1. AN INTRODUCTION TO CONCEPTS,
Chapter 2 – Balance Sheet: Presenting the Investments and Financing of a Firm
FINANCIAL ACCOUNTING
AN INTRODUCTION TO CONCEPTS,
METHODS, AND USES
12th Edition
Clyde P. Stickney and Roman L. Weil

2. Learning Objectives
Understand the accounting concepts of assets, liabilities, and shareholders’ equity, including the conditions when firms recognize such items (recognition issues), their amounts (valuation issues), and where these items appear on the balance sheet (classification issues).

3. Learning Objectives
Understand the dual-entry recording framework and learn to use it to record a series of transactions, ending with the balance sheet.
Develop skills to analyze a balance sheet, focusing on the relations between assets, liabilities and shareholders’ equity that one would expect for financially healthy firms in different industries.

4. Chapter Outline Underlying concepts
Accounting procedures for preparing the balance sheet
Balance sheet account titles
Analysis of the balance sheet
An international perspective
Appendix 2.1: Using a spreadsheet to record business transactions
Chapter Summary

5. Discuss Accounting Concepts of Assets
1. Asset -- a resource that has a potential future economic benefit.
2. Asset Valuation -- the monetary amount assigned to an asset.
3. Asset Classification -- assets are grouped into like categories.

6. Asset Recognition Recognize a resource as an asset only if:
1. The firm has acquired rights to its use in the future as a result of a past transaction or exchange, and
2. The firm can measure or quantify the future benefits with a reasonable degree of precision.
All assets are future benefits but not all future benefits are recognized as assets.

7. Asset Valuation
Valuation -- the assignment of a monetary amount to an asset
Several methods of assignment:
1. Acquisition or historical cost
2. Current replacement cost
3. Net realizable value
4. Present value of future net cash flows

8. Terms Match Historical Cost
The amount of cash a firm would currently receive if it sold an asset
Current Replacement Cost
The discounted value of future cash flows generated by an asset
Current Net Realizable Value
The amount of cash paid in acquiring an asset
Present Value of Future Net Cash Flows
Assets might appear at the current cost of replacing it.

9. Review Asset Classification
Similar assets are grouped together in financial statements into classes.
Examples of common classes of assets:
Current assets
Investments
Property, plant and equipment
Intangible assets

10. Discuss Accounting Concepts of Liabilities
1. Liability -- arises when a firm receives benefits or services and in exchange promises to pay for these at a definite future time
2. Liability Valuation -- the monetary amount assigned to the liability
3. Liability Classification -- liabilities are grouped into like categories

11. Terms Match Going Concern
Ability of a measure to faithfully represent what it purports to measure
Accounting assumes a firm will remain in operation long enough to carry out all of its current plans.
Reliability
Intangibles
Tangible long-lived asset a firm uses in its operations
Items such as patents, franchises and goodwill
Plant or Fixed Assets

12. Review Liability Recognition
Recognize an obligation as a liability when:
1. The firm has received benefits, and
2. In exchange, promised to pay the provider, and
3. The payment will occur at a definite future time.
All liabilities are obligations but not all obligations are recognized as liabilities.

13. What is liability valuation?
Valuation -- assignment of a monetary amount to a liability.
Two main methods of assignment:
1. Liabilities due within a year or less are generally valued at amount of the cash payment.
2. Liabilities due after one year are generally valued at the net present value of the future cash payments.

14. Explain Liability Classification
Similar liabilities are grouped together in the financial statements into classes:
Examples of common classes of liabilities:
Current liabilities
Long-term debt
Other long-term liabilities

15. Shareholders’ Equity
Shareholders’ equity -- residual interest in the firm, all assets above those required to satisfy the liabilities.
Shareholders’ equity is equal to total assets less total liabilities.
The valuation of assets and liabilities determines the valuation of shareholders’ equity.

16. Review Classifications of Shareholders’ Equity
Shareholders’ equity is divided into:
1. Contributed Capital -- original investment by owners
2. Retained Earnings -- amount of earnings left in the firm after the payment of dividends to the owners

17. Discuss Contributed Capital
Contributed Capital is divided into:
1. A par or stated value of the shares which has a legal definition, and
2. The remaining amount called Additional Paid-In Capital (A.P.I.C.).
This distinction is made for legal reasons and may have no relationship to market value of the shares.

18. What are Retained Earnings?
Retained earnings -- net accumulation of earnings of the firm since its beginning
Increased by net income
Reduced by losses, and by the payment of dividends to the shareholders or owners

19. Retained Earnings For any accounting period:
Beginning Retained Earnings
+ net income (or less net losses)
- dividends declared during the period
= Ending Retained Earnings.

20. Dual-Entry Recording Framework
Every economic event has two sides, a give and a take.
Accountants record both sides economic events as a transaction.
The two sides of a transaction must balance so that the basic accounting equation remains in balance.

21. Dual Effect of a Transaction
Recall the basic accounting equation
Assets = Liabilities + Owners’ Equity
Any transaction will effect one or more on the three classes of accounts.
Remember that the transaction must balance, and
That the basic equation must balance.
Remember the basic rule of math, you can do whatever you want to an equation as long as you do it to both sides of the equal sign.

22. Individual Transactions and Events
Dual Effect of a Event
Accounting Systems for Accumulating Information about Transactions and Events
Individual Transactions and Events
Principal Financial Statements

23. Effect on the Equation There are four general combinations:
1. Increase an asset and a liability or owners’ equity by the same amount,
2. Decrease an asset and a liability or owners’ equity by the same amount,
3. Increase an asset and decrease another by the same amount, and
4. Increase a liability or owners’ equity and decrease another liability or owners’ equity by the same amount.

