Investing and Financing Decisions and the Balance Sheet

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Chapter 2

• Investing and Financing Decisions and the Balance
  Sheet

2
The Conceptual Framework
Objective of External Financial Reporting To
provide useful economic information to external
users for decision making and for assessing
future cash flows.
3
The Conceptual Framework
Objective of External Financial Reporting To
provide useful economic information to external
users for decision making and for assessing
future cash flows.

• Primary Characteristics
• Relevancy predictive value,
• feedback value, and timeliness.
• Reliability verifiability,
• representational faithfulness, and
• neutrality.
• Secondary Characteristics
• Comparability across
• companies.
• Consistency over time.

Elements of Statements Asset Liability Stockholder
s Equity Revenue Expense Gain Loss
Qualitative Characteristics Relevancy Reliability
Comparability Consistency
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The Conceptual Framework
Asset economic resource with probable
future benefit. Liability probable future
sacrifices of economic resources. Stockholder
s Equity financing provided by owners and
operations. Revenue increase in assets or
settlement of liabilities from ongoing
operations. Expense decrease in assets or
increase in liabilities from ongoing
operations. Gain increase in assets or
settlement of liabilities from peripheral
activities. Loss decrease in assets or
increase in liabilities from peripheral
activities.
Objective of External Financial Reporting To
provide useful economic information to external
users for decision making and for assessing
future cash flows.
Qualitative Characteristics Relevancy Reliability
Comparable Consistent
Elements of Statements Asset Liability Stockholder
s Equity Revenue Expense Gain Loss
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The Conceptual Framework
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 (). Time period The long life of a company
can be reported over a series of shorter time
periods.
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The Conceptual Framework
Principles Historica
l cost Cash equivalent cost given up is the
basis for initial recording of
elements. Revenue recognition Record when
measurable, realizable (transaction
takes place and collection probable),
and earned (substantially accomplished
what is necessary to be entitled to
benefits). Matching Record expenses when
incurred in earning revenue. Full disclosure
Provide information sufficiently important
to influence a decision.
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The Conceptual Framework
Constraints Cost-be
nefit Benefits to users should outweigh costs of
providing information. Materiality
Relatively small amounts not likely to
influence decisions are to be recorded in most
cost beneficial way. Industry peculiarities
Industry specific measurements and
reporting deviations may be acceptable. Conservati
sm Exercise care not to overstate assets
and revenues or understate liabilities and
expenses.
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Nature of Business Transactions
External events exchanges of assets and
liabilities between the business and one or more
other parties.
Internal events not an exchange between the
business and other parties, but have a direct
effect on the accounting entity.
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Accounts

• An organized format used by companies to
  accumulate the dollar effects of transactions.

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Principles of Transaction Analysis

• Every transaction affects at least two accounts
  (duality of effects).
• The accounting equation must remain in balance
  after each transaction.

A L SE
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Balancing the Accounting Equation

• 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.

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Direction of Transaction Effects

• The left side of the
• T-account is always the debit side.

The right side of the T-account is always
the credit side.
Account Name
Left
Right
Debit
Credit
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The Debit-Credit Framework
Debits and credits affect the Balance Sheet Model
as follows
A L SE
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Analytical Tool The Journal Entry
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Updating the General Ledger

• After journal entries are prepared, the
  accountant posts (transfers) the dollar amounts
  to each account that was affected by the
  transaction.

Ledger
Post
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Focus on Cash Flows
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Financial Leverage Ratio
Average Total Assets Average
Stockholders Equity
Financial Leverage Ratio