Chapter 2

Investing and Financing Decisions

& Balance Sheet

Chapter Two Slide 1 of 33

Learning Objectives

The impact of business transactions on balance sheet

- what transactions affect the elements on balance sheet?
- How do these transactions change () the value of these elements?
The elements of balance sheet
- what does balance sheet describe?

How are the business transactions recorded/recognized?

(1) Transaction analysis in terms of the accounting
equation: Assets = Liabilities + shareholders equity
(2) general journals and T- accounts

Prepare a simple classified balance sheet

Understanding investing and financing transactions in

cash flow statement and the link to the balance sheet
Chapter Two Slide 2 of 33
Recall the business operation cycle

APPLICATIONS SOURCES
Assets Liabilities & Shareholders
Equity
Cash START HERE
Build factories
Buy equipments Get money from
Manufacture products Shareholders and
creditors

Expenses Revenues
Assets is used Hopefully leads to... More wealth
Products sold can then buy more assets
Manufacture more products
Equipment consumed Hire more employees
Salaries paid
Chapter Two Slide 3 of 33
Balance Sheet tells us about

Financing activities
- Where does the firm get the money, by how much?
- from shareholders
- from creditors

Investing activities
- How does the firm use the money, by how much?
- deposit in the bank
- purchase productive assets- inventories, warehouse,
equipment
-invest in stock market or other companies

Chapter Two Slide 4 of 33

Balance Sheet
Papa John's International, Inc. and Subsidiaries
Assets: Consolidated Balance Sheet
Economic resources (dollars in thousands)
January 31, December 28,
Probable future benefits 2007 2006
Owned or controlled ASSETS
Current assets
Resulted from past Cash $ 15,000 $ 13,000
transactions Accounts receivable 23,000 23,000
Listed by the order of Supplies 27,000 27,000
liquidity (how quickly the Prepaid expenses 8,000 8,000
assets will be turned into Other current assets 14,000 14,000
cash) Total current assets 87,000 85,000
Long-term investments 2,000 1,000
Property, and equipment (net of
accumulated depreciation of $189,000) 208,000 198,000
Long-term notes receivable 15,000 12,000
Intangibles 67,000 67,000
Other assets 17,000 17,000
Total assets $ 396,000 $ 380,000

Chapter Two Slide 5 of 33

 Balance Sheet

Liabilities: Papa John's International, Inc. and Subsidiaries

Consolidated Balance Sheet
Probable debt or (dollars in thousands)
obligations January 31, December 28,
Will be paid with assets 2007 2006
or services LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Resulted from past Accounts payable $ 29,000 $ 29,000
transactions Dividends payable 3,000 -
Listed in order of Accrued expenses payable 73,000 73,000
maturity (how quickly be Total current liabilities 105,000 102,000
paid in cash)
Unearned franchise fees 7,000 7,000
Long-term notes payable 110,000 96,000
Shareholders equity: Other long-term liabilities 27,000 27,000
Total liabilities 249,000 232,000
Provided by owner Stockholders' equity
(contributed capital) Contributed capital 3,000 1,000
Generated by business Retained earnings 144,000 147,000
operations (retained Total stockholders' equity 147,000 148,000
earnings) Total liabilities and stockholders' equity $ 396,000 $ 380,000
Chapter Two Slide 6 of 33
To record the business transactions, we have to set
certain rules first
Assumptions

Separate entity: Activities of the business are separate

from activities of owners.

Continuity: The entity will not go out of business in the near

future.

Unit-of-measure: Accounting measurements will be in the

national monetary unit ($).
Principle

Historical cost: Cash equivalent cost given up is the basis

for initial recording of elements.
Chapter Two Slide 7 of 33
 Definitions of Transactions

Past events that have an economic impact on the company

- External events: exchanges of assets/service of the firm

for assets/service/liabilities of other parties.
e.g., Fortress buys computers from Dell and pays in cash
(exchange one asset cash for another asset computer)

- Internal events: not an exchange between the firm and

other parties, but have a direct effect on the accounting
entity.
e.g., an unexpected fire ruined the factories, the company
suffers from losing one asset factories and reduction in S/E

- An event is not a transaction if the exchange hasnt

occurred yet. e.g., sign a contract (to promise to exchange
assets/service in the future)
Chapter Two Slide 8 of 33
Principles of transaction analysis (1)

Duality of Effects

Most transactions with external parties involve

an exchange where the business entity
gives up something but
receives something in return.

