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Solution Manual for Fundamentals of Financial Accounting, 5th Edition

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    Instructor’s Resource Manual, Chapter 1 1 - 1 CHAPTER 1 BUSINESS DECISIONS AND FINANCIAL ACCOUNTING Student Learning Objectives and Related Assignment Materials Student Learning Objectives Mini - Exercises Exercises Coached Problems Problems (Groups A & B) Skills Development Cases Continuing Case LO1 - 1 Describe various organizational forms and business decision makers. 2 1 * , 2, 3 LO1 - 2 Describe the purpose, structure, and content of the four basic financial statements. 2, 3, 4 , 5, 6, 7, 8, 9, 10, 11, 12 * , 13 , 14 , 15^, 16 1, 2, 3 * , 4, 5, 6 * , 7, 8 * , 9, 10, 11, 12 1, 3 A1, A3, B1, B3 1 * , 2, 3, 4, 6, 7 1 † LO1 - 3 Explain how financial statements are used by decision makers . 1 6 3 * , 4, 6 * , 9, 10 2 , 4 A2, A4, B2 , B4 1 * , 2, 3, 4, 6 1 † LO1 - 4 Describe factors that contribute to useful financial information . 1, 2, 3 4, 5 , 6 * 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. † C ontinuing Case 1 - 1 introduces Nicole Mackisey, who is thinking of forming her own spa business, Nicole’s Getaway Spa . This case focuses on preparing a (forecasted) income statement, statement of retained earnings, and balance sheet for the business. The case will be extended in future chapters. Overview A real entrepreneur meets with his local CPA, who walks him through the decisions he must make when planning his business. Students discover the role of accounting, with an emphasis on financial statement reporting and use.

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    1 - 2 Fundamentals of Financial Accounting, 5/e Synopsis of Chapter Revisions • New contemporary focus company: replaced pizza company with SonicGateway — a private company that develops game apps for smartphones and tablets • New description of financial statement users, with new illustration (Exhibit 1.2) • Revision to account names to match streamlined chart of accounts • Updated IFRS map in Spotlight on the World • Expanded discussion of conceptual framework, with new illustration (Exhibit 1.9) • Updated demonstration case featuring Under Armour • Reviewed and updated all end - of - chapter material, including new exercise and problem formats to expand number of algorithmic online problems PowerPoint Slides Student Learning Objective PowerPoint® Slides LO1 - 1 Describe various organizational forms and business decision makers. 1 - 3 through 1 - 6 LO1 - 2 Describe the purpose, structure, and content of the four basic financial statements. 1 - 7 through 1 - 22 LO1 - 3 Explain how financial statements are used by decision makers. 1 - 23 through 1 - 24 LO1 - 4 Describe factors that contribute to useful financial information. 1 - 25 through 1 - 28 LO1 - S1 Accounting Careers 1 - 29 through 1 - 30 Animated Builds and Animated Solutions PowerPoint® Slides Mini - Exercise 1 - 12 1 - 32 through 1 - 33 Exercise 1 - 3 1 - 34 through 1 - 35 Exercise 1 - 6 1 - 36 through 1 - 38 Exercise 1 - 8 1 - 39 through 1 - 40 Skills Development Case 1 - 6 (Requirement 1) 1 - 41 through 1 - 42

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    Instructor’s Resource Manual, Chapter 1 1 - 3 Chapter Summary LO 1 - 1 Describe various organizational forms and business decision makers. • Sole proprietorships are owned by one individual, are relatively inexpensive to form, and are not treated legally as separate fro m their owners. Thus, all profi ts or losses become part of the taxable income to the owner , who is also responsible personally for all debts of the business. • Partnerships are businesses similar legally to proprietorships, but with two or more owners. • Corporations are separate legal entities (thus, corporations pay taxes) that issue shares of stock to investors (stockholders) and are more costly to establish. Stockholders cannot be held liable for more than their investment in the corporation. Private corporations issue stock to a few individuals while public corporations issue stock in the stock market. • Business decision makers include creditors (banks, suppliers), investors (stockholders), customers, governments, and other external users. LO 1 - 2 Describe the purpose, structure, and content of the four basic financial statements. • The income statement reports the net amount that a business earned (net income) over a period of time by subtracting the costs of running the business (expenses) from the total amount earned (revenues). • The statement of retained earnings explains changes in the R etained E arnings account over a period of time by considering increases (from net income) and decreases (from dividends to stockholders). • The balance sheet reports what the business owns (reported as assets) at a particular point in time and whether the financing for these assets came from creditors (reported as liabilities) or stockholders (reported as stockholders’ equity). • The statement of cash flows explains changes in the cash account over a period of time by reporting inflows and outflows of cash from the business’s operating, investing, and financing activities. LO 1 - 3 Explain how financial statements are used by decision makers. • Creditors are mainly interested in assessing whether the company (1) is generating enough cash to make payments on its loan, and (2) has enough assets to cover its liabilities. Answers to these questions are indicated by the statement of cash flows and the balance sheet. • Investors look closely at the income statement for information about a company’s ability to generate profits, and at the statement of retained earnings for information about a company’s dividend distributions. LO 1 - 4 Describe factors that contribute to useful financial information . • Companies generate useful financial information by applying G enerally A ccepted A ccounting P rinciples (GAAP) or International Financial Reporting Standards (IFRS) in an ethical business environment. • To be useful, information must be relevant and a faithful representation of reality. Information is more useful when it is comparable, verifiable, timely, and understandable.

