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"