Chapter 2

Owners' equity is separated into two parts:

- Capital Stock - Retained Earnings

Alternative forms of business organization from corporation =

- The sole of proprietorship - The partnership

Which statements describe revenues?

- They result in positive cash flows, either now or in the future. - They result from profit-directed activities. - They increase net assets. NOT result in an immediate increase in cash.

Three Primary Financial Statements

1 Statement of financial position 2 Income Statement 3 Statement of Cash Flows

Heading of a Statement of Financial Position communicates three things:

1 The name of the business 2 The name of the financial statement 3 The Date

Increases in Owner's Equity: The owner's equity in a business comes from two primary sources:

1. Investments of cash or other assets by owners 2. Earnings from profitable operation of the business.

Decreases in owners' equity also are caused in two ways:

1. Payments of cash or transfers of other assets to owners. 2. Losses from unprofitable operation of the business.

Summers Inc bought a piece of equipment for 100,000 by issuing a long-term note for $80,000 and paying cash of __________.

20,000

Operating Activities

A category in the cash flows that includes the cash effects of all revenues and expenses included in the income statement.

Accounts Receviable

A company found it had purchased more than needed -- sell to a different company.

Statement of Financial Position = Balance Sheet

A financial statement that describes where the enterprise stands at a specific date. It is sometimes described as a snapshot of the business in financial or dollar terms (that is, what the enterprise looks like at a specific date). DATE is important as the financial position of a business may change quickly

The Stable-Dollar Assumption

A limitation of measuring assets at historical cost is that the value of the monetary unit or dollar is not always stable.

A balance sheet consists of...

A listing of the assets, the liabilities, and the owners' equity of the business.

Corporation

A unique form of organization that allows many owners to combine their resources into a business enterprise that is larger than would be possible based on the financial resources of a single owner or small number of owners.

Note Payable

A written promise to repay the amount owed by a particular date and usually calls for the payment of interest as well. More formal than accounts payable

Totals increased equally by debt incurred in ________ ______.

Acquiring Assets

Statement of Cash Flows

An activity statement that explains the enterprise's change in cash in terms of operating, investing, and financing activities. Is particularly important in understanding an enterprise for purposes of investment and credit decisions. As its name implies, the statement of cash flows shows the ways cash changed during a designated period—the cash received from revenues and other transactions as well as the cash paid for certain expenses and other acquisitions during the period.

Business Entity

An economic unit that engages in identifiable business activities. For accounting purposes, the business entity is regarded as separate from the personal activities of its owners.

The Objectivity Principle

Another reason for using cost rather than current market values in accounting for many assets is the need for a definite, factual basis for valuation. Accountants use the term objective to describe asset valuations that are factual and can be verified by independent experts.

Regardless of whether a business grows or contracts, the equality between the assets and the claims on the assets is always maintained.

Any increase in the amount of total assets is necessarily accompanied by an equal increase on the other side of the equation—that is, by an increase in either the liabilities or the owners' equity. Any decrease in total assets is necessarily accompanied by a corresponding decrease in liabilities or owners' equity.

The body of a balance sheet has three distinct sections:

Assets, Liabilities, Owner's Equity

Why is it frequently called a balance sheet?

Because the amount of total assets is equal to the total amount of liabilities and owner's equity.

Notice that ______ is listed first among the assets, followed by notes receivable, accounts receivable, supplies, and any other assets that will soon be converted into cash or used up in business operations. Following are the more permanent assets: equipment, buildings, and land.

Cash

Investing Activities

Cash effects of purchasing and selling assets, such as land and buildings and equipment.

Financing Activities

Cash effects of the owners investing in the company and creditors loaning money to the company and the repayment of either or both.

Assets

Economic resources that are owned by a business and are expected to benefit future operations. May have definite physical characteristics such as buildings, machinery, or an inventory of merchandise. On the other hand, some assets exist not in physical or tangible form, but in the form of valuable legal claims or rights; examples are amounts due from customers, investments in government bonds, and patent rights held by the company. One of the most basic and at the same time most controversial problems in accounting is determining the correct dollar amount for the various assets of a business. At present, generally accepted accounting principles call for the valuation of some assets in a balance sheet at cost, rather than at their current value.

Exception to the cost principle?

Found in some of the most liquid assets (that is assets that are expected to soon become cash). Included in the balance sheet at their net realizable value - which is an amount that approximates the cash that is expected to be received when the receivable is collected.

Deflation

In which the value of the monetary unit increases, meaning that it will purchase more than it did previously.

Income Statement

Is a summarization of the company's revenue and expense transactions for a period of time. The income statement is particularly important for the company's owners, creditors, and other interested parties to understand. Ultimately the company will succeed or fail based on its ability to earn revenues in excess of its expenses. Once the company's assets are acquired and business commences, revenues and expenses are important dimensions of the company's operations.