Chapter Two Slide 9 of 33

Principles of Transaction Analysis (2)

Every transaction affects at least two accounts (duality

of effects).
The accounting equation must remain in balance after
each transaction.

Assets = Liabilities + Contributed capital + Beginning

retained earnings + Revenue - Expenses + Gains
- Losses - Dividends

A = L + SE
(Assets) (Stockholders
(Liabilities)
Equity)

Chapter Two Slide 10 of 33

 Shareholders Equity

Shareholders Equity

Contributed Retained
+
Capital Earnings

Begin retained earnings + Net income -

Dividends

Revenue Expenses + Gains - Losses

Chapter Two Slide 11 of 33
Principle of transaction analysis (3)

Transaction analysis procedures

Accounts and effects

- Identify the accounts affected and classify them by

type of account (A, L, SE).
- Determine the direction of the effect (increase or
decrease) on each account.

Balancing
- Verify that the accounting equation (A = L + SE)
remains in balance.

Chapter Two Slide 12 of 33

 Analyzing Transactions

Papa Johns issues $2,000 of additional

common stock to new investors for cash.

Identify & Classify the Accounts

1. Cash (asset).
2. Contributed Capital (equity).

Determine the Direction of the Effect

1. Cash increases.
2. Contributed Capital increases.

Chapter Two Slide 13 of 33

 Analyzing Transactions

Papa Johns issues $2,000 of additional

common stock to new investors for cash.
Notes Notes Contributed Retained
Cash Investments Equip. Receivable Payable Capital Earnings
(a) 2,000 2,000

Effect 2,000 = 2,000

A = L + SE

Chapter Two Slide 14 of 33

 Analyzing Transactions

The company borrows $6,000 from the

local bank, signing a three-year note.

Identify & Classify the Accounts

1. Cash (asset).
2. Notes Payable (liability).

Determine the Direction of the Effect

1. Cash increases.
2. Notes Payable increases.

Chapter Two Slide 15 of 33

 Analyzing Transactions

The company borrows $6,000 from the

local bank, signing a three-year note.
Notes Notes Contributed Retained
Cash Investments Equip. Receivable Payable Capital Earnings
(a) 2,000 2,000
(b) 6,000 6,000

Effect 8,000 = 8,000

A = L + SE

Chapter Two Slide 16 of 33

 Analyzing Transactions

Papa Johns purchases $10,000 of new equipment, paying

$2,000 in cash and signing a two-year note payable for the
rest.

Identify & Classify the Accounts

1. Equipment (asset).
2. Cash (asset).
3. Notes Payable (liability).

Determine the Direction of the Effect

1. Equipment increases.
2. Cash decreases.
3. Notes Payable increases.

Chapter Two Slide 17 of 33

 Analyzing Transactions

Papa Johns purchases $10,000 of new equipment, paying

$2,000 in cash and signing a two-year note payable for the
rest.
Notes Notes Contributed Retained
Cash Investments Equip. Receivable Payable Capital Earnings
(a) 2,000 2,000
(b) 6,000 6,000
(c) (2,000) 10,000 8,000

Effect 16,000 = 16,000

A = L + SE

Chapter Two Slide 18 of 33

 Analyzing Transactions
Papa Johns board of directors declares and
pays $3,000 in dividends to shareholders.

