Chapter 2 Investing and Financing Decisions and the Accounting System What Business Activities Cause Changes in Financial Statement Amounts I Nature of Business Transactions a Transactions are events recorded as part of the accounting process b Transactions include two types of events i External events are exchanges of assets good or services by one party for the same or promises to pay liabilities from one or more other parties 1 Ex sale of merchandise ii Internal Events include events that aren t exchanges between the business and other parties but nevertheless have a direct and measurable effect on the entity 1 Ex using up insurance paid in advance c Signing a contract isn t considered an accounting transaction i Only the exchange of promises and not assets a Standardized format to accumulate the dollar effect of transactions on each financial statement item b Chart of accounts is a list of all account titles and their unique c Usually organized by financial statement element listed in this order II Accounts numbers i Asset ii Liability iii Stockholders equity iv Revenue v Expense accounts d Fits the nature of its business activities e Trade Accounts Receivable is the same as Accounts Receivable f Merchandise Inventory is the same as Inventory Chapter 2 Investing and Financing Decisions and the Accounting System How Do Transactions Affect Accounts I Principles of Transaction Analysis a Process of studying a transaction to determine its economic effect on the entity in terms of the accounting equation aka fundamental accounting model b Assets A Liabilities L Stockholders Equity SE c Two principles underlying the transaction analysis i Every transaction affects at least two accounts 1 Must ID those accounts and the direction of the effect ii The accounting equation must remain in balance after each transaction d Success in performing transaction analysis depends on a clear understanding of these principles e Dual effects i Idea that every transaction has at least two effects on the basic accounting equation ii Most transactions with external parties involve an exchange by which the business both receives something and gives up something in return f Balancing the Accounting Equation i Total assets must be equal to total liabilities and SE ii If all correct accounts have been IDed and the appropriate direction of the effect on each account determined in balance iii Systematic transaction analysis for investing and financing activities includes these steps 1 Ask what was received and what was given a ID account affected by title b Classify by type of account c Determine direction of effect 2 Verify accounting equation is in balance II Analyzing Chipotle s Transactions a The following events are during the first quarter of 2012 b Account titles are from the balance sheet and for simplicity are in the thousands c Chipotle issued 10 000 additional shares of common stock receiving 62 300 in cash from investors i Each share of common stock usually has a par value nominal low printed on the face of the certificate 1 Par value legal amount per share est by the board of directors It has no relationship to the market price of the stock a Significance establishes the minimum amount that a stockholder must contribute ii When a corporation issues common capital stock the amount received affects two separate accounts Chapter 2 Investing and Financing Decisions and the Accounting System 1 The Common Stock account for the of shares times the par value per share a CS of shares x par value per share 2 Additional Paid in Capital or Contributed Capital in Excess of Par for the excess received above par d Chipotle borrowed 2 000 from its local bank signing a note to be paid in three years i Companies that need cash often 1 Sell stock to investors as in transaction or 2 By borrow from creditors as in transaction e Chipotle purchased new ovens counters refrigerators and other equipment costing 63 100 paid 55 100 in cash and signed a note for the rest i Investing activities are purchasing selling property equipment and investments in stock of other companies ii Sometimes more than two accounts can be affected f Chipotle paid 400 to the local bank on the amount borrow above ignore interest cash i g Chipotle purchased the stock of other companies paying 60 400 in Intends to hold 20 900 of the stock as long term investments and the rest as short term investments h Assume Chipotle s board of directors declared that the Company will pay 3 000 in cash as dividends to shareholders next quarter i Reinvests profits into growing the business and doesn t pay the dividends Chapter 2 Investing and Financing Decisions and the Accounting System How Do Companies Keep Track of Account Balances I The Accounting Cycle a During the period i Analyze transactions ii Record journal entries in the general journal iii Post amounts to the general ledger b At the End of the Period i Prepare a trial balance ii Adjust revenues and expenses 1 Record in journal and post to ledger iii Prepare financial statements a disseminate them to users iv Close revenues expenses gains and losses to retained earnings 1 Record in journal and post to ledger c Effects are first recorded in the general journal i Listing in chronological order of each transaction s effects d The accounts are updated by posting the effects from the general journal in the general ledger to determine account balances i Record of effects to and balances of each account e The formal records are based on journal entries and T accounts i Foundation for understanding account system and future accounting coursework II The Direction of Transaction Effects a Basic Transaction T Analysis Model Increases in asset accounts are on the left Increases in liability and SE accounts are on the right i ii iii Debit dr always on the left iv Credit cr always on the right v Asset accounts increase on the left debit side and Assets many accounts normally have debit balances Liabilities many accounts Stockholders Equity Contributed Capital 2 accts Debit Credit Debit Credit Common Stock Additional Paid in Capital Credit Investment by owners Earned Capital 1 act Retained Earnings Debit Credit Dividends Net Declared Income vi Liability and SE accounts increase on the right credit side and normally have credit balances b Assets are accounts with debit balances c Liabilities and SE accounts have credit balances Chapter 2 Investing and Financing Decisions and the Accounting System d The total dollar
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