CHAPTER 2
THE BALANCE SHEET
Student Learning Objectives and Related Assignment Materials
Student Learning Objectives
Mini-
Exercises
Exercises
Coached
Problems
Problems
(Groups
A & B)
Skills
Development
Cases
Continuing
Case
LO 2-1 Identify financial
effects of common
business activities that
affect the balance sheet.
4, 5, 6
1, 2, 3, 4*,
5, 9, 11,
13, 14
1, 2, 3, 4, 5,
6
1†
LO 2-2 Apply transaction
analysis to accounting
transactions.
3, 7, 8, 9
1, 2, 4*, 5,
8, 9, 10,
11, 12, 13,
15^
1, 2, 3
A1, A2,
A3, B1,
B2, B3
4, 7
1†
LO 2-3 Use journal entries
and T-accounts to show
how transactions affect
the balance sheet.
1, 2, 3, 5,
6, 10, 11,
13*, 14,
15*, 16,
17*, 18,
19*^, 20
1, 3, 6*, 7,
8, 10, 12,
13, 15^
2, 3
A2, A3,
B2, B3
1†
LO 2-4 Prepare a trial
balance and a classified
balance sheet.
4, 5, 6, 12,
21, 22
3, 9, 10,
12, 15
2, 3
A2, A3,
B2, B3
1, 2, 3, 6
1†
LO 2-5 Interpret the balance
sheet using the current
ratio and an
understanding of related
concepts.
3, 22, 23,
24^, 25^
1, 2, 5, 7,
8, 11, 14,
15^
1, 2, 3
A1, A2,
A3, B1,
B2, B3
1, 2, 3, 4, 5,
6
1†
* Animated solution included in the PowerPoint Slides.
^ Particularly challenging; requires students to combine multiple concepts in order to advance to the
next level of accounting knowledge.
† Continuing Case 2-1 builds on the story of Nicole’s Getaway Spa, introduced in chapter 1. This case
focuses on analyzing transactions, preparing and recording journal entries, posting to T-accounts,
preparing a classified balance sheet, and interpreting the current ratio. This case will be extended in
future chapters.
Overview
The entrepreneur from chapter 1 organizes his business as a corporation and completes business
transactions to establish the business.
Students learn how to analyze and record business transactions that affect the balance sheet and then
prepare and interpret a classified balance sheet.
Synopsis of Chapter Revisions
• New contemporary focus company: replaced pizza company with SonicGateway, thereby replacing
peculiar Cookware account with contemporary intangible accounts such as Software and Trademarks
• New margin illustration of accounting cycle
• Expanded learning objectives to include trial balance preparation
• Revised illustration of T-accounts to include normal balance (Exhibit 2.7)
• Updated analysis of current ratios in Exhibit 2.14 and Spotlight on Financial Reporting to focus on
technology companies, including Apple, Expedia, Electronic Arts, Facebook, and LinkedIn
• Reviewed and updated all end-of-chapter material, including new problem formats that automatically
post journal entries to T-accounts and prepare trial balances
PowerPoint Slides
Student Learning Objective
PowerPoint® Slides
LO 2-1 Identify financial effects of common business activities that affect the
balance sheet.
2-2 through 2-6
LO 2-2 Apply transaction analysis to accounting transactions.
2-7 through 2-19
LO 2-3 Use journal entries and T-accounts to show how transactions affect the
balance sheet.
2-20 through 2-34
LO 2-4 Prepare a trial balance and a classified balance sheet.
2-35 through 2-37
LO 2-5 Interpret the balance sheet using the current ratio and an understanding
of related concepts.
2-38 through 2-40
Animated Builds and Animated Solutions
PowerPoint® Slides
Mini-Exercise 2-13
2-42 through 2-43
Mini-Exercise 2-15
2-44 through 2-45
Mini-Exercise 2-17
2-46 through 2-47
Mini-Exercise 2-19
2-48 through 2-49
Exercise 2-4
2-50
Exercise 2-6
2-51 through 2-52
Chapter Summary
LO 2-1 Identify financial effects of common business activities that affect the balance sheet.
• Financing activities involve debt transactions with lenders (e.g., Notes Payable) or equity
transactions with investors (e.g., Common Stock)
• Investing activities involve buying and selling long-term assets (e.g., Buildings, Equipment).
• Operating activities involve day-to-day transactions with suppliers, employees, and customers, and
typically affect current assets and current liabilities.
LO 2-2 Apply transaction analysis to accounting transactions.
• Transactions include external exchanges and internal events.