Identify & Classify the Accounts

1. Cash (asset).
2. Retained Earnings (equity).

Determine the Direction of the Effect

1. Cash decreases.
2. Retained Earnings decreases.

Chapter Two Slide 19 of 33

 Analyzing Transactions

Papa Johns board of directors declares and

pays $3,000 in dividends to shareholders.
Notes Notes Contributed Retained
Cash Investments Equip. Receivable Payable Capital Earnings
(a) 2,000 2,000
(b) 6,000 6,000
(c) (2,000) 10,000 8,000
(d) (3,000) (3,000)
Effect 13,000 = 13,000

A = L + SE

Chapter Two Slide 20 of 33

CH 2- Q. 1 Analyzing the Effects of Transactions in T-
accounts
Montoya Especial Company was organized by Deigo Montoya and five other investors.
The following activities occurred during the year:

a. Received $94,500 cash from the investors; each was issued 1,400 shares of stock.
b. Purchased equipment for use in the business at a cost of $30,000; one-fourth was paid
in cash and the company signed a note (due in six months).
c. Signed an agreement with a cleaning service to pay $180 per week for cleaning the
corporate offices.
d. Received an additional contribution from investors who provided $6,000 in cash and
land valued at $19,500 in exchange for stock in the company.
e. Lent $3,750 to one of the investors who signed a note due in six months.
f. Diego Montoya borrowed $15,000 for personal use from a bank, signing a one-year note.

Required:
1. Create T-accounts for the following accounts: Cash, Note Receivable, Equipment, Land,
Note payable, and contributed Capital. Beginning balance are $0. For each of the
preceding transactions, record the effects of the transaction in the appropriate T-
accounts. Include good referencing and totals for each T-account.
2. Using the balance in the T-accounts, fill in the following amounts for the accounting
equation:
Assets $ = Liabilities $ + Stockholder's equity $
3. Explain your response to events (c) and (f)
Chapter Two Slide 21 of 33
CH 2- Q. 4 Recording Transactions in T-accounts and
Preparing the Balance Sheet
Juarez Plasticos has been operating for three years. At December 31, 2016, the
accounting records reflected the following:

Cash $ 38,000 Intangibles $ 6,000

Investment (short- 4,000 Accounts payable 30,000
term)
Accounts Receivable 6,000 Accrued liabilities 4,000
payable
Inventory 48,000 Notes payable(short- 14,000
term)
Notes receivable (long- 2,000 Long-term notes 92,000
term) payable

Equipment 96,000 Contributed capital 180,000

Factory building 180,000 Retained earnings 60,000

Chapter Two Slide 22 of 33

CH 2- Q. 4 Recording Transactions in T-accounts and
Preparing the Balance Sheet
During the year 2017, the company had the following summarized activities:
a. Purchased short-term investments for $18,000 cash.
b. Lent $14,000 to a supplier who signed a two-year note.
c. Purchased equipment that cost $36,000; paid $12,000 cash and signed a one-year note
for the balance.
d. Hired a new president at the end of the year. The contract was for $170,000 per year
plus options to purchase company stock at a set price based on company performance.
e. Issued an additional 2,000 shares of capital stock for $24,000 cash.
f. Borrowed $24,000 cash from a local bank, payable in three months.
g. Purchased a patent (an intangible asset) for $6,000 cash.
h. Build an addition to the factory for $50,000; paid $18,000 in cash and signed a three-
year notes for the balance.
i. Returned defective equipment to the manufacturer, receiving a cash refund of $2,000.

Required:
1. Create T-accounts for each of the accounts on the balance sheet and enter the balances
at the end of 2016 as beginning balances for 2017.
2. Record each of the events for 2017 in T-accounts (including references) and determine
the ending balances.
3. Explain your response to event (d).
4. Prepare a classified balance sheet at December 31, 2017.
Chapter Two Slide 23 of 33
 To prepare the balance sheet, for each item on the
balance sheet, we need to take the beginning balance
and add the change for the year.

Chapter Two Slide 24 of 33

 The Accounting Cycle

During the period Close temporary accounts

Analyze transactions: What accounts are of revenues, gains,
affected, do they increase or decrease, by expenses and losses
How much to retained earnings.
Record journal entries in the general journal.
Post amounts to the general ledger.

End of the period Prepare a complete

Adjust revenues and expenses set of financial statements.
and related balance sheet accounts Disseminate statements
(Chapter 4). to users.

Chapter Two Slide 25 of 33

 Debits and Credits T- account

The left side of the The right side of the

T-account is always the T-account is always the
credit side.
debit side.

