Lec 3 & 4 (Compatibility Mode)

Measuring and
Evaluating
Financial Position
CHAPTER 2
Measuring and Evaluating Financial Position
Main topics in Chapter 2:
Introduction to the balance sheet

Some relevant history, ending with the invention of double
entry
Double--entry bookkeeping for recording transactions
Double
Journal entries, accounts and trial balance
Account classification on the balance sheet
Activities that affect and are reported in the balance sheet
Introductory interpretation and analysis of the balance sheet
Overview of a bank’s balance sheet
Balance Sheet…
Summarizes an organization’s financial resources,

obligations, and owners’ interest
Measures the financial position at a particular date
and is the basis for much financial analysis
Accumulates the financial history of the
organization as recorded in the accounting system
Central part of a company’s financial disclosure to
the shareholders (investors) and others outside the
company’s management
1
The Balance Sheet portrays the enterprise
by arranging its lists of accounts so that the
left side lists the total resources (“assets”)
and the right side shows how the assets
were financed.
Real Resources Sources of Resources

ASSETS LIABILITIES
•Current •Current
•Non-current •Non-current
EQUITY
•Contributed Capital
•Retained Earnings
Components-- Assets
Components
Asset:
“A resource available to do business in the future, represented by
an ownership of or right to expected future economic benefits.”
Current Asset:
“Cash and other assets such as temporary investments, inventory,
receivables, and current prepayments that are realizable or will be
consumed within the normal operating cycle of an enterprise
(usually one year).”
Non-current Asset:
“Assets expected to bring benefit for more than one fiscal year.”

left side lists the assets and the right side
shows how the assets were financed
(liabilities and equity).

ASSETS LIABILITIES
EQUITY
2
Components-- Liabilities
Components
Liability:
“A debt or obligation, legally existing or estimated via accrual
accounting techniques, of the enterprise to another party
(creditor) arising from a past transaction.”
Current Liability:
“Debts or estimated claims on the resources of a firm that are
expected to be paid within the normal operating cycle of an
enterprise (usually one year).”
Non-current Liability:
“Liabilities expected to be repaid or otherwise removed more than
one year in the future. ”

left side lists the assets and the right side
shows how the assets were financed
(liabilities and equity).

ASSETS LIABILITIES
EQUITY
Components-- Equity
Components
Equity:
“The net assets or residual interest of an owner or shareholder
(Assets-Liabilities=Equity)”
Contributed Capital:
“Direct investment(s) of the owner(s) in the business”
Retained Earnings:
“Earnings not yet distributed to owners: the sum of net incomes
earned over the life of a company, less distributions (dividends
declared) to owners.”
3
ASSETS = LIABILITIES + EQUITY
ASSETS LIABILITIES
EQUITY
Historical basis
As at a particular date
Signed on behalf of the Board of Directors
History informed by estimates of future
Many supplementary notes
Comparative to at least prior year
Equity is the “book value” of the whole company:
Equity = Assets - Liabilities
Sound and Light Corporation

Balance Sheet as at April 30, 2001
in Thousands of Dollars
Side-by-side style
Assets Liabilities and Equity

Current assets $245 Current liabilities $103
Non-current assets 250 Non-current liabilities 87
Total liabilities $190
Owners' equity:
Contributed capital $130
Retained earnings 175 305
TOTAL $495 TOTAL $495
4
Sound and Light Corporation
in Thousands of Dollars
Vertical style Assets
Current assets $245
Non-current assets 250
TOTAL $495
Liabilities and Equity

Current liabilities $103
Non-current liabilities 87
Total liabilities $190
Owners' equity:
Contributed capital $130
Retained earnings 175 305
TOTAL $495
Seven Key Ingredients that Led to the Creation of

Accounting: The Early Days
I. Private property: The beginnings of family

business and the ability to establish ownership,
II. Capital: Wealth is desired and accumulated;

