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Chapter Outline Notes
3. Equity—owner’s claim on assets; assets minus liabilities. Also
called stockholders’ equity, shareholders’ equity or capital, net
assets or residual equity. Changes in Equity—result from stock
issuances or owner investments, revenues, dividends, and
expenses.
a. Common stock—part of contributed capital include cash and
other net assets from stockholders in exchange for stock.
Amounts stockholders invest in the company. Recorded under
the title Common Stock.
b. Revenues—are sales of products or services to customers.
Revenues increase equity (via net income) and result from a
company’s earnings activities.
c. Dividends—outflow of assets such as cash and other assets to
stockholders (results in decrease in equity).
d. Expenses—cost of assets or services used to earn revenues
(results in decrease in equity).
e. Retained earnings -- accumulated revenues less accumulated
expenses and dividends since the company began.
B. Expanded Accounting Equation:
Assets = Liabilities + Common Stock – Dividends + Revenues –
Expenses
C. Transaction Analysis—each transaction and event always leaves
the equation in balance. (Assets = Liabilities + Equity)
1. Investment by owner:
Increase on both sides of equation-- keeps equation in balance.
2. Purchase supplies for cash:
3. Purchase equipment for cash:
4. Purchase supplies on credit:
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Chapter Outline Notes
5. Provide services for cash:
Decrease on both sides of equation keeps equation in balance.
7. Payment of expense in cash (salaries):
8. Provide services for credit:
9. Receipt of cash from account receivable:
10. Payment of accounts payable:
11. Payment of cash dividend:
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Chapter Outline Notes
IV. Financial Statements
A. The four financial statements and their purposes are:
1. Income Statement—describes a company’s revenues and
expenses along with the resulting net income or loss over a
period of time. (Net income occurs when revenues exceed
expenses. Net loss occurs when expenses exceed revenues.)
2. Statement of Retained Earnings—explains changes in equity
from net income (or loss) and from owner investment and
dividends over a period of time.
3. Balance Sheet—describes a company’s financial position
(types and amounts of assets, liabilities, and equity) at a point
in time.
4. Statement of Cash Flows—identifies cash inflows (receipts)
and cash outflows (payments) over a period of time.
B. Statement Preparation from Transaction Analysis—prepared in the
following order using the procedure indicated below.
1. Income Statementinformation about revenues and expenses
is conveniently taken from the equity columns. Total revenues
minus total expenses equals net income or loss. Notice that
stockholders’ investments and dividends are not part of
income (or loss).
2. Statement Retained Earningsreports retained earnings
changes over reporting period. Beginning retained earnings,
net income, from the income statement is added (or the net
loss is subtracted) and dividends are subtracted to arrive at the
ending retained earnings. Ending retained earnings is carried
to the Balance Sheet.
3. Balance Sheetthe ending balance of each asset is listed and
the total of this listing equals total assets. The ending balance
of each liability is listed and the total of this listing equals total
liabilities. Equity is separated into common stock and retained
earnings (note that retained earnings is taken from the
statement of retained earnings). Equity is added to total
liabilities to get total liabilities and equity. This total must
agree with total assets to prove the accounting equation. Either
the account form or the report form may be used to prepare the
balance sheet.
4. Statement of Cash Flowsthe cash column must be carefully
analyzed to organize and report cash flows in categories of
operating, investing, and financing. The net change in cash is
determined by combining the net cash flow in each of the
three categories. This change is combined with the beginning
cash. The resulting figure should be the ending cash that was
shown on the balance sheet.
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Chapter Outline Notes
V. Global View—Financial Accounting using U.S. GAAP is similar, but
not identical to IFRS. Similarities and differences:
A. Basic Principles—both GAAP and IFRS include broad and similar
guidance for accounting.
B. Transaction Analysis—identical as shown in this chapter. Later,
some differences will arise. GAAP is rules-based whereas IFRS is
more principles-based.
C. Financial Statements—both systems require preparation of the same
four basic financial statements
VI. Decision Analysis—Return on Assets (ROA)—a profitability measure.
Also called Return on Investment (ROI)
A. Useful in evaluating management, analyzing and forecasting profits,
and planning activities.
B. The return on assets is: calculated by dividing net income for a
period by average total assets. (Average total assets is determined by
adding the beginning and ending assets and dividing by 2.)
C. As with all analysis tools, results should be compared to previous
business results as well as competitor’s results and industry norms.
VII. Risk and Return Analysis—Appendix 1A
A. Risk—the uncertainty about the return we will earn on an
investment.
B. The lower the risk, the lower the return.
C. Higher risk implies higher, but riskier implied returns.
VIII. Business Activities and the Accounting Equation—Appendix 1B
A. The accounting equation is derived from business activities.
B. Three major business activities are:
1. Financing activities—activities that provide the means
organizations use to pay for resources such as land, buildings, and
equipment to carry out plans. Two types of financing are:
a. Owner financing—refers to resources contributed by owner
including income left in the organization.
b. Non-owner (or creditor) financing—refers to resources
contributed by creditors (lenders).
2. Investing activities—are the acquiring and disposing of resources
(assets) that an organization uses to acquire and sell its products
or services.
3. Operating activities—involve using resources to research,
develop, purchase, produce, distribute, and market products and
services.
C Investing (assets) is balanced by Financing (liabilities and equity).
Operating activities is the result of investing and financing.
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VISUAL #1-1
WARNING: NO MATTER WHAT HAPPENS
ALWAYS KEEP THIS SCALE
IN BALANCE
ASSETS L + E
Basic Accounting Equation
ASSETS = LIABILITIES + EQUITY
TRANSACTION ANALYSIS RULES
1) Every transaction affects at least two items.
2) Every transaction must result in a balanced equation.
TRANSACTION ANALYSIS POSSIBILITIES:
A = L + E
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