Chapter 2

From Scorekeeping to Financial Statements

Learning Objectives for Chapter 2

See syllabus

Financial Accounting Statements

Balance Sheet - reports the assets, liabilities, and stockholders’ equity at a specific date

Income Statement - reports the results of operations for a specific period of time

Retained Earnings Statement - reports the changes in retained earnings for a specific period of time

Statement of Cash Flows - reports the cash receipts and payments for a specific period of time

Brief Introduction to the Balance Sheet and Income Statement

Balance sheet – snapshot of a company’s financial position at a certain point in time.

Income statement – summarizes financial activity of a company for a certain period of time.

Relationship between the balance sheet and income statement

Basic Terms

Assets - resources owned by a business Liabilities - debts and obligations of the business - represents

claims of creditors on the assets of the business Common stock - stock representing the primary ownership interest

in a corporation

Practice With the Balance Sheet and Income Statement

Wiggler Company

Tuesday, June 21

Email – use your COB account. To find your account:• Go to the computer lab in the basement

• Log in under your ONID account and open Outlook

• Open a screen to send a new email, type your last name in the address space, then key ’Ctrl +k’

• A list of email addresses will appear, find your COB address Access to course materials folder

• Go to the computer lab in the basement and log in under your COB username and password. Passwords can be obtained in BX 204C, if you forgot yours or need one.

• Now, the URL \\cob-storage\classes\BA215wong can be used in the Explorer web browser

Debit and Credit Conventions and T-accounts

T-accounts are a convenient way to record transaction information and keep running totals of accounts.

Debits represent the left hand side of a T-account. Credits represent the right hand side of a T-account.

See Fig 2.2 of text

Balance Sheet Accts. Income Stmt. Accts.

↑ Assets | Liabilities ↑ ↑ Expenses | Revenues ↑

| Equity ↑

Recording Transactions

Note for every transaction:• $debits = $credits

For every transaction involving only balance sheet accounts: A = L + E

Balance sheet for Wiggler, up to transaction #5, using T-accounts for assistance.

The Trial Balance

A listing of all debit and credit balances as of the balance sheet date

Used to insure that debits = credits for recorded transactions Checks whether the accounting equation was maintained No assurance that transactions have been recorded properly

Trial Balance for Wiggler transactions #1 to #5

Put together a trial balance for these transactions.

Debit Credit

Cash $3,250

Inventory (worms) 220

Land & Farm 750

Accounts Payable $120

Note Payable 2,100

Common Stock 2,000

Total $4,220 $4,220

Balance Sheet: Classification and Some Common Accounts

The balance sheet classifies assets and liabilities according to whether they are short- or long-term.

Generally:• Short-term assets are those which will be consumed or

converted to cash in a year or less. All other assets are long-term.

• Short-term liabilities are those which will be paid in a year or less. All other liabilities are long-term.

Common balance sheet accounts – see sample balance sheet, and text pp. 54-58.

Income Statement

Classified income statement Definition of elements

• Revenues – resource inflows earned from the sale of products or services that are the main activities of the organization

• Expenses - resource outflows incurred in the sale of products or services that are the main activities of the organization

• Gains – similar to revenues, only from ancillary activities of the organization

• Losses – similar to expenses, only from ancillary activities of the organization

Table 2.3 From the Text Sample Income Statement: Operating Section

Net sales $2,500,000

Cost of goods sold 1,900,000

Gross margin 600,000

(Discussion of these three accounts on pp. 50-51)

Table 2.3 From the Text Sample Income Statement: Operating Section

Operating Expenses:

Selling expenses

Sales salaries $140,000

Advertising expenses 20,000 160,000

Administrative expenses

Office salaries 170,000

Rent 20,000

Depreciation 40,000 230,000

Total operating expenses 210,000

(Discussion of these accounts on p. 51)

Table 2.3 From the Text Sample Income Statement: Non-Operating Section* to end

Other income $20,000

Other expenses (interest) 35,000 55,000

Income before taxes 195,000

Income taxes 97,500

Net Income (Income after taxes) $97,500

* This is the section where gains and losses would also appear

(Discussion of these accounts on pp. 50-51)

Statement of Retained Earnings

Helps to link the balance sheet with the income statement.

Closes the results of the income statement (net income) to Retained Earnings

Accounts for dividends paid from Retained Earnings. Overview of the statement:

Beginning Retained Earnings

+ Net income (Net loss)

- Dividends paid or declared and payable

= Ending Retained Earnings

Homework

Finish recording the transactions in the Wiggler exercise

After recording the transactions• Make a trial balance, balance sheet, and income statement

for Wiggler

Wednesday, June 22

Web-based course materials access is now available Selected T/F and multiple choice questions from

Ch. 2

GAAP and Accrual-Based Accounting Consistency of accounting practices is achieved by

companies adhering to GAAP (Generally Accepted Accounting Principles)

Accrual-based accounting means that we recognize:• Revenues when earned, regardless of when the cash is

collected.• Revenues are generally earned when services or goods

are provided to customers.

• Expenses when incurred, regardless of when the cash is collected.• Expenses are generally incurred when services or goods

are provided by others.

Cash-based accounting vs. accrual-based accounting

Specific Instances of Accrual-Based Accounting

Inventory is not expensed as Cost of Good Sold until a sale is made.

Sales made on credit are recorded even though cash has not been collected from the customer.(Debit Accounts receivable, Credit Sales)

Wages expense can be recorded, even if cash has not yet been paid to employees.(Debit Wages Expense, Credit Wages Payable)

Accounting for Depreciation of Long Term Assets – General Concept

Depreciation is taken on assets over time in an attempt to match the expense to the time period that the assets help to generate revenues.

How to record the transaction:• Debit Depreciation Expense (Income Statement)

• Credit Accumulated Depreciation

Accounting for Depreciation of Long Term Assets – Example

A truck is purchased for $40,000 that has a 5 year life and will be depreciated using the straight line method.

At the end of each year for the next 5 years, $8,000 of depreciation expense is recognized ($8,000 / 5yrs)

Effect of this transaction:• Increase in Depreciation Expense (debit)

• Increase in Accumulated Depreciation, a ‘contra-asset’ (credit)

Accounting for Depreciation of Long Term Assets – Example

Impact on the balance sheet:Long-Term Assets

Equipment – Truck $40,000

Accumulated depreciation (8,000)

Equipment, net 32,000

Impact on the income statement:Depreciation Expense $8,000

Specific Items in Chapter 2 to Skip

Auditor’s report, p. 61 Any type of depreciation method other than straight

line, pp. 65-66 Deferred taxes, pp. 66-67