III.Commerce: The interchange of goods on many
levels (trade);
Seven Key Ingredients that Led to the Creation of

Accounting: The Early Days
IV. Credit: The present use of future goods,
recognizing cash exchanges expected to occur in
the future;
V. Writing: A mechanism for making a permanent
record (keeping track of possessions):
VI. Money: The "common denominator" for
exchanges, and
VII.Arithmetic: A means of computing the monetary
details of the deal.
5
Let’s do an example of Balance Sheet
transactions using XYZ Inc.
Inc.
This morning, XYZ had the following amounts on its Balance Sheet:
CA + NCA = CL + NCL + SC + RE
$50 + $210 = $30 + $80 + $60 + $90
CA $50 CL $30
NCL $80
NCA $210 SC $60
RE $90
Total $260 Total $260

$50 + $210 = $30 + $80 + $60 + $90
+35 +35
EVENT #1:
New Shares were issued for $35 cash.
RESULT?
Left Side : CA (cash) increases by $35
Right Side : SC (Share Capital) increases by $35

$50 + $210 = $30 + $80 + $60 + $90
+35 +35
-35 -35
EVENT #2:
The Share proceeds were used to reduce long-
term debt.
RESULT?
Left Side : CA (cash) decreases by $35
Right Side : NCL decreases by $35
6
$50 + $210 = $30 + $80 + $60 + $90
+35 +35
-35 -35
-15 +55 +40
EVENT #3:
A new delivery truck costing $55 was bought by
paying $15 down and promising to pay the rest in
three years.
RESULT?
Left Side : NCA increase by $55
CA (cash) decreases by $15
Right Side : NCL increases by $40

$50 + $210 = $30 + $80 + $60 + $90
+35 +35
-35 -35
-15 +55 +40
+20 +20
EVENT #4:
A demand loan of $20 was borrowed from the bank.
RESULT?
Left Side : CA (cash) increases by $20
Right Side : CL increases by $20

$50 + $210 = $30 + $80 + $60 + $90
+35 +35
-35 -35
-15 +55 +40
+20 +20
$55 + $265 = $50 + $85 + $95 + $90
$320 = $320
Total up each balance sheet component
7
New totals for XYZ Inc.
Inc.
$55 + $265 = $50 + $85 + $95 + $90
CA $55 CL $50
NCL $85
NCA $265 SC $95
RE $90
Total $320 Total $320
Some Information to Note:

The Balance Sheet Equation always stays in balance.
Each transaction affects at least two accounts.
Often it affects more.
Some transactions affect only one side of the balance
sheet equation; some transactions affect both sides.
Double Entry Accounting
Method of reducing error by recognizing a

transaction twice….
Once…to recognize the resource involved in the
transaction; and
Once…to recognize the source or effect of that
resource change.
8
As a Result of Double Entry Accounting:
The lists of resources and sources, once

with little connection, are now connected
Errors are more easily discovered. A quick
check is performed by summing both lists
(the resources and the sources). If they are
equal, it is said that they “balance”, if not,
there is an error that needs to be found and
corrected.
How Does Double-

Double-Entry Accounting Work?
Remember: A transaction is the basis of bookkeeping and

must meet the following criteria:
1)Exchange 2)External
3)Evidence 4)Dollars
What do you do when you have a transaction?
We need to revisit the balance sheet to explain the
connection between transactions and double entry
accounting…

ASSETS LIABILITIES
Current Current
Non-current
Non-current
EQUITY
Contributed Capital
Retained Earnings
Positive: Debits Positive: Credits

Negative: Credits Negative: Debits
9
RESOURCES (LEFT) SOURCES (RIGHT)
Positive Items (debits)
Sum of Resources = Sum of Sources

Assets = Liabilities + Equity
For Example : An increase in cash is a positive
item and thus a debit to resources

Positive Items (debits) Positive Items (credits)

For Example: An increase in cash is funded by a
source such as an obligation of the organization to
repay a loan. The obligation is a positive item on the
right and so is a credit to sources.