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    1 - 4 Fundamentals of Financial Accounting, 5/e Chapter Outline Teaching Notes Provide a learning strategy Overview the textbook:  You Should Know (m arginal boxes )  Coach’s Tip (marginal boxes)  Review the Chapter — Demonstration C ase  Chapter S ummary  Key T erms Highlight and demo the student edition of the textbook web site at www.mhhe.com/phillip s4 e :  Practice Quizzes  Narrated slides  iPod Content I. Understand the Business LO 1 - 1 Describe various organizational forms and business decision makers. A . Organizational Forms: 1. S ole proprietorship — A business owned (and usually operated) by one individual . 2. P artnership — Similar to a sole proprietorship, except that profits, taxes, and legal liability are the responsibility of two or more owners instead of just one. 3. C orporation — A separate entity from both a legal and accounting perspective. The corporation, not its owners, is legally responsible for its own taxes and debts. Thus, owners cannot lose more than their investment in the corporation. This text book focuses on corporations. 4 . Other — Other organizational forms exist, such as a limited liability company (LLC), which combines characteristics of a partnership and a corporation. B. Accounting for Business Decisions 1. Most companies exist to earn profits for their stockholders ; profits are earned by selling goods or services to customers for more than they cost to produce. 2. Accounting — S ystem of analyzing, recording, and summarizing the results of a business’s activities and then reporting the results to decision makers. 3. Business people talk about their companies using accounting terms; accounting is the “language of business. ” 4. Every organization needs accountants to assist in reporting financial information for decision making and to help its owners understand the financial effects of those business decisions.

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    Instructor’s Resource Manual, Chapter 1 1 - 5 Chapter Outline Teaching Notes 5 . The accounting system produces two kinds of reports: a. Managerial accounting reports — I nclude detailed financial plans and continually updated reports about the financial performance of the company. These reports are made available only to employees of the company so that they can make business decisions. b. Financial accounting reports — C alled financial statements : i. P repared periodically to provide information to people not employed by the business. ii. E xternal financial statement users aren’t given access to detailed internal records of the company, so they rely extensively on the financial statements 6 . Users of financial information: Illustrated in Exhibit 1. 2 a. Creditors — S uppliers, banks, and anyone to whom m oney is owed . b. Investors — E xisting and potential future stockholders. c . Directors — M embers of a company’s board of directors; elected by stockholders to oversee the company’s managers. c. Government agencies — Include the Securities and Exchange Commission and Internal Revenue Service. II. Study t he Accounting Methods LO 1 - 2 Describe the purpose, structure, and content of the four basic financial statements. A. The Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity Describe as “what a company owns must equal 1. Separate entity assumption — The financial reports of a business are assumed to include the results of only that business’s activities. what a company owes to its creditors and stockholders.” 2. Asset — E conomic resource presently controlled by the company; it has measureable value and is expected to benefit the company by producing cash inflows or reducing cash outflows in the future. To decide: Does company own /have legal rights to it ? If yes, will it have benefit beyond the end of the current 3. Liabilities — M easurable amounts that the company owes to creditors. month? If so, it’s an asset. 4. Stockholders’ Equity — Represents t he owners’ claims on the business; claims arise for two reasons: a. First, the owners have a claim on amounts they contributed directly to the business in exchange for its stock ( Common Stock ). b. Second, the owners have a claim on amounts the company has earned through profitable business operations ( R etained E arnings).

