influenced by estimates. NO!

43 Some Misconceptions Some people believe that financial statements report the market value of the company. Financial statements really report the cost of of assets, liabilities and stockholders equity.

44 End of Chapter 2