Negative Items (debits)

For Example: A reduction in an obligation, such as a
bank loan, is a negative item and thus a debit to
sources.
10
Negative Items (credits) Negative Items (debits)

For Example: A reduction in an obligation is paid by a

resource such as cash. A reduction in cash is a negative
item and thus a credit to resources.
The Balance Sheet Equation

Debits = Credits
Like any equation, if you move any item to
the other side, it changes sign.
For example: Debits - Credits = 0
or 0 = Credits - Debits
Journal Entries, Debits and Credits
Increases in assets are Increases in liabilities and/or equity

debits are credits (revenues and income
increase equity and are therefore
credits)
Debits = Credits
Decreases in assets are Decreases in liabilities and/or equity
credits are debits (expenses and dividends
decrease equity and are therefore
debits)
Credits = Debits
11
Journal Entries and Accounts
A journal entry lists all the accounts debited and

credited
The journal entry’s debits = its credits
Accounts record all the journal entries (from the
general journal or more specialized journals)
For demonstration and analysis purposes a “T-
account” is often used as a simplified version of an
account
Example of Journal Entry:

An organization takes out a bank loan worth $1000
DR Cash 1000
CR Bank Loan 1000
Using T- accounts we get:
CASH Bank Loan
DR CR DR CR
1000 1000
Accounts are summaries of all the entries

Let’s use a cash example:
CASH
1000
Entries:
DR Cash 1000
CR Bank Loan 1000
12
CASH
1000
500
Entries:
DR Cash 500
CR Share Capital 500

CASH
1000 400
500
Entries:
DR Loan Payable 400
CR Cash 400

CASH
1000 400
500 250
Entries:
DR Rent 250
CR Cash 250
13
CASH
1000 400
500 250
850
The total of the cash account is $850. Its

“balance” is $850.
General Ledger and Trial Balance
The general ledger is made up of all the accounts

A “trial balance” determines if the ledger is in balance
(the sum of the debits = the sum of the credits)
Ledger can be in balance without being free of errors
The trial balance is the basis for the Balance Sheet,
Income Statement, and Retained Earnings Statement
(Cash Flow Statement is derived from the other 3
statements)
A Balance Sheet Example
Calico Inc. had the following account balances at June 30, 2001.
Place each account in the appropriate location in the balance sheet
and show that the balance sheet balances.
$ $
Land 100,000 Accounts Receivable 43,000
Cash on Hand 5,000 Retained Earnings 223,000
Unsold Inventory 62,000 Buildings & Fixtures 193,000
Accum. Amortization 41,000 Cash in Bank 21,000
Accounts Payable 45,000 Demand Bank Loan 30,000
Share Capital 50,000 Mortgage Payable 35,000
14
Calico Inc., Balance Sheet as at June 30, 2001
(Assets)
Assets
Current assets:
Cash on hand and in bank $26,000
Accounts receivable 43,000
Inventory 62,000
$131,000
Non-current assets:
Land $100,000
Building and fixtures 193,000
Less: Accumulated amortization (41,000)
$252,000
TOTAL $383,000
Calico Inc., Balance Sheet as at June 30, 2001

(Liabilities and Equity)
Liabilities and Equity

Current Liabilities:
Demand Bank Loan $30,000
Accounts Payable 45,000
$75,000
Non-current liabilities:
Mortgage payable $35,000
Shareholders' equity:
Share capital $50,000
Retained earnings 223,000
$273,000
TOTAL $383,000
CappuMania Inc.
Balance Sheet as at March 31, 2001
Assets Liabilities and Shareholders' Equity

Current assets: Current liabilities:
Cash $4,000 Owing to suppliers $1,200
Inventory of unsold food 800 Sales and other taxes owing 600
Inventory of supplies 1,900 $1,800
$6,700 Non-current liabilities:
Non-current assets: Loan to buy equipment 5,000
Equipment $9,000 $6,800
Accum. Amortization (1,500) Shareholders' equity:
$7,500 Share capital contributed $3,000
$7,400
$14,200 $14,200
15
CappuMania Inc.
Trial Balance (March 31, 2001)
Account names Account balances