• Transaction analysis is based on the duality of effects and the basic accounting equation. Duality
of effects means that every transaction affects at least two accounts.
• Transaction analysis follows a systematic approach of picturing the documented business activity;
naming the exchanged asset, liability, and stockholders’ equity accounts; and analyzing the
financial effects on the basic accounting equation.
LO 2-3 Use journal entries and T-accounts to show how transactions affect the balance sheet.
• Debit means left and credit means right.
• Debits increase assets and decrease liabilities and stockholders’ equity.
• Credits decrease assets and increase liabilities and stockholders’ equity.
• Journal entries express, in debits-equal-credits form, the effects of a transaction on various asset,
liability, and stockholders’ equity accounts. Journal entries are used to record financial
information in the accounting system, which is later summarized by accounts in the ledger (T–
accounts).
• T-accounts are a simplified version of the ledger, which summarizes transaction effects for each
account. T-accounts show increases on the left (debit) side for assets, which are on the left side of
the accounting equation. T-accounts show increases on the right (credit) side for liabilities and
stockholders’ equity, which are on the right side of the accounting equation.
LO 2-4 Prepare a trial balance and a classified balance sheet.
• A trial balance checks on the equality of debit and credit balances.
• A classified balance sheet separately classifies assets as current if they will be used up or turned
into cash within one year. Liabilities are classified as current if they will be paid, settled, or
fulfilled within one year.
LO 2-5 Interpret the balance sheet using the current ratio and an understanding of related
concepts.
• The current ratio divides current assets by current liabilities to determine the extent to which
current assets are likely to be sufficient for paying current liabilities.
• Because accounting is transaction-based, the balance sheet does not necessarily represent the
current value of a business. Some assets are not recorded because they do not arise from
transactions.
• The amounts recorded for assets and liabilities may not represent current values because under the
cost principle they generally are recorded at cost, using the exchange amounts established at the
time of the initial transaction.
Accounting Decision Tools
Current Ratio = Current Assets ÷ Current Liabilities
• It tells you whether current assets are sufficient to pay current liabilities.
• A higher ratio means better ability to pay.
Chapter Outline
Teaching Notes
I. Understand the Business
LO 2-1 Identify financial effects of common business activities that affect the balance sheet.
A. Building a Balance Sheet
1. Asset––Resources presently owned by a business that
generate future economic benefits.
In this chapter, the Retained
2. Liabilities––Amounts presently owed by a business
Earnings account has a zero
3. Stockholders’ equity––Amount invested and reinvested
in a company by its stockholders.
balance because there have
been no operating
4. Key activity for any start-up company is to obtain
financing.
transactions
a. Equity financing––Money obtained through owners’
contributions and reinvestments of profit; business is
not legally obligated to repay.
b. Debt financing––Money obtained through loans;
business is legally obligated to repay.
5. After obtaining initial financing, company will start
investing in assets that will be used when business opens.
6. Features important for understanding how accounting
works; a company always:
a. Documents its activities.
b. Receives something and gives something (basic
feature of all business activities).
c. Determines a dollar amount for each exchange based
on value of items given and exchanged.
i. Exchange is either to earn a profit immediately or
obtain resources that will allow it to earn a profit
later.
Fundamental idea of business
is to create value through
exchange.
ii. Any exchange that affects company’s assets,
liabilities, or stockholders’ equity must be captured
in and reported by the accounting system.
iii. A dollar amount is determined for each exchange
based on the value (cost) of items given and
received.
iv. Cost principle––At the time of a transaction,
assets and liabilities should be recorded at their
original cost to the company.
7. Accounting for business activities:
Illustrated in Exhibit 2.3
a. Picture the documented activity.
b. Name what’s exchanged
Ultimate goal––capture
c. Analyze the financial affects––Building on the last
step, show how the costs cause elements of the
accounting equation to increase and/or decrease.
financial effects so that they
can be reported in financial
statements.
Chapter Outline
Teaching Notes
B. Transactions and Other Activities
1. Transaction––An event or activity that has a direct and
measurable financial effect on the assets, liabilities, or
stockholders’ equity of a business.
2. Transactions include two types of events:
a. External exchanges––Exchanges involving assets,
liabilities, and/or stockholders’ equity that you can see
between the company and someone else.
b. Internal events––Events that do not involve exchanges
with others outside the business, but rather occur
within the company itself.
3. Exchange of only promises is not an accounting
transaction.
a. Documents are created to indicate activities occurred.
b. Later, when promises result in actually receiving or
giving an asset or services, they will become
transactions captured by the accounting system.
