Accounting Chapter 2: Investing & Financing Decisions and the Balance Sheet

account

An organized/standardized format companies use to accumulate the dollar effects of transactions on each financial statement item. Belong to one the the accounting elements (assets, liabilities, stockholders' equity, revenues, expenses, gains, and losses - those are the subcategories) in the conceptual framework (ex: inventory, notes payable, accounts receivable) the ones on financial statements are usually summations/aggregations of a number of specific accounts in their record keeping system

the accounting equation?

Assets (economic resources) = liabilities + stockholders equity (sources of financing) (must always balance)

What are the elements in the accounting conceptual framework?

Assets, Liabilities, Stockholders' Equity, Revenues, Expenses, Gains, Losses

the four financial statements

Balance Sheet (point in time) Income Statement (period of time) Statement of Stockholders' Equity (period of time) Statement of Cash Flows (period of time)

separate-entity assumption

Business transactions are accounted for separately from those of the owner (if the owner of a company purchases a boat for personal use, the boat is not an asset of the company)

How do we increase a liability account?

Credits increase liability accounts Debits decrease liability accounts

How do we increase a stockholders' equity account?

Credits increase stockholders' equity accounts Debits decrease stockholders' equity accounts

How do we increase an assets account?

Debits increase asset accounts Credits decrease asset accounts

external event

Exchanges of assets or services by one party for assets, services, or promises to pay (liabilities) by an external party

What makes information relevant?

If information can influence decision making - allows users to assess past activities and/or predict future activities, then it is relevant. Information is more relevant when it is more timely, consistent, comparable, and understandable. (and verifiable!). Has predictive and/or feedback value.

What makes information reliable?

Information that is complete and free from error (accurate, unbiased) is reliable. Information is more reliable if it can be verified by an independent party (e.g., auditor) (Accounting regulators consider the potential loss of competitive advantage as a cost of public financial disclosure as well as the direct cost of preparation when considering new disclosures. )

the difference between journal entries and t-accounts

Journal entries describe individual transactions and do not track account balances whereas T-accounts track account balances but do not provide a summary of the transaction (the journal entry describes the play that happened whereas the t-account is like a scoreboard: Vince Carter Clip)

debit means

Left side of the t-account

Liabilities

Probable debts or obligations (claims to a company's resources) (future sacrifices of economic benefits arising from present obligations) that result from a company's past transactions and will be paid with assets or services (listed in order of maturity - how soon an obligation is to be paid)

Who files financial statements with the SEC?

Publicly traded companies (either stock or bonds)

liabilities not recorded on the balance sheet

Rental (of facilities or equipment) and lease agreements may not be reported as liabilities and can be significant obligations. Rental and lease arrangements are reported in the notes to the financial statements. (Why its so important to look at financial statement notes)

When revenues are recognized on the income statement

Revenues are recognized in the period in which goods and services are provided, not necessarily in the period the cash is received ((if you order footballs, you would record revenue in the income statement for the month when they were delivered; the income statement would be unaffected by collecting cash flows (the statement of cash flows is what would be affected))

credit means

Right side of the t-account

the materiality exception

Small amounts that are not likely to influence a user's decision can be accounted for in the most cost-beneficial manner

stable monetary unit assumption

The accounting information should be measured and reported in the national monetary unit (US dollars in the USA) without any adjustment for changes in purchasing power

Additional Paid-in Capital

The amount of capital contributed by the shareholders less the par value of the stock

the cost-benefit exception

The benefits of accounting for financial reporting/providing information should outweigh the costs (Accounting regulators assess the potential loss of competitive advantage and the direct costs of preparation when they consider requiring new disclosure)

continuity (going-concern) assumption

The company is assumed to continue to operate into the foreseeable future (if the company is likely to go bankrupt within the next year, the continuity assumption is not met)

the industry practices exception

The company should use similar accounting practices as the majority of the firms in the industry

What we need to understand prior to doing the accounting for a company

The economic transactions

Stockholders' Equity

The financing provided by the owners (contributed capital - owners invest in the business by providing cash/other assets and receive shares of stock in exchange as evidence of ownership) and financing provided by operations (earned capital/retained earnings - when companies earn profits and they are reinvested in the business rather than distributed to owners as dividends). Aka the residual interest in assets of the entity after subtracting liabilities

four ways to raise capital to start a business

Those who generate the idea can contribute money Investors outside the company can purchase ownership of the company Borrow money from banks or other individuals Use the profits generated by the company's operations (only can be done once the company is up and running)

trial balance

a list of all accounts with their balances to provide a check on the equality of the debits and credits