24. Complete Chart for Miller Corp.
Transaction Assets = Liability + Equity
1. Issue 10,000 shares for
$10,000 (par = $10).
2. Purchase equipment for
$60,000 cash.
3. Purchase inventory for
$15,000 on account.
4. Pay supplier $8,000 cash
of the $15,000 owned.
5. Issue 700 shares of stock
to supplier for balance due.
6. Pay for one year insurance
policy, $600 in cash.
7. Customer pays $3,000 for
merchandise to be delivered
in the future.

25. Complete Chart for Miller Corp.
Transaction Assets = Liability + Equity
1. Issue 10,000 shares for
$10,000 (par = $10).
2. Purchase equipment for
$60,000 cash.
3. Purchase inventory for
$15,000 on account.
4. Pay supplier $8,000 cash
of the $15,000 owned.
5. Issue 700 shares of stock
to supplier for balance due.
6. Pay for one year insurance
policy, $600 in cash.
7. Customer pays $3,000 for
merchandise to be delivered
in the future.
+$100, $100,000
+$60,000
-$60,000
+$15, $15,000
-$8, $8,000
-$7, $7,000
+$600
-$600
+$3, $3,000

26. Debits and Credits
Increases do not always equal other increases, nor do they always equal decreases.
Accountants use the definitions of debit and credit to describe the requirement to balance the two sides of a transaction and to keep the basic equation in balance.

27. Debits and Credits
Debits are defined as increases to asset accounts (the right side of the basic equation) or decreases to liabilities or owners’ equity (the left side).
Credits are defined as increases to to liabilities or owners’ equity (the left side of the basic equation) or decreases to asset accounts (the right side).
Debits = Credits for all transactions and for the basic equation at any time.

28. Journal Entries
Accountants recognize an economic transaction by recording a journal entry.
A journal entry shows both sides of the transaction with the name of the accounts and their respective debit or credit.
For example, transaction 1 from the Miller Corporation Example would be:
Jan 1 Cash ,000
Common Stock ,000

29. The Ledger The journal entry records both sides to a transaction, but
The Ledger summarizes changes to individual accounts which may be one side of several transactions.
Accountants often use a shorthand notation for the ledger called a T-Account.

30. T-Accounts
A T-Account summarizes debits and credits to a specific account, for example cash.

31. Summary of the Accounting Process
Periodic Posting
to the Appropriate
Accounts in the
General Ledger
Journalizing
in General
Journal
Results of
Events and
Transactions
Preparation of
Unadjusted
Trial Balance
Correction and
Adjustments of
the Unadjusted
Trial Balance
Preparation of
Financial
Statements

32. Analysis of the Balance Sheet
The balance sheet reflects the effects of a firm’s investing and financing decisions.
The asset side gives the resources that are available to the firm. Owners expect management to make efficient use of the assets that are entrusted to them.
The liabilities and shareholders’ equity side gives the sources of those assets. The ratio of liability to shareholders’ equity is called leverage and shareholders expect management to balance liabilities against new shareholders’ equity.

33. Name that Asset (Descriptions are mixed up you supply the name)
Inventory
Goods purchased for Resale
Amounts due from customers from the sale of goods or services. Collection occurs after the sale (charge accounts).
Rent paid in advance
Factories, Stores, Garages, Warehouses
Land used in operations or occupied by buildings used in operations
Computers, Ovens, Cranes, Trucks
Coins Cash, Checks
Accounts Receivable
Prepaid Rent
Equipment
Land
Buildings
Cash

34. Name that Liability (Descriptions are mixed up you supply the name)
Notes Payable
The face value of promissory notes given in connection with loans.
Obligations incurred when the firm receives payment in advance for goods or services it will furnish to customers.
Long-term notes that the borrower has protected by pledging specific pieces of property as security for payment.
Amounts owed for goods or services acquired under an informal credit agreement.
Amounts borrowed by a business for a relatively long period under a formal written contract called an indenture
Accounts Payable
Bonds Payable
Mortgage Payable
Advances from Customers

35. Name that Shareholder Equity (Descriptions are mixed up you supply the name)
Common Stock
A measure of the amount of cash or other assets received equal to par or stated value of voting stock.
Since the time business began operation, all assets – all liabilities.
A measure of the amount of cash or other assets received equal to par or stated value of stock that has some preference.
A measure of the of cash or other assets received in the issuance of common or preferred stock in excess of par or stated value.
The cost of shares of stock that a firm originally issued but subsequently reacquires
Retained Earnings
Preferred Stock
Additional Paid-in Capital
Treasury Shares

36. Rapid Review - True or False
The accounting equation is (assets = A, liabilities =L, shareholders’ equity = SE)
A + L = SE (b) A = L - SE
(c) A = L + SE (d) A + SE = L
A liability arises when a firm receives benefits or services and in exchange promises to pay for these at a definite future time.
TRUE
The ratio of liability to shareholders’ equity is called overage and shareholders expect management to balance liabilities against new shareholders’ equity.
FALSE The correct term is LEVERAGE.

37. Chapter Summary
The balance sheet and the basic accounting equation were introduced.
Assets, liabilities and shareholders’ equity were defined.
Recording transactions as a dual-entry format was presented. The initial recording is called journalizing and the summary of the journal into accounts is called posting.
The terms trial balance and ledger were defined.
Closing of the temporary accounts to retained earnings was presented.