II. Study the Accounting Methods
LO 2-2 Apply transaction analysis to accounting transactions.
A. Step 1––Analyze Transactions
1. A systematic accounting process is used to capture and
report the financial effects of a company’s activities.
a. Process is called the accounting cycle; repeats itself
over and over.
b. Steps include: analyze, record, summarize, prepare
trial balance, and report financial statements.
2. Once a transaction is identified, it must be analyzed
carefully to determine its financial effects; two simple
ideas are used when analyzing transactions:
Analyze transactions from the
standpoint of the business,
not its owners.
a. Duality of effects––Every transaction has at least two
effects on the basic accounting equation.
b. The dollar amount for assets must always equal that
for liabilities plus stockholders’ equity for every
accounting transaction. A = L + SE.
c. As part of transaction analysis, name (or account title)
is given to each item exchanged.
d. Chart of accounts––A summary of all account names
(and corresponding account numbers) used to record
financial results in the accounting system.
Illustrated in Exhibit 2.4.
Chart of accounts shown in
Chapter 2 includes only
i. Ensures account titles are used consistently.
balance sheet accounts.
ii. Tailored to each company’s business.
iii. Many account titles are common across all
companies; others may be used only by a particular
company.
Chapter Outline
Teaching Notes
3. SonicGateway’s Business Activities
Stress that students should
(a) Issue Stock to Owners––Scott incorporates
SonicGateway and the company issues common stock
to Scott and Angus as evidence of their contribution of
$10,000 cash, which is deposited in the company’s
bank account.
not skip this section with the
plan of coming back to it
later; the next part of the
chapter builds on this part.
• Name:
SonicGateway has received $10,000 cash.
SonicGateway issues $10,000 of common stock.
• Analyze:
Assets = Liabilities + Stockholders’ Equity
Cash (A) +10,000 = Common Stock (SE) +10,000
(b) Invest in Equipment––SonicGateway pays $300 cash
for the company’s logo.
• Name:
SonicGateway has received a logo costing $300.
SonicGateway gave $300 cash.
• Analyze:
Assets = Liabilities + Stockholders’ Equity
Cash (A) −300 + Logo/Trademarks (A) +300 = 0
(c) Obtain Loan from Bank––SonicGateway borrows
$20,000 from a bank, depositing those funds in its
bank account and signing a formal agreement to repay
the loan in two years (on September 1, 2017).
Notes payable are like
accounts payable except
that they:
(a) charge interest,
• Name:
SonicGateway has received $20,000 cash.
SonicGateway gave a note, payable to the bank for
$20,000.
(b) can be outstanding for
periods longer than one
year, and
(c) are documented using
• Analyze:
Assets = Liabilities + Stockholders’ Equity
Cash (A) +20,000 = Note Payable (L) +20,000
formal documents called
notes.
(d) Invest in Equipment––SonicGateway purchases and
receives $9,600 in computers, printers, and desks,
signing a purchase order to indicate its promise to pay
$9,600 at the end of the month.
• Name:
SonicGateway has received $9,600 of equipment.
SonicGateway gave a promise to pay $9,600 on
account.
• Analyze:
Assets = Liabilities + Stockholders’ Equity
Equipment (A) +9,600 = Accounts Payable
+9,600
Chapter Outline
Teaching Notes
(e) Pay Supplier––SonicGateway pays $5,000 of its
promise to the equipment supplier in (d).
Stress that the company
would typically wait until the
• Name:
SonicGateway has received back its $5,000
promise to pay on account. SonicGateway gave
$5,000 cash.
end of the month to pay the
amount owed to the supplier.
• Analyze:
Assets = Liabilities + Stockholders’ Equity
Cash –5,000 = Accounts Payable –5,000
(f) Order Software for App––SonicGateway signs a
contract with a programmer for program code for the
Static Charge game app for $9,000. No code has been
received yet.
• Name:
An exchange of only promises is not a transaction.
This does not affect the accounting equation.
Not all business activities are
considered accounting
transactions.
• Analyze:
Assets = Liabilities + Stockholders’ Equity
No change = No change
(g) Receive Software––SonicGateway receives the
$9,000 of app game code ordered in (f); pays $4,000
cash, and promises to pay the remaining $5,000 next
month.
• Name:
SonicGateway has received software costing
$9,000. SonicGateway gave $4,000 cash and a
promise to pay $5,000 on account.
• Analyze:
Assets = Liabilities + Stockholders’ Equity
Cash (A) –4,000 + Software (A) +9,000 =
Accounts Payable (L) +5,000
✓ Supplemental Enrichment
Activity (Activity) #1
✓ Activity #2
(h) Receive Supplies––SonicGateway receives supplies
costing $600 on account.
