Ch. 2 The Balance Sheet (BOOK NOTES)
Ch. 2 The Balance Sheet (BOOK NOTES) Acct 2010
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This 6 page Class Notes was uploaded by Jordan Notetaker on Tuesday January 12, 2016. The Class Notes belongs to Acct 2010 at Clemson University taught by Holly Hawk in Fall 2016. Since its upload, it has received 74 views. For similar materials see Financial Accounting Concepts in Accounting at Clemson University.
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Date Created: 01/12/16
Chapter 2 - The Balance Sheet Prof Holly Hawk, Section 004 Learning Objectives: i. Identify ﬁnancial effects of common business activities that affect the balance sheet. ii. Apply transaction analysis to accounting transactions. iii. Use journal entries and T-accounts to show how transactions affect the balance sheet. iv. Prepare a trial balance and a classiﬁed balance sheet. v. Interpret the balance sheet using the current ration and an understanding of relate concepts. _____________ BUILDING A BALANCE SHEET FROM BUSINESS ACTIVITIES • Before selling goods and services, a business must be established which means acquiring assets. The assets are owned by the company; however, creditors have claim to those assets in equal amount of liabilities the company owes to them. The business owners themselves would also have claim to the assets of the company [stockholders’ equity], but their claim is less important than that of the creditors. A=L+SE • A new company’s ﬁrst goal should be to gather ﬁnancing which is either an equity or a debt. ⁃ equity: ﬁnancing through a business owners contributions and reinvestments. *no repayment obligation ⁃ debt: ﬁnancing through loans *repayment obligation Financing Activities • In the beginning, it is not uncommon for business owners to use their own personal funds as a form of initial investment on part of the business. This will be exchanged for common stock as proof of ownership. • Promissory note: legal documentation outlining the terms and conditions of an issued loan. • Post-ﬁnancing, the company will then start investing in assets to use after the business opens. ⁃ Cash is typically not used for things like equipment and supplies, instead businesses will buy those goods on credit with a 30-day repayment agreement ⁃ An invoice is given as “proof of loan”, similar to a receipt Investing Activities • A company will always document business activity i.e. promissory notes, e-stock certiﬁcates, invoices, and other documents that will indicate certain exchanges • A company always receives something but will give something in return. This is the “fundamental idea of business” to create value through exchange. ALL exchanges must be captured in the accounting system • The exchanges are then evaluated and assigned a cost based on the value of the items. TRANSACTIONS AND OTHER ACTIVITIES • Business activities that affect the basic accounting equation are transactions. These are the only activities to enter the ﬁnancial accounting system. Transactions can be classiﬁed through two types of events: ⁃ External exchanges: involves assets, liabilities, and/or stockholders’ equity between the company and an individual outside of the company. ⁃ Internal events: occur solely within the company (see Red Bull example pg. 48) • Not all important activities are transactions therefore will not be in the accounting system. For example, an exchange of promises and things of that nature will be documented to show that those exchanges happened BUT they will not be available in the accounting records THE ACCOUNTING CYCLE: ANALYZE, RECORD, SUMMARIZE 1) Analyze transactions: determining whether or not a transaction exists and if it is found, analyzing its impact on the accounting equation ⁃ Duality of effects: this idea means that at least two effects occur per one transaction to the basic accounting equation. Similar idea to Newton’s 3rd law ⁃ A = L + SE : just a reminder that the dollar amount for assets must equal total liabilities plus total SE ⁃ if the equation doesn’t add up, it was done incorrectly ⁃A chart of accounts is created to ensure that titles are used consistently throughout account documents and records. Usually includes title name and reference number. ⁃ The chart is tailored to each company’s business but some account titles are common across most 9if not all) companies like Cash or Accounts Payable/Receivable. ⁃ Working through examples will help with the understanding of analyzing transactions. ⁃ When analyzing transactions, it may be helpful to use reference numbers or letters to associate with important values in exercise problems or homework. ⁃ ***note that even if a single step does not directly affect the basic accounting equation IF the equation is in balance the analysis was properly done. ⁃ PAGES 50-55 WORK THROUGH PRACTICE PROBLEM 2) Record and 3) summarize: Accounts will not list out each effect step-by-step as in the previous