Account Name

Left Right
Debit Credit

Its DEFINITION, no economic meaning

Changes in Debits = Changes in Credits
Chapter Two Slide 26 of 33
 The 1st way to remember debits and credits

When an accounting item increases,

if items on the LHS (RHS) of equation Debit (Credit)

Assets = Liabilities + Contributed capital +

Beginning retained earnings + Revenue -
Expenses + Gains - Losses - Dividends

Rearrange terms so only + signs

Assets + Expenses + = Liabilities + Contributed capital +

Losses + Dividends Beginning retained earnings + Revenue +
Gains
Chapter Two Slide 27 of 33
 The 1st way to remember debits and credits

Debit Left Credit Right

Increases
Assets
in Increases in
= Liabilities + Contributed capital +
Left-hand sideBeginning retained earnings
Right-hand
+ Revenue - sid
Expenses + Gains - Losses - Dividends
Debit Accounts Credit Account
Rearrange terms so only + signs

Assets + Expenses + = Liabilities + Contributed capital +

Losses + Dividends Beginning retained earnings + Revenue +
Gains
Chapter Two Slide 28 of 33
 Transaction Analysis Model:
The 2nd way to remember debits and credits

Debits and credits affect the Balance Sheet

Model as follows:

A = L + SE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase

Chapter Two Slide 29 of 33

 A = L + SE
ASSETS LIABILITIES
Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

CONTRIBUTED RETAINED
Next, lets see how CAPITAL EARNINGS
Revenues and
Expenses affect Debit Credit Debit Credit
Retained Earnings. for for for for
Decrease Increase Decrease Increase

Chapter Two Slide 30 of 33

 Transaction Analysis Model:
The 2nd way to remember debits and credits
RETAINED
Dividends decrease EARNINGS
Net Income increases
Retained Earnings. Retained Earnings.
Debit Credit
for for
Decrease Increase

REVENUES EXPENSES
Debit Credit Debit Credit
for for for for
Decrease Increase Increase Decrease

Chapter Two Slide 31 of 33

Transaction Analysis Model:
The 3rd way to remember debits and credits

Once you remember whats for assets, you can easily

remember whats for liability and stockholders
equity.
For the rest of items, they are all related stockholders
equity.

If they increase equity, it would be credit.

If they decrease equity, it would be debit.

Chapter Two Slide 32 of 33

Another representation: General Journal (1)

A journal entry might look like this:

GENERAL JOURNAL
Posted
Date Account Titles and Explanation Ref. Debit Credit
Jan. 1 Cash 500,000
Contributed Capital 500,000
Jan 3 Fixed assets - equipment 480,000
Cash 120,000
Bank loan 360,000

Transactions are recorded in chronological order

in general journal
Chapter Two Slide 33 of 33
General Journal (2)

Provide a reference Debits are written first.

date for each transaction.

GENERAL JOURNAL
Posted
Date Account Titles and Explanation Ref. Debit Credit
Jan. 1 Cash 500,000
Contributed Capital 500,000

Total debits must equal

Credits are indented and total credits.
written after debits.

Chapter Two Slide 34 of 33

General Ledger

After journal entries are prepared, the accountant

posts (transfers) the dollar amounts to each account
affected by the transaction.

GENERAL JOURNAL
Posted
Date Account Titles and Explanation Ref. Debit Credit Ledger
Jan. 1 Cash
Contributed Capital
500,000
500,000
Post

Chapter Two Slide 35 of 33

 Papa Johns issues $2,000 of additional common
stock to new investors for cash.

GENERAL JOURNAL
Posted
Date Account Titles and Explanation Ref. Debit Credit
(a) Cash 2,000
Contributed Capital 2,000

Cash Contributed Capital

Beg. Bal. 6,000 1,000 Beg. Bal.
(a) 2,000 2,000 (a)

8,000 3,000

Chapter Two Slide 36 of 33

 Papa Johns borrows $6,000 from the local
bank, signing a three-year note.