Debits Credits
Cash 4,000
Inventory of unsold food 800
Inventory of supplies 1,900
Equipment 9,000
Accumulated Amortization 1,500
Owing to suppliers 1,200
Sales and other taxes owing 600
Loan to buy equipment 5,000
Share capital contributed 3,000
15,700 15,700
Journal Entries-
Entries- CappuMania
DR Sales and other taxes owing 500

CR Cash 500
Transaction 1 reduces an asset and a liability
DR Inventory of supplies 450

CR Cash 100
CR Owing to suppliers 350
Transaction 2 increases one asset, decreases another, and increases a

liability
Journal Entries-
Entries- CappuMania
DR Loan to buy equipment 1,100

CR Share capital contributed 1,100
Transaction 3 reduces a liability and increases an equity, having no

effect on assets
DR Equipment cost 200

CR Cash 200
Transaction 4 increases one asset and reduces another, with no other

effect
16
CappuMania Inc.
Trial Balance (April 1, 2001)
Account names Account balances

Debits Credits
Cash 3,200
Inventory of unsold food 800
Inventory of supplies 2,350
Equipment 9,200
Accumulated Amortization 1,500
Owing to suppliers 1,550
Sales and other taxes owing 100
Loan to buy equipment 3,900
Share capital contributed 4,100
15,550 15,550
CappuMania Inc.
Assets Liabilities and Shareholders' Equity

Current assets: Current liabilities:
Cash $3,200 Owing to suppliers $1,550
Inventory of unsold food 800 Sales and other taxes owing 100
Inventory of supplies 2,350 $1,650
$6,350 Non-current liabilities:
Non-current assets: Loan to buy equipment 3,900
Equipment $9,200 $5,550
Accum. Amortization (1,500)Shareholders' equity:
$7,700 Share capital contributed $4,100
$8,500
$14,050 $14,050
Using Debits and Credits
The following table is behind accounting's designation of a change in

an account, or an account balance, as a debit or credit.
Increase Decrease
Assets Debit Credit
Liabilities Credit Debit
Equity Credit Debit
17
Transaction Recording and Journal Entries
Corey MacDonald formed Movie Inc. by purchasing

$95,000 of common shares on July 1, 2001 for cash.
Analyze the transaction:
What happens to Movie Inc.’s Assets,
Liabilities, and Equity??
DR Cash 95,000
CR Common Shares 95,000
RECORDING TRANSACTIONS
CASH COMMON SHARES
95,000 95,000

The business bought a building lot for $60,000 cash.
Increase/
Decrease/NC Which Account?
INCREASE LAND
ASSETS DECREASE CASH
LIABILITIES NO CHANGE
EQUITY NO CHANGE
DR Land 60,000
CR Cash 60,000
18
CASH COMMON SHARES
95,000 60,000 95,000
LAND
60,000
Let’s look at Movie Inc.’s general ledger

at this point…
Movie Inc.’s General Ledger
Dr Cr
Cash 35,000
Land 60,000
Common Shares 95,000
95,000 95,000

The business purchased $600 of office supplies,
agreeing to pay in 30 days.
Increase/
OFFICE
ASSETS INCREASE SUPPLIES
ACCOUNTS
LIABILITIES INCREASE
PAYABLE
EQUITY NO CHANGE
DR Office Supplies 600