• Name:
SonicGateway has received supplies costing $600.
SonicGateway gave a promise to pay $600 on
account.
• Analyze:
Assets = Liabilities + Stockholders’ Equity
Supplies (A) +600 = Accounts Payable (L) +600
Chapter Outline
Teaching Notes
B. Steps 2 and 3: Record and Summarize
1. One method for recording and summarizing the financial
effects of accounting transactions is to prepare a
spreadsheet.
Illustrated in Exhibit 2.5
a. By summing each spreadsheet column, the new
balances can be computed at the end of the month and
reported on a balance sheet.
b. This method is impractical for most large
organizations.
2. Most companies use computerized accounting systems,
which can handle a large number of transactions.
a. These systems follow the accounting cycle, which is
repeated month-after-month and year-after-year.
Illustrated in Exhibit 2.6
b. Three-step analyze-record-summarize process is
applied to daily transactions, as well as adjustments at
the end of each month, before preparing a trial balance
and financial statements; same three steps are part of
the closing processes that occurs at the end of each
year.
Focus here is on applying the
three-step process during the
period to activities that affect
only balance sheet accounts.
3. Transactions are analyzed, and their financial effects are
entered into journals each day they occur. Later, these
journal entries are summarized in ledger accounts that
keep track of the financial effects on each account.
a. Journal––Used to record the effects of each day’s
transactions; organized by date.
b. Ledger––Used to summarize the effects of journal
entries on each account; organized by account.
LO 2-3 Use journal entries and T-accounts to show how transactions affect the balance sheet.
C. The Debit/Credit Framework
✓ Activity #3
1. The accounting equation (A = L + SE) can be thought of
as a scale that tips at the equals sign; assets are put on the
left side of the scale and liabilities and stockholders’
equity accounts are put on the right.
✓ Activity #4
2. Each individual account has two sides, with one side used
for increases and the other for decreases.
3. Accounts increase on the same side as they appear in A =
L + SE (decreases are the opposite):
a. Assets increase on the left side of the account.
b. Liabilities increase on the right side of the account.
c. Stockholders’ equity accounts increase on the right
side of the account.
4. Debit (dr)––The left side of an account, or the act of
entering an amount into the left side of an account.
5. Credit (cr)––The right side of an account, or the act of
entering an amount into the right side of an account.
Chapter Outline
Teaching Notes
6. When combined with how increases and decreases are
entered into accounts, the following rules emerge:
a. Use debits for increases in assets (and for decreases in
liabilities and stockholders’ equity accounts).
Illustrated in Exhibit 2.7
b. Use credits for increases in liabilities and
stockholders’ equity accounts (and for decreases in
assets).
7. Normal balance––the side on which an account increases.
a. Assets accounts normally have debit balances.
b. Liabilities and stockholders’ equity accounts normally
have credit balances.
8. In addition to requiring that A = L + SE, the double-entry
system also requires that debits = credits.
a. Step 1: Analyzing Transactions––The debit/credit
framework does not change this step.
b. Step 2: Recording Journal Entries––The financial
effects of transactions are entered into a journal using
a debits-equal-credits format.
9. Journal entries––Indicate the effects of each day’s
transactions in a debits-equal-credits format.
Illustrated in Exhibit 2.8
a. A date is included for each transaction.
b. Debits appear first; credits are written below the debits
and are indented to the right (words and amounts).
c. Total debits must equal total credits.
d. Dollar signs are not used.
e. The reference column (Ref.) will be used later (in step
3) to indicate when the journal entry has been
summarized in the ledger accounts.
f. A brief explanation of the transaction is written below
the debits and credits.
g. The line after the description is left blank.
D. Step 3: Summarizing in Ledger Accounts:
1. After journal entries have been recorded (in step 2), their
dollar amounts are copied (“posted”) to each ledger
account affected by the transaction so that account
balances can be computed.
Illustrated in Exhibit 2.9
2. The posting of journal entries to general ledger accounts
is kept track of by writing the account number in the Ref.
column of the journal and the journal page number in the
Ref. column of the ledger.
✓ Activity #5
3. T-account––Simplified version of a ledger account used
for summarizing the effects of journal entries.
Illustrated in Exhibit 2.10
a. Every account starts with a beginning balance
normally on the side where increases are summarized.
b. Dollar signs are not needed.
c. Each amount is accompanied by a reference to the
related journal entry, which makes it easy to trace
back to the original transaction should errors occur.