Debit Credit
(b) Cash 6,000
Notes Payable 6,000

Cash Notes Payable

Beg. Bal. 6,000 146,000 Beg. Bal.
(a) 2,000 6,000 (b)
(b) 6,000

14,000 152,000

Chapter Two Slide 37 of 33

 CH 2- Q. 4

Requirements:

1. Record journal entries in the general journal

2. Post each transaction to the general ledger

Chapter Two Slide 38 of 33

 Focus on Cash Flows

Operating activities
(Covered in the next chapter.)
Investing Activities
Related to changes in noncurrent assets in balance sheet
Purchasing long-term assets and investments for cash
Selling long-term assets and investments for cash +
Lending cash to others
Receiving principal payments on loans made to others +
Financing Activities
Related to changes noncurrent liabilities and S/E in balance sheet
Borrowing cash from banks +
Repaying the principal on borrowings from banks
Issuing stock for cash +
Repurchasing stock with cash
Paying cash dividends

Chapter Two Slide 39 of 33

 Investing and Financing Activities

Papa John's International, Inc.

Consolidated Statement of Cash Flows
For the Month Ended January 31, 2007
(in thousands)
Operating activities
(None in this chapter.)
Investing Activities
Purchased property and equipment $ (2,000)
Purchased investments (1,000)
Lent funds to franchisees (3,000)
Net cash used in investing activities (6,000)
Financing Activities
Issued common stock 2,000
Borrowed from banks 6,000
Net cash provided by financing activities 8,000
Net increase in cash 2,000
Cash at beginning of month 13,000
Cash at end of month $ 15,000

Chapter Two Slide 40 of 33

 CH 2- Q. 2 Inferring Typical Investing and
Financing Activities in Accounts
The following T-accounts indicate the effects of normal
business transactions

Equipment Notes Receivable Notes Payable

Jan 1 500 Jan 1 150 Jan 1 100
250 ? ? 225 ? 170
Dec 31 100 Dec 31 170 Dec 31 160

Required:
1. Describe the typical investing and financing transactions that
affect each T-account. That is, what economic events occur to
make each of these accounts increase and decrease?
2. For each T-account, compute missing accounts.
Chapter Two Slide 41 of 33
 CH 2- Q. 3 Identifying Investing and Financing
Activities Affecting Cash flows
Foot Locker, Inc. is a large global retailer of athletic footwear and
apparel selling directly to customers and through the Internet. It
includes the Foot Locker family of stores, Champs Sports, and Eastbay.
The following are several of Foot Locker's investing and financing
activities as reflected in a recent annual statement of cash flows.
a. Reduction of long-term debt.
b. Issuance of common stock
c. Capital expenditures (for property, plant, and equipment).
d. Dividends paid on common stock.

Required:
For each of these, indicate whether the activity is investing (I) or
financing (F) and the direction of the effect on cash flows (+ for increase
cash; for decrease cash).

Chapter Two Slide 42 of 33

 Cash balance

In 1995, Nick Leeson was a the general manager of

Barings Future Singapore, a subsidiary of the Barings
Group.

He was hiding losses of increasing size in an account

(called 88888) that was not supposed to exist.

This ghost account was classified as an asset but

obviously of dubious quality (losing money does not bring
future benefit !)

Chapter Two Slide 43 of 33

 Cash balance

When the internal auditors came, he could not show this

account. So he moved the losses to the cash account.

The cash balance was overvalued by GBP 50 Millions.

The internal auditors did not catch the problem.

Barings Group, the oldest English bank at the time,
subsequently collapsed.
What should have they done?

Chapter Two Slide 44 of 33

 Cash balance

They should have reconciled the cash balance in the

books of the company with the bank statement and
demanded an explanation for any deviation.

Organizations should do this at least on a monthly basis,

and more often in some businesses.

More generally, there should be a segregation of duties

between the ones who order the expenses and the ones
who pay.

Chapter Two Slide 45 of 33

 Take Aways

Importance of accounting equation

How individual accounts of balance sheet fit together
Importance of adjusting and closing entries
Debits and credits
T-accounts and general journal

Chapter Two Slide 46 of 33