1. Financial Accounting Chapter 2
Financial Accounting Chapter 2. Investing and Financing Decisions and the Balance Sheet

2. Objectives Balance Sheet Accounting Equation
Double-Entry Accounting and Transaction
Major Assumptions of Accounting
Today, we will discuss definition of several accounts and how to measure each account in the balance sheet. To estimate amount of each account, you can use accounting equation.
Then we will talk about what is transaction and how a transaction affects financial statement. To record transaction in the financial statement, you should use concept of double-entry.

3. The Conceptual Framework
Objective of Financial Reporting
To provide useful economic information to external users for decision making and for assessing future cash flows.
Fundamental Characteristics
Relevance
Faithful Representation
Enhancing Characteristics
Comparability
Verifiability
Timeliness
Understandability
The primary objective of external financial reporting is to provide useful economic information about a business to help external parties. Therefore, they use financial statement.
To fulfill the objective of providing useful information, the conceptual framework provides guidance on what characteristics are essential. Information should be relevant to the decision and reliable

4. Balance Sheet
Balance sheet shows the company’s financial status at a particular time.
Especially, the B/S reports assets, liabilities, and owners’ equity (shareholders’ equity).
Assets = Liabilities + Owners’ Equity
Asset, liabilities, and shareholders’ equity are the elements of a corporation’s balance sheet. When you see balance sheet, you can find out a company’s financial condition. We will study each element more detail.

5. Assets
Assets are economic resources with probable future benefits owned or controlled by an entity as a result of past transaction.
The balance sheet of an entity records the monetary value of the assets owned by the entity
The assets include cash, accounts receivable, inventory, land, buildings, equipment, and intangible items.
Probable is a possibility. When they have assets, this asset should have a higher possibility to provide future benefits for a company. If assets just have a lower possibililty, then we cannot classify it as assets.
The second characteristic of asset is owned or controlled by a company. A company have a right to use, upgrade, disposal of the assets.
The third characteristic of asset is as a result of past transaction
For example,
Cash -- $100  $100 is asset
If you sell goods on credit and value of goods is $100. However, based on historical evidence, probability to recevice a/r in sold goods is very low. Usually, company know that $98 is reasonable. Then a/r is $98
a/r -- $100, $98(historical evidence) $98 is asset.
To be reported, assets must have a measurable, verifiable value, usually based on the purchased amount. If you buy this car as exchange for your computer plus cash, the cost of the car is equal to the cash paid plus the market value of the computer.
These accounts are typical accounts for manufacturing company.

6. Liabilities
Liabilities are economic obligations to pay cash or other assets, or provide services to someone else.
Liabilities are probable debt or obligations that result from an entity’s past transactions and will be paid for with assets or services
The liabilities include accounts payable, notes payable, and interest payable.

7. Types of Assets and Liabilities
Current assets
cash and other assets that are expected to be converted to cash within a year.
Current assets generally are listed in order of liquidity.
Long-term assets (or non-current assets)
Assets that a company needs in order to operate its business over an extended period of time.
The examples are land, buildings, and equipments.
Liabilities are also classified as either current liabilities or long-term (or non-current) liabilities.
Tangible or intangible assets.
Note that inventory is always considered a current asset, regardless of how long it takes to produce and sell the inventory.
Long term assets are to be used or turned into cash beyond the coming year.

8. Owners’ equity
The owner’s equity is the residual claim against the assets of a business, after deducting liabilities (= residual amount, net assets).
The owner of a business can be one person (sole proprietorship), a small group (a partnership), or a diffuse group of owners (a corporation).

9. Owners’ equity (Cont.)
The portion of a corporation’s owners’ equity contributed by owners in exchange for shares of stock is contributed capital (=paid-in capital).
Par value is the face value (nominal value) of stocks. Usually, the sales price (total Paid-in capital = contributed capital) of stocks is higher than par value.
The difference is called as Additional Paid-in Capital (APIC), Paid-in Capital in excess of par, or Contributed capital in excess of par.
The portion of the profit which is not distributed to shareholders as dividends is called as retained earnings (=retained income).

10. Transaction
Transaction is an event that should be recorded in the accounting book.
Only the event that influences the economic value of the company is the transaction.
In summary, the event that does not change assets, liabilities, or SHE is not a transaction.
Transaction analysis is the process of studying a transaction to determine its economic effect on the entity in terms of the accounting equation. The two principles underlying the transaction analysis process follow.
Every transaction affects at least two accounts. Correctly identifying these accounts and the direction of the effect is critical.
The accounting equation must remain in balance after each transaction.
When a company borrows cash from a bank, its financial position is affected because assets increase and liabilities increase. So a company records that event. However, a company hires **as a front-door greeter. The action does not change the company’s assets, liabilities or stockholder’s equity. The company hopes that hiring ** will favorably affect its financial position in the future. But hiring itself does not.
What business activities cause changes in financial statement amounts?
Accounting focuses on certain events that have an economic impact on the entity. We call those events as transactions.

11. Double-Entry Accounting
Double-entry accounting is a system of recording transactions in a way that maintains the equality of the accounting equation.
Every transaction has at least two effects (=duality of effects) on the accounting equation.
Step 1: Identify and classify accounts and effects
Step 2: Verify account equation is in balance.
What business activities cause changes in financial statement amounts?
Accounting focuses on certain events that have an economic impact on the entity. We call those events as transactions. The first step in translating the results of business events to financial statement numbers is determining which events to include. When you identify this transaction affects balance in financial statements, then analyze the impact of the transaction on the accounting equation.
Record the transaction and post the transaction to the t-account in the general ledger. then, prepare a trial balance.
How to record the transaction? The basic idea is double-entry accounting. Each transaction will have a dual effect.
Every transaction affects at least two accounts: correctly identifying those accounts and the direction of the effect is critical.
Transaction –
1) purchased paper for cash
Company received – paper increased
Company pay- cash decreased
2) Purchased paper on credit
Company pay- account payable(promise to pay) increased
3) Issue common stock – to begin operation, company needs cash. To generate cash from external sources. Company sells shares of common stock for 25,000  asset increased (cash) SE increased (common stock)
Do assets equal liabilities plus stockholder’s equity?