analysis but rather compile the list of effects in a spreadsheet. ⁃ the spreadsheet makes it easier to see each individual occurrence in its entirety. ⁃ a spreadsheet may be impractical for large organizations; instead a digital system would be implemented. ⁃ a digital system still follows the accounting cycle in a daily, monthly, and yearly fashion. THE DEBIT/CREDIT FRAMEWORK • Even with the help of digital systems, a basic knowledge of ledger accounting and journals is useful. • For example, think of A=L+SE as a weight scale that tips at the equal sign (assets on the left, liabilities and SE on the right) ****SEE PAGE 56**** • Three major rules of the “Scale” system: ⁃ 1. Accounts increase on the same side as they appear in A= L + SE ⁃ assets increase on the left ⁃ liabilities and stockholders’ equity increase on the right ⁃ decreases are the opposite ⁃ 2. Left is “dr” or debit, and right is “cr” or credit ⁃ debits are used for increases in assets *and decreases in liabilities and stockholders’ equity accounts ⁃ credits are increases in liabilities and stockholders’ equity *and decreases in assets ⁃ 3. The normal balance is shown on the side that increases ⁃ assets typically have debit balances while liabilities and SE have credit balances • This framework was implemented to ensure the balance of the double-entry system i.e. debits=credits • D/C framework doesn’t negate the ﬁrst step of the accounting process which is to ANALYZE TRANSACTIONS • When recording journal entries, notice the following list of attributes ⁃ the date of the transaction ⁃ debits go on top, and credits go below debits (indented right). that format is repeated per account ⁃ total debits must equal total credits ⁃ no dollar signs because the journal is a recording of ﬁnancial efforts ⁃ reference column is used LATER when journal entry is used in ledger accounts ⁃ blank line after description and then next journal entry is started • In this course, we will use the simpliﬁed format in which the date is not given, omit reference column, omit transactions description, reference transactions rather than re-stating, account type (A, L, or SE) is displayed with direction (-/+) to reinforce debit to credit framework. • Next, SUMMARIZE LEDGER ACCOUNTS ⁃ ledger accounts are necessary because journal entries do not show account balances. ⁃ in these docs, the dollar amount is recorded from where the journal entry left off ⁃ simpliﬁed ledger accounts are called T-accounts ⁃ each account starts with a beginning balance and ends with an ending balance. ⁃ beginning balance is typically displayed on “increases” side ⁃ dollar signs are NOT necessary ⁃ each amount includes a reference to a related journal entry ⁃ ending balance is double underlined to symbolize ﬁnal results ⁃ ending balance is shown on the side with the highest total dollar amount ****FOR EXAMPLES SEE PAGES 60-64**** PREPARING A TRIAL BALANCE AND BALANCE SHEET •A trial balance is an internal accounting report that checks to see is records are in balance by evaluating debits=credits to be true. • The trial balance lists the ending balance in all T-account, then computes total debits and total credits • The balance sheet is then created by grouping all assets, liabilities, and SE in the balance sheet format. •A classiﬁed balance sheet which contains subcategories for assets and liabilities labels ‘current’. • Current assets are those that the business plans to use up or convert to cash within a year of the balance sheet date. • Current liabilities are ones that will be paid in full within a year from balance sheet date. • Note payable is a noncurrent liability because it is to be paid in two years • Assets are listed in order of liquidity (order of “quickest to be used or converted to cash”) while liabilities are listed in order of maturity (order of “fastest ti be paid off or fulﬁlled via service”) ASSESSING THE ABILITY TO PAY • looking at total dollar amounts makes it hard to compare across companies that’s why the CURRENT RATIO is used instead (current assets divided by current liabilities) to determine liquidity • high ratio=good liquidity; current rations are between 1.0 and 2.0 BALANCE SHEET CONCEPTS AND VALUES • The balance sheet reports what a company owes and owns but does NOT speak to the company’s worth • a balance sheet does NOT report the company’s current value • Accounting is based on recording/reporting transactions which affects a) what is/ isn’t recorded and b) the respective amounts ⁃ ONLY measurable exchanges are recorded (not intangible “wealth” or “poverty”) ⁃ Respective amounts? Follow the cost principle—assets and liabilities are initially recorded at their cash-equivalent value to date of transactions; LATER, increases are not typically recorded under gap BUT if the value drops, the lower value is stated. In conclusion, the amount on the balance sheet may not be the current value of the asset.
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