Chapter 2 Reporting Investing and Financing Results on the Balance Sheet 1 © McGraw-Hill Ryerson. All rights reserved.

Building a Balance Sheet LO1 2 Assets Amounts presently owed by a business to creditors. The amount invested and reinvested in a company by its shareholders. Resources presently owned by a business that will generate future economic benefits. Shareholders’ Equity Liabilities = + © McGraw-Hill Ryerson. All rights reserved.

Financing Activities There are two sources of financing: 3 Issue Stock The business receives $50,000 cash The business gives stock certificates Equity Obtain Loan The business receives $20,000 cash The business gives a promissory note Debt LO1 A business must repay debt financing; but it is not obligated to repay equity financing. © McGraw-Hill Ryerson. All rights reserved.

Investing Activities 4 Purchase Equipment The business receives equipment The business gives cheques for $42,000 Purchase Cookware The business receives kitchen cookware The business gives a promise to pay $630 LO1 A business must invest in assets required to operate the business Assets can be purchased with cash or on account © McGraw-Hill Ryerson. All rights reserved.

Accounting for Business Activities LO1 5 Picture the documented activity. Picture what is described in words. This is vital to succeeding in the next step. Name what’s exchanged. Assign names to what your business has received and given. Analyze the financial effects. Show how the activity causes elements of the accounting equation to increase and/or decrease. © McGraw-Hill Ryerson. All rights reserved.

Transactions are events or activities that have a direct and measurable financial effect on the assets, liabilities, or shareholders’ equity of a business. – External exchanges involve assets, liabilities and shareholders’ equity between the company and someone else. – Internal events occur within the company; for example, using assets to create an inventory product. 6 LO1 © McGraw-Hill Ryerson. All rights reserved.

Apply Transaction Analysis Duality of effects means every transaction has at least two effects on the basic accounting equation. A = L + SE must hold true for every transaction. A Chart of Accounts is a summary of all account names (and corresponding account numbers) used to record financial results in the accounting system. 7 1 Analyze 2 Record 3 Summarize LO2 © McGraw-Hill Ryerson. All rights reserved.

Step 1: Analyze Transactions 8 (a) Issue Shares to Owners Pizza Palace receives $50,000 cash Pizza Palace gives $50,000 stock (contributed capital) LO2 © McGraw-Hill Ryerson. All rights reserved.

9 (b) Invest in Equipment Pizza Palace receives $42,000 equipment Pizza Palace gives $42,000 cash LO2 © McGraw-Hill Ryerson. All rights reserved.

10 (c) Obtain Loan from Bank Pizza Palace receives $20,000 cash Pizza Palace gives $20,000 note payable to the bank LO2 © McGraw-Hill Ryerson. All rights reserved.

11 (d) Invest in Equipment Pizza Palace receives $18,000 equipment Pizza Palace gives $16,000 cash and a promise to pay $2,000 on account LO2 © McGraw-Hill Ryerson. All rights reserved.

12 (e) Order Cookware Pizza Palace receives promise of future delivery Pizza Palace gives promise to pay for purchase An exchange of only promises is not a transaction. This does not affect the accounting equation. LO2 © McGraw-Hill Ryerson. All rights reserved.

13 (f) Pay Supplier Pizza Palace receives a release from its promise to pay $2,000 on account Pizza Palace gives $2,000 cash LO2 © McGraw-Hill Ryerson. All rights reserved.

14 (g) Receive Cookware Pizza Palace receives cookware costing $630 Pizza Palace gives a promise to pay $630 on account LO2 © McGraw-Hill Ryerson. All rights reserved.

Elements of the Accounting Process 15 LO2 The three step process of Analyze, Record and Summarize is repeated many times in the Accounting Cycle Daily transactions occur during the accounting period Adjustments and closing transactions occur at the end of the period © McGraw-Hill Ryerson. All rights reserved.

The Debit/Credit Framework The framework used for journals and ledger accounts was created more than 500 years ago. Journals are used to record the effects of each day’s transactions; organized by date. Ledgers are used to summarize the effects of journal entries on each account; organized by account. 16 LO3 © McGraw-Hill Ryerson. All rights reserved.

Think of the accounting equation as a scale with assets on the left side and liabilities and shareholders’ equity on the right side. 17 ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY LO3 © McGraw-Hill Ryerson. All rights reserved.

Accounts increase on the same side as they appear in the accounting equation. – Assets increase on the left side – Liabilities increase on the right side – Shareholders’ equity accounts increase on the right side 18 LO3 © McGraw-Hill Ryerson. All rights reserved.

19 Left is debit (dr) and right is credit (cr) Use debits for increase in assets, and decreases in liabilities and shareholders’ equity accounts. Use credits for increases in liabilities and shareholders’ equity, and decreases in asset accounts. LO3 © McGraw-Hill Ryerson. All rights reserved.

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Step 2: Record Journal entries are used to record transactions and indicate the effects in a debits-equal- credits format. – Each journal entry includes a date – Debits appear first and credits are written below – Total debits equal total credits – Dollar signs are not used 21 LO3 © McGraw-Hill Ryerson. All rights reserved.

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Step 3: Summarize Posting is the process of transferring details of journal entries into the corresponding ledger accounts. 23 LO3 © McGraw-Hill Ryerson. All rights reserved.

T-Accounts are a simplified version of a ledger account used for summarizing the effects of journal entries. Remember: – Debits are the left side of an account, or the act of entering an amount into the left side. – Credits are the right side of an account, or the act of entering an amount into the right side. The normal balance of an account is the side where increases occur. 24 LO3 © McGraw-Hill Ryerson. All rights reserved.

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Trial Balance A trial balance is an internal report that lists all accounts and their balances, and provides a check on debits = credits. 26 LO3 © McGraw-Hill Ryerson. All rights reserved.

Classified Balance Sheet A classified balance sheet shows subtotals for current assets and current liabilities. – Current assets are assets that will be used up or converted into cash within 12 months. – Current liabilities are debts and obligations that will be paid, settled, or fulfilled within 12 months. – Noncurrent (or long term) assets and liabilities are assets and liabilities that do not meet the definition of current. 27 LO4 © McGraw-Hill Ryerson. All rights reserved.

28 LO4 © McGraw-Hill Ryerson. All rights reserved.

Current Ratio The Current Ratio shows whether current assets are sufficient to pay current liabilities. A higher ratio means better ability to pay. Pizza Palace’s current ratio is unusually high. 29 LO5 Current Ratio = Current Assets Current Liabilities = $ 10,630 $ 630 =16.9 © McGraw-Hill Ryerson. All rights reserved.

Let’s try it E2-15 © McGraw-Hill Ryerson. All rights reserved.30