CR Accounts Payable 600
19
CASH ACCOUNTS COMMON SHARES
95,000 60,000 PAYABLE
95,000
600
LAND
60,000
OFFICE
SUPPLIES
600

Movie Inc. invested in $40,000 worth of equipment. Half of the total
was paid in cash, while the remainder was owed to the supplier.
Increase/
INCREASE EQUIPMENT
ASSETS DECREASE CASH
ACCOUNTS
LIABILITIES INCREASE
PAYABLE
EQUITY NO CHANGE
DR Equipment 40,000
CR Cash 20,000
CR Accounts Payable 20,000
95,000 60,000 PAYABLE
95,000
20,000 600
20,000
LAND
60,000
OFFICE
SUPPLIES EQUIPMENT
600 40,000
20
95,000 60,000 PAYABLE
95,000
20,000 600
20,000 95,000
15,000
LAND 20,600
60,000
60,000
OFFICE
SUPPLIES EQUIPMENT
600 40,000
600 40,000
Movie Inc.
BALANCE SHEET
AS AT JULY 1, 2001
Assets Liabilities and Equity

CURRENT ASSETS: CURRENT LIABILITIES:
Cash $ 15,000 Accounts
Payable $ 20,600
Office Supplies 600
NON-CURRENT ASSETS: EQUITY:

Common
Land 60,000
Shares 95,000
Equipment 40,000
TOTAL $115,600 TOTAL $115,600
Financing an Organization
The right hand side of the balance sheet

indicates an organization’s source of
financing.
Depending on the form of the organization,

the owners’ equity section found on the
balance sheet will vary. It might not even be
called that.
21
Business Financing
The balance sheet’s right side lists the sources of assets (liabilities
& owners’ equity). Here is a list of a few of the main sources.
Current liabilities:
Demand loans from the bank
Financing provided by suppliers and trade creditors (buy now/pay
later)
Wages earned but not yet paid to employees
Non-current liabilities:
Mortgages, bonded debt, debentures, and other debts extending
over several years
Business Financing
Owner’s or Owners’ Equity:

For a proprietorship: owner’s capital (contributed capital and income
not withdrawn by proprietor)
For a partnership: owners’ capital (contributed capital and income
not withdrawn by partners)
For a corporation: share capital received plus retained earnings
Financial Instruments:
FI’s may or may not be included in the balance sheet. FI’s are the set
of contracts, debts, shares, etc. that a business uses for financing and
protection against harmful changes in the financial environment.
Proprietorship
•Owned by a single individual.
•A sole proprietorship is not a separate legal entity, therefore
the owner has unlimited liability for business debts.
•Direct contributions and retained earnings are lumped
together in the equity section of the balance sheet. This
equity is known as owner’s capital.
Example of Equity Section:
Owner’s equity
Owner’s capital $XXXX
22
Partnership
•Owned by more than one individual.

•A partnership has some legal existence but is not legally
separate from the owners, who are liable for business debts.
•There is no distinction between direct contributions and
retained earnings in the equity section of the balance sheet.
•Each owner’s total capital is identified on the balance sheet
or in a schedule.
Partnership

Partners’ equity
Partners’ capital:
Partner A $XXXX
Partner B XXXX
Partner C XXXX
Total capital: $XXXX
Corporation
•Legally exists on its own (a legal “person”).

•Owners’ losses are limited (limited liability).
•The equity section on the balance sheet is known as
Shareholders’ equity.
•A distinction is made between direct contributions and
retained earnings in the equity section of the balance sheet.
23
Corporation
DIRECT CONTRIBUTIONS:
• People become owners by purchasing shares.
• Shares entitle a person to voting rights or other
powers.
• Share capital is only the amount received by the
corporation the first time a share was sold.
Classes of shares include:
•Common Shares
•Preferred Shares
Corporation
INDIRECT CONTRIBUTIONS (Retained Earnings):
•Earnings belong to the corporation.
• Retained Earnings equal the past earnings minus the
past dividends.
Corporation
Shareholders’ equity
Share capital:
Authorized (narrative describing all the classes of
shares authorized)
Issued capital received:
Class A shares (for example) $XXXX
Class B shares (for example) XXXX
Total issued capital $XXXX
Retained earnings $XXXX
Total shareholders’ equity $XXXX
24
Corporate Groups
Consist of several corporations.