What's included in a journal entry

accounting method for expressing the effects of a transaction on accounts in a debits-equals-credits format Date of the event Accounts involved Direction of the effect Dollar amount of the effect Brief description of the transaction (write debts first, indent credits and list them after) (DR=CR)

compound entry

any journal entry affecting more than two accounts

the account of prepaid expenses

assets ( it represents amounts paid by the company to others for future benefits like future insurance coverage, rental of property, advertising)

accounts with "receivable" in the title

assets (they represent amounts owed by (receivable from) customers and others to the business)

historical cost

cash paid plus the current dollar value of all noncash consideration given on the date of the exchange (ex: if you buy something for $1000 and the price of it changes, you continue to represent it in the financial statements as being worth $1000. this is because in a very liquid market, a different price might very well be just an opinion)

internal event

certain events that are not exchanges between the company and other parties but nevertheless have a direct and measurable effect on the company (E.g., using equipment/building over several years, using up insurance paid in advance)

accounts with "expense" in the title

expenses (source followed by the word expense - wages expense, rent expense, interest expense, depreciation expense, etc excluding cost of goods sold)

accounts with "payable" in the title

liabilities (they represent amounts owed by the company to be paid to others in the future)

accounts with "unearned" in the title

liabilities (they represent amounts paid in the past to the company by others who expect future goods or services from the company)

(historical) cost principle

most balance sheet elements are recorded at their cash-equivalent value on the date of the transaction

mixed-attribute measurement model

most balance sheet elements are recorded following the historical cost principle--financial statement elements should be recorded at cash equivalent cost on the date of the transaction; however, these values may be adjusted to other amounts such a market value depending on certain conditions.

Assets

probable future economic benefits owned or controlled by the entity as a result of past transactions or events (historical cost is applied when recording most assets -otherwise, fair-market value but that's less likely and will be discussed later) (listed in order of liquidity - how soon an asset is expected by management to be turned into cash or used)

faithful representation

requires that the information be complete, neutral, and free from error

accounts with "revenue" in the title

revenues (source followed by the word revenue - sales revenue, fee revenue, interest revenue, etc)

Common Stock

the account that is equal to the number of shares issued by the corporation times the par value per share

Par value

the legal amount per share established by the board of directors. It has no relation to the market price of the stock and represents the minimum amount a shareholder must contribute

accounting cycle

the process followed by entities to analyze and record transactions, adjust the records at the end of the period, prepare financial statements, and prepare the records for the next cycle

transaction analysis

the process of studying a transaction to describe its economic effect on the entity in terms of the accounting equation. has 2 principles: 1) every transaction affects at least two accounts (the dual effects concept- most transactions w/external parties includes exchange in which business entity both receives something and gives up something else so total dollar value of all debits equals total dollar value of all credits BUT singing a contract involving the exchange of two promises doesn't result in an accounting transaction that's recorded); correctly identifying those accounts and the direction of the effect is critical 2) the accounting equation must remain in balance after each transaction.

assets not recorded on the balance sheet

those assets that are generated by/developed inside the company (internally generated trademarks, patents, and copyrights) are typically not recorded on the Balance Sheet. (These same assets that are purchased from another company would be included on the balance sheet.)

primary objective or financial reporting to external users

to provide financial info about the reporting entity that is useful to existing and potential investors, lenders, other creditors in making decisions bout providing resources to the entity. those individuals are interested in info to help them assess the amount, timing, and uncertainty of a business's future cash inflows and outflows ((potential) creditors need to assess an entity's ability to pay interest on a loan over time and pay back the principal on the loan when its due, (potential)investors want to assess an entity's ability to pay dividends in the future and be successful so the stock price rises, enabling investors to sell stock for more than they paid f)

financing activity

Activities directly related to the debtors or equity shareholders of the company. so borrowing/repaying debt, including short-term bank loans, issuing/repurchasing stock, payind dividends) The one exception is interest paid to debtors. The FASB has specifically stated that this is an operating activity.

investing activity

Activities related to the acquisition or disposal of noncurrent assets and investments (not including inventory)

a general ledger

All journal entries are posted to the t-accounts in the general ledger. Records the balance for all accounts used by the company

transaction

An economic event that is recorded in the accounting process. Results from external and internal events. So: 1) an exchange of cash, goods, services for cash, goods, services, or promises to pay between a business and one+ external parties to a business OR 2) a measurable internal event like adjustments for the use of assets in operations

When expenses are recognized on the income statement

An expense is recognized in the period in which goods and services are provided and when revenue is earned, not necessarily in the period cash is paid (so with a year of insurance, 1/12 of the premium would be recognized each month as you receive the service. cash flow would be affected once - when you initially buy)

The process to record transactions

1) Understand and analyze the transaction (It is essential to understand the transaction before attempting subsequent steps in the transaction recording process. Most transactions with external parties involve an exchange where the business entity gives up something but receives something in return) 2) Determine the impact on the accounting equation (Every transaction affects at least two accounts (duality of effects). The accounting equation must remain balanced after each transaction. Ask yourself what are the accounts that are affected? (At least two accounts must always change. Must determine the classification (e.g., asset, liability or stockholders' equity) of the account) Do these accounts increase or decrease? What is the amount that they increase or decrease?) 3) Assess whether the accounts will be debited or credited 4) Record the transaction in the general journal 5) Post the transaction to the T-account in the general ledger (The process of transferring the debit and credit information from the journal to individual accounts in the ledger is called "posting")

general journal

A chronological record of all transactions affecting a company and its effects The individual transactions of the company are recorded with journal entries

a T-Account

A tool for summarizing transaction effects for each account, determining balances, and drawing inferences about a company's activities. (basically to track the balances - think of it as a score board) Every account has a T-account.

the three things one needs to determine immediately prior to creating a journal entry

Accounts Direction Amounts