1.2 The Balance Sheet Equation

Big Balance Sheet Equation

Assets = Liabilities + Contributed Capital + Prior Retained Earnings + Net Income (which is Revenue - Expenses) - Dividends

Balance Sheet Equation (The Accounting Identity)

Assets = Liabilities + Stockholders' equity

Retained earnings

Created by operating the business =Prior Retained Earnings + Net Income - Dividends

Key Features of Balance Sheet Equation

-Must always balance! (double-entry bookkeeping) -Changes over a period between two Balance Sheets are summarized in the Income Statement, Statement of Stockholders' Equity, and Statement of Cash Flows

Sources of Stockholders' Equity

1. Contributed Capital 2. Retained Earnings

Criteria of recognition as an asset

1. It is acquired in a past transaction or exchange (of cash, goods, or services) 2. The value of its future benefits can be measured with a reasonable degree of precision

Criteria of recognition as a liability

1. The obligation is based on benefits or services received currently or in the past 2. The amount and timing of payment is reasonably certain

Retained earnings, end

= retained earnings, beg + net income - dividends

Stockholders' Equity

=Contributed Capital + Retained Earnings

Net Income

=Revenues - Expenses

Liability

a claim on assets by "creditors" (non-owners) that represents an obligation to make future payment of cash, goods, or services

Asset

a resource that is expected to provide future economic benefits (i.e. generate future cash inflows or reduce future cash outflows)

Retained Earnings (arises from operations)

accumulation of net income (revenue - expenses), less dividends, since start of business

Contributed Capital

common stock, additional paid-in capital (excess over par value), treasury stock (stock repurchased by company)

Dividends

distributions of retained earnings to shareholders (not an expense; recorded as a deduction to retained earnings on the declaration date - creates a liability until payment date)

Difference in Retained Earnings between two Balance Sheets

Explained by the Income Statement

Difference in Cash between two Balance Sheets

Explained by the Statement of Cash Flows

Contributed Capital

Money raised from shareholders

Another way to say the balance sheet equation

Resources = Claims on Resources by Outsiders + Owners

Stockholders' Equity

the residual claim on assets after settling claims of creditors (=assets - liabilities); -also called "net worth," "net assets," or "net book value"