Shareholders’ equity section represents the equity of the primary
corporation in the group (often called the “parent”).
Sometimes some of the other corporations in the group (called
subsidiaries) are partly owned by other corporations outside the
parent corporation.
Often contain the word “consolidated” at the top of the balance
sheet and the other financial statements. This consolidated balance
sheet likely has “minority interest” and “goodwill.”
Features of the Balance Sheet-

Sheet- CAE Inc.
Comparative: contains figures of two dates (e.g. 2001 and 2000) to

help the users recognize changes.
Units: to avoid clutter, figures are shown in thousands, millions or
even billions of dollars.
Notes: references are made to various notes, since it is not possible
to include them on the face of the balance sheet
Consolidated: this tells us that CAE is a corporate group, not a
single corporation
Date: The balance sheet date is March 31.
Signatures: The balance sheet has been signed by 2 members of the
B of D’s, showing the board’s approval.
The Toronto-Dominion Bank

Balance Sheet
As at October 31, 1999 (millions of dollars)
Assets
Cash and short-term securities $101,027
Loans (net of allowance for credit losses) 87,485
Other assets 25,905
Total assets $214,417
Liabilities
Deposits $140,386
Other liabilities 62,498
Total liabilities 202,884
Shareholders' Equity
Capital stock 2,839
11,533
Total liabilities and shareholders' equity $214,417
25

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Measuring and

Main topics in Chapter 2:

Introduction to the balance sheet

Summarizes an organization’s financial resources,

Real Resources Sources of Resources

The Balance Sheet portrays the enterprise

Real Resources Sources of Resources

The Balance Sheet portrays the enterprise

Real Resources Sources of Resources

Sound and Light Corporation

Assets Liabilities and Equity

TOTAL $495 TOTAL $495

Liabilities and Equity

Seven Key Ingredients that Led to the Creation of

I. Private property: The beginnings of family

II. Capital: Wealth is desired and accumulated;

Seven Key Ingredients that Led to the Creation of

ASSETS = LIABILITIES + EQUITY

ASSETS = LIABILITIES + EQUITY

ASSETS = LIABILITIES + EQUITY

ASSETS = LIABILITIES + EQUITY

$55 + $265 = $50 + $85 + $95 + $90

Total up each balance sheet component

Some Information to Note:

Double Entry Accounting

Method of reducing error by recognizing a

The lists of resources and sources, once

How Does Double-

Remember: A transaction is the basis of bookkeeping and

Real Resources Sources of Resources

Positive: Debits Positive: Credits

Sum of Resources = Sum of Sources

RESOURCES (LEFT) SOURCES (RIGHT)

Sum of Resources = Sum of Sources

RESOURCES (LEFT) SOURCES (RIGHT)

Negative Items (debits)

Sum of Resources = Sum of Sources

Negative Items (credits) Negative Items (debits)

Sum of Resources = Sum of Sources

For Example: A reduction in an obligation is paid by a

The Balance Sheet Equation

Assets = Liabilities + Equity

Journal Entries, Debits and Credits

Increases in assets are Increases in liabilities and/or equity

A journal entry lists all the accounts debited and

Example of Journal Entry:

Accounts are summaries of all the entries

Accounts are summaries of all the entries

Accounts are summaries of all the entries

The total of the cash account is $850. Its

General Ledger and Trial Balance

The general ledger is made up of all the accounts

A Balance Sheet Example

Calico Inc., Balance Sheet as at June 30, 2001

Liabilities and Equity

Assets Liabilities and Shareholders' Equity

Account names Account balances

DR Sales and other taxes owing 500

Transaction 1 reduces an asset and a liability

DR Inventory of supplies 450

Transaction 2 increases one asset, decreases another, and increases a

DR Loan to buy equipment 1,100

Transaction 3 reduces a liability and increases an equity, having no