Chapter 2

Current Liabilities

Debts and obligations that will be paid, settled, or fulfilled within 12 months of the balance sheet date.

Duality of Effects

Every transaction has at least two effects on the basic accounting equation (give & receive, push & pull).

Journal Entries

Indicate the effects of each day's transactions in a debits-equal-credits format. A date is included for each transaction. Debits appear first (on top) and credits are written below the debits and are indented to the right (words & amount). The order of the debited accounts or credited accounts doesn't matter. Dollar signs are not used because the journal is understood to be a record of financial effects.

Transaction Analysis

Involves determining whether a transaction exists, and if it does, analyzing its impact on the accounting equation.

Current Ratio

Makes it easier to compare across companies. By dividing current assets by current liabilities, this calculation is used to evaluate liquidity, which is the ability to pay liabilities as they come due in the short run. A high current ratio suggests good liquidity. Current ratios typically vary from 1.0 to 2.0.

The Accounting Cycle

Most companies record and summarize the financial effects of transactions with computerized accounting systems, which is repeated day after day, month after month, and year after year.

Balance Sheet

The balance sheet is prepared by taking the ending balances for each account and grouping them as assets, liabilities, and stockholders' equity. Its purpose is to report what a company owns and owes, but not necessarily what the company is worth.

Trial Balance

The equality of debits and credits can be checked by preparing this internal accounting report.

External Exchanges

These are exchanges involving assets, liabilities, and/or stockholders' equity that you can see between the company and someone else.

Internal Events

These events do not involve exchanges with others outside the business, but rather occur within the company itself.

Current Assets

To be used up or converted into cash within 12 months of the balance sheet date.

Chart of Accounts

To ensure account titles are used consistently, every company creates a list that designates a name and reference number that the company will use when accounting for each item it exchanges.

Financing

Two sources of financing are available to businesses: equity and debt. A business is obligated to repay debt financing, but it is not obligated to repay its equity.

Journals

Used to record the effects of each day's transactions; organized by date.

Ledger

Used to summarize the effects of journal entries on each account; organized by account.

Transactions

(A = L + SE) An event or activity that has a direct and measurable financial effect on the assets, liabilities, or stockholder's equity of a business. Transactions only include two types of events: external exchanges and internal events. An exchange of only promises is not an accounting transaction.

Credit

(cr.) Accounts on the right side of the equation increase on the right. Liabilities and stockholders' equity increase on the right side of the account, and assets decrease.

Debit

(dr.) Accounts on the left side of the accounting equation increase on the left side of the account. Assets increase on the left side of the account, and liabilities and stockholders' equity decrease.

Noncurrent

(long-term) Assets and liabilities that do not meet the definition of current.

Classified Balance Sheet

A balance sheet that shows a subtotal for urgent assets and current liabilities. It contains subcategories for assets and liabilities labeled "current." This format makes it easy to see whether current assets are sufficient to pay current liabilities.

T-account

A simplified version of a ledger account used for summarizing the effects of journal entries. Each one represents the debit and credit columns of a ledger account. Every account starts with a beginning balance, usually on the side where increases are summarized. Dollar signs are not needed. Each amount is accompanied by a reference to the related journal entry. After this process, make sure debits = credits to start the balance sheet.