Income Statement

Is an activity statement that shows the revenues and expenses for a designated period of time.

__________ are shown before owner's equity. Each major type of liability (such as notes payable, accounts payable, and salaries payable) is listed separately, followed by a figure for total liabilities.

Liabilities

Why do total assets equal the total of liabilities and owners' equity? Accounting Equation: Assets =

Liabilities + Owner's Equity

Expenses result in ____________. Either past present or future.

Negative Cash Flow

The amount that approiximates the cash that is expected to be received when the receivable is collected.

Net Realizable Value

A company provided $30,000 of consulting services during the month of December, half of which was paid in cash and half which is due on account. Which effects did this transaction have on the accounting equation.

Owners equity increased by $30,000 Retained Earnings increased by $30,000 Total assets increased by $30,000

Unlike balance sheets... what is the timing for Income Statements?

Period of Time NOT Point in Time

Revenues result in ______________. Either past present of future

Positive Cash Flows

As businesses operate, they engage in transactions that create _________ and incur expenses that are necessary to earn those ________.

Revenues

Financial Statement

Simple a declaration of what is believed to be true about an enterprise, communicated in terms of monetary unit, such as the dollar. Accountants prepare financial statements, they are describing in financial terms certain attributes of the enterprise that they believe fairly represent its financial activities.

Inflation

Term used to describe the situation where the value of the monetary unit decreases, meaning that it will purchase less than it did previously. When inflation becomes severe, historical cost amounts for assets lose their relevance as a basis for making business decisions.

Retained Earnings

The accumulated earnings of previous years that remain within the enterprise. Considered part of the equity of the owners and serves to enhance their investment in the business.

Capital Stock

The amount the owners originally paid into the company to become owners. It consists of individual shares and each owner has a sen number of shares.

The Going-Concern Assumption

The balance sheet of a business is prepared on the assumption that the business is a continuing enterprise, or a going concern. Consequently, the present estimated prices at which assets like land and buildings could be sold are of less importance than if these properties were intended for sale. These are frequently among the largest dollar amounts of a company's assets. Determining that an enterprise is a going concern may require judgment by the accountant.

Articulation

The close relationship that exists among the financial statements that are prepared on the basis of the same underlying transaction information.

Net Income or Net Loss

The difference between all of an enterprise's revenues and expenses for a designated period of time.

Owner's Equity

The excess of assets over liabilities. The amount of the owners investment in the business , plus profits from successful operations that have been retained in the business If you are the owner of a business, you are entitled to assets that are left after the claims of creditors have been satisfied in full. Therefore, owners' equity is always equal to total assets minus total liabilities. Owners' equity does not represent a specific claim to cash or any other particular asset. Rather, it is the owners' overall financial interest in the entire company.

Accounts Payable

The liabilities arising from purchases "on account" - Merchandise, supplies, and services. No written promises and do not call for interest payments.

Creditor

The person or organization to whom the debt is owed to.

When reading a balance sheet - keep in mind that the dollar amounts listed for many assets do not indicate what?

The prices at which the assets could be sold or the prices at which they could be replaced. A frequently misunderstood feature of a balance sheet is that it does not show how much the business currently is worth, although it contains valuable information in being able to calculate such a value.

Use the entire Cash column of the analysis to create a statement of cash flows.

The statement classifies the various cash flows into three categories—operating, investing, and financing—and relates these categories to the beginning and ending cash balances.

The combined total of the three categories of the statement explains...

The total change in cash from the beginning to the end of the period.

The Cost Principle

The widely used principle of accounting for assets at their original cost to the current owner. The prevailing accounting view is that such assets should be presented in the statement of financial position at their cost. When we say that an asset is shown at its historical cost, we mean the original amount the business entity paid to acquire the asset.

DeMenna, Inc, bought a piece of equipment for 200000 cash. What was the immediate effect of this transaction

There was no effect on total assets.

True or False: The operating, investing, and financing categories include both positive and negative cash flows.

True. The negative cash flows are in parentheses.

Liabilities

Usually listed in the order they need to be repaid. Debts or obligations of an entity that resulted from past transactions. They represent the claims of creditors on the enterprises values

An account payable is settled with cash. As a result of this transaction, cash flow decreases ________

immediately. This transaction reduced Overnight's cash and accounts payable by the same amount, leaving total assets and the total of liabilities plus owners' equity in balance.

An asset was purhcased on account. As a result of this transaction, cash flow will decrease

in the future.

An advantage of cost over fair value is that cost is more

objective

A limitation of recording assets at historical cost is that --

the monetary unit or dollar is not always stable.