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Chapter 2Investing and Financing Decisions and the Balance Sheet
Zining LiACCT 2301 FALL 2009
Cox School of Business, SMU
ACCT 2301Zining Li
Cox, SMUFall 2009
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What do we hope to learn
Characteristics of Financial Accounting Information
How does a company record business transactions (Transactional Analysis)
How does a company keep track of accounting records
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Accounting – Who Sets the Rules?
Securities and Exchange Commission (SEC) Legal authority to set accounting rules for publicly traded
companies Delegated responsibility to the accounting profession
Financial Accounting Standards Board (FASB) Currently the standards setting body GAAP
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Qualitative Characteristics of Financial Accounting Information Relevant
Specific / Timely Reliable
Representational faithfulness Verifiable
Comparable For same company Across different company
Consistent Same rules over time
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Elements Assets: economic resources that are measurable;
owned or controlled by the company that will bring future benefits
Liabilities: economic obligations Stockholders’ equity (contributed capital +
retained earnings) Revenues: inflow of assets or settlement of liabilities from
on-going business
Expenses: decreases (increases) in assets (liabilities) from on-going business
Gains (Losses): from peripheral activities
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Assumptions
Separate-entity assumption Unit-of-measure Continuity (going-concern) Time period
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Principles
Historical Cost (the Balance Sheet) Revenue Recognition (the Income
Statement) Matching(the Income Statement) Full disclosure
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Constraints
Cost benefit Materiality Conservatism Industry practice
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How does a Company Record Business Transactions? (1)
Definition of Transaction Economic events that impact a business entity
External v.s. Internal NOT all economic events are reflected in
financial statements!
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How does a Company Record Business Transactions? (2)
Let’s start with A= L + SE Duality of Effects
Each transaction affects at least two items (accounts)
The accounting equation always remains in balance after each transaction
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Determining the Financial Statement Effects of Following Transactions
• Received investment of $24,000 cash by organizers and distributed stock to them
• Purchased $8,000 of equipment, paying $1,000 in cash and signing a note for the rest
• Loaned $500 to an employee who signed a note• Borrowed $7,000 cash from a bank by signing a
note• Purchased $15,000 of land; paid $4,000 in cash
and signed a mortgage note for the balance
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Event Assets = Liabilities + Stockholders’ Equity
a. 1)Cash (F) +24,000 1)Contri. capital
+24,000
b. 2)Equipment
2)Cash (I)
+8,000
–1,000
2)Notes payable
+7,000
c. 3)Note receivable
3)Cash (I)
+500
–500
d. 4)Cash (F) +7,000 4)Notes payable
+7,000
e. 5)Land
5)Cash (I)
+15,000
–4,000
5)Mortgage note payable
+11,000
Assets = Liabilities + Stockholders’ Equity $49,000 $25,000 $24,000
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Debits, Credits and T-accounts?
T-account: We can use a “T” to represent an account Debit (Dr)
Means the left side of an account Numbers put on the left side of an account are debits
Credit (Cr) Means the right side of an account Numbers put on the right side of an account are credits
What do we mean when we say “to credit (debit) an account”?
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Debits, Credits, &Accounting Equation
Assets = Liabilities + Shareholders’ Equity
+Dr.
-Dr.
+Cr.
-Cr.
+Cr.
-Dr.
(Contr. Cap. + R/E)
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Record Journal Entries
Information recorded in a journal entry: Date of transaction Accounts affected Dollar amounts of debits and credits A brief explanation of the transaction (can be
skipped for our purposes) Remember:
Assets = Liabilities + Owner’s Equity Debits = Credits
In every journal entry there are equal dollar amounts of debits and credits.
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Received investment of $24,000 cash by organizers and distributed stock to them
Transaction Account Titles Debits Credits
#1 Dr. Cash 24,000
Cr. Contributed Capital 24,000
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Purchased $8,000 of equipment, paying $1,000 in cash and signing a note for the rest
Transaction Account Titles Debits Credits
#2 Dr. Equipment 8,000
Cr. Notes Payable Cr. Cash
7,0001,000
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Loaned $500 to an employee who signed a note
Transaction Account Titles Debits Credits
#3 Dr. Notes Receivable 500
Cr. Cash 500
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Borrowed $7,000 cash from a bank by signing a note
Transaction Account Titles Debits Credits
#4 Dr. Cash 7,000
Cr. Notes Payable 7,000
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Purchased $15,000 of land; paid $4,000 in cash and signed a mortgage note for the balance
Transaction Account Titles Debits Credits
#5 Dr. Land 15,000
Cr. Mortgage notes payable
Cr. Cash 11,000
4,000
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T-account
Cash Notes Receivable
0 0
24,000 500
1,000 500
500
7,000 4,000
25,500
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Land Equipment
0 0
15,000 8,000
15,000 8,000
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Notes PayableMortgage Notes
Payable
0 0
7,000 11,000
7,000 11,000
14,000
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Contributed Capital
0
24,000
24,000
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Record Transactions: Summary
To record a transaction, Identify items (accounts) that are affected Determine the direction of impact on each account
(increase or decrease) Verify that the accounting equation (A=L+SE) remains
in balance
Example To start, focus on investing and financing activities
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How is the Cash Flow Statement affected by Investing and Financing Activities?
Investing Cash Flows Outflows: cash paid for acquisition of long-term assets Inflows: cash proceeds from sale of long-term assets
Financing Cash Flows Inflows: cash received from issues of common stock
and long-term debts Outflows: cash paid directly related to issues of
common stock and long-term debts. E.g. retirement of long-term debts, repurchase of common stock, and cash dividend
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