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ACCT Chap 2 1

Chapter 2: Investing and Financing Decisions and the Balance Sheet

Understanding amounts on a company's balance sheet
1. What business activities cause changes in the balance sheet?
2. Ho do speci!ic activities a!!ect each balance?
". Ho do companies #eep trac# o! balance sheet amounts?
Primary objective of external financial reporting: to provide use!ul economic
in!ormation to e$ternal users !or decision ma#ing and assessing !uture cash !los
%mportant &e!initions
asset: economic resource ith probable !uture bene!its
liability: probable !uture sacri!ices o! economic resources
stockholders' equity: !inancing provided by oners and business operations
revenue: increase in assets or settlement o! liabilities !rom ongoing operations
expense: decrease in assets or settlement o! liabilities !rom ongoing operations
gain: increase in assets or settlement o! liabilities !rom peripheral operations
loss: decrease in assets or settlement o! liabilities !rom peripheral operations
'evie o! (lements o! the )alance *heet+ in more detail
assets: economic resource ith probable !uture bene!its oned or controlled by the
entity. ,easured by historic cost principle
liabilities: probable debts or obligations that result !rom a compay's past transactions
and ill be paid ith assets or services.
stockholders' equity: !inancing provided by oners and business operations.
oner provided cash is called contributed capital
Three )asic Assumptions
1. separate entity assumption- business transactions are accounted !or separately !rom oner
2. unit.o!.measure assumption- accountin in!o measured and reported in national monetary unit
". continuity assumption- businesses assumed to continue to operate into the !oreseeable !uture
historic cost principle: re/uires assets to be recorded at historical paid plus
current dollar value o! all noncash considerations given on date o! e$change
current assets: resources that a company ill use or turn into cash ithin a year. all
other assets are considered long.term
current liabilities: obligations that ill be settled ithin a year
retained earnings: earnings that are reinvested in the company and not distributed to
o generally+ stoc#holders hope to ma#e money either through dividends or capital
materiality: small amounts that are not lie#ly to in!luence user's decision are accounted
!or in most cost.bene!icial manner. usually this means this item is simply recorded as an
e$pense hen purchased
conservatism: care should be ta#en not to overstate assets and revenues or understate
liabilities and e$penses
0ature o! )usiness Transactions
ACCT Chap 2 2
,ost transactions ith e$ternal parties involve an e$change here the business entity
gives up something but receives something in return
signing a contract is not a transaction because it is an e$change o! promises and not o!
1rinciples o! Transaction Analysis
Transaction analysis: process o! studying a transaction to determine its economic
e!!ects on the entity in terms o! the accounting e/uation
Exchange: business both receives something and gives up something in return.
every transaction a!!ects at least to accounts
1. The accounting e/uation must remain in balance a!ter each transaction
2. Debits and credits do not describe negatives or positives+ rather debit is on the
le!t and credit is on the right. The total dollar amounts o! the to should e/ual a!ter a
The 2ournal (ntry
1. Account titles- debited accounts on top. Credited accounts on bottom+ usually indented
2. &ebited amounts on le!t+ credited accounts on the right.
3. Credits and debits should have same amount
The T account
1. *tart ith a beginning balance
2. &ra a line across the T 3assets on one side+ liabilities on other side o! T4
ACCT Chap 2 "
3. 1ut ending balance amount on the side o! the T account that it represents
Classi!ied )alance *heet
Current: those to be used or turned into cash ithin the upcoming year
oncurrent: those that ill last longer than one year