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    1 - 6 Fundamentals of Financial Accounting, 5/e Chapter Outline Teaching Notes c . Profits are generated when the total amount earned from selling goods and services (revenues) is greater than all the costs incurred to generate those sales (expenses). i. Revenues — Earned by selling goods or services to customers. ii. Expenses — All costs of doing business that are necessary to earn revenues. iii. Net Income (or profit ) — Revenues minus expenses (net loss if revenues are less than expenses); net income increases stockholders’ equity. iv. Dividends — Distribution of a company’s profits to its stockholders; not an expense incurred to generate earnings. B. Financial Statements ✓ Supplemental Enrichment 1 . Reports prepared at any time during year. Activity (Activity) #1 a. Mos t commonly monthly, quarterly, and annually using calendar year or fiscal year (a 12 - month period ending on a day other than December 31). b . Each financial statement has a heading ( name of company, name of statement, and time period ) . c. E ach major caption has an underlined subtotal ; “bottom line” amount has a double underline. d. A dollar sign appears at the top and bottom of each column of numbers. 2 . There are four basic financial statements: Summarized in Exhibit 1. 8 a. Income statement — R eports the amount of revenues less expenses for a period of time. i. Unit of measure assumption — R esults of business activities should be reported in an appropriate monetary unit . ii. Accounts — A ccumulate and report the effects of each different business activity. iii. When listing the accounts on the income statement, revenues are on top ( largest, most relevant revenue listed first ), then expenses are subtracted, from largest to smallest ( except that Income Tax Expense is the last expense listed ) . Illustrated in Exhibit 1. 3 Other income statement formats are possible, as explained in Chapter 6. iv. Revenues – Expenses = Net Income (or Net Loss) b. S tatement of retained earnings — R eports the way that net income and the distribution of dividends affected the financial position during the period. Illustrated in Exhibit 1. 4 i. Retained earnings are profits that have accumulated over a period of time. ii. Beginning balance of retained earnings + N et income (or – N et loss) – D ividends = E nding balance of retained earnings

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    Instructor’s Resource Manual, Chapter 1 1 - 7 Chapter Outline Teaching Notes c. B alance sheet — R eports the amount of assets, liabilities, and stockholders’ equity of a business at a specific point in time ; it “balances.” Illustrated in Exhibit 1.5 ✓ Activity #2 i. Assets = L iabilities + S tockholders’ equity ii. Assets listed in order of how soon they are to be u sed or converted into cash; liabilities in order of how soon each is to be paid or settled. d. Statement of cash flows — R eports the operating, investing, and financing activities that caused increases and decreases in cash during the period. Illustrated in Exhibit 1.6 ✓ Activity #3 i. Operating — Activities directly related to running the business to earn profit. ii. Investing — Activities involving buying and selling productive resources with long lives, purchasing investments, and lending to others. iii. Financing — Any borrowing from banks, repaying bank loans, receiving cash from stockholders for company stock, or paying dividends to stockholders. e. Notes to the Financial Statements (footnotes) — Help financial statement users understand how the amounts were derived and what other information may affect their decisions. 3 . The four basic financial statements connect to one another: ✓ Activity #4 a. Net income , from the income statement, is a component in determining ending R etained E arnings on the statement of r etained e arnings . Illustrated in Exhibit 1. 7 b. Ending R etained E arnings is then reported on the balance sheet. c. Cash on the balance sheet is equal to the ending Cash reported on the statement of cash flows. III. Evaluate t he Results LO 1 - 3 Explain how financial statements are used by decision makers. A. Using Financial Statement s 1 . Creditors — Interested in assessing two things: a. Is the company generating enough cash to make payments on its loans? Answers come from statement of cash flows. b. Does the company have assets to cover its liabilities? Answers come from comparing assets and liabilities reported on the balance sheet.

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    1 - 8 Fundamentals of Financial Accounting, 5/e Chapter Outline Teaching Notes 2 . Investors — Expect a return on their contribution to the company: a. Return may be immediate (through dividends) or long - term (through selling stock certificates at a price higher than their original cost) . b. Looks closely at the income statement (and statement of retained earnings) for information about the company’s ability to generate profits (and distribute dividends) . LO 1 - 4 Describe factors that contribute to useful financial information. B. Useful Financial Information 1 . Generally Accepted Accounting Principles (GAAP ) — Rules of accounting created by the Financial Accounting Standards Board for use in the United States. a. Financial Accounting Standards Board (FASB) — Currently has primary responsibility for setting the underlying rules of accounting. b. Accounting rules in U.S. are similar to those used elsewhere, with some important differences ; FASB works alongside International Accounting Standards Board (IASB) to eliminate differences. 2. M ain goal of GAAP and IFRS is to ensure companies produce financial information that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the companies. 3. For financial information to be judged useful, it must possess two fundamental characteristics: Illustrated in Exhibit 1. 9 a. R elevance — Information makes a difference in decision making . b. Faithful representation — Information fully depicts the economic substance of business activities. 4. Usefulness is enhanced when it is: a. Timely — If it is a vailable in time to influence decision makers. b. Verifiable — If others, such as external auditors, reach similar values using similar methods. c. Comparable — If the same accounting principles are used over time and across companies. d. Understandable — If reasonably informed users can comprehend and interpret it.

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    Instructor’s Resource Manual, Chapter 1 1 - 9 Chapter Outline Teaching Notes 5 . Ethical Conduct ✓ Activity #5 a. Ethics — The standards of conduct for judging right from wrong, honest from dishonest, and fair from unfair. b. Intentional financial misreporting is both unethical and illegal. c . T he American Institute of Certified Public Accountants (AICPA) requires all its members to adhere to a Code of Professional Conduct to help ensure these decisions are made in a p rofessional and ethical manner . d. Regardless of the above, some individuals have been involved in accounting scandals and fraud. e . Sarbanes - Oxley Act (SOX) — A set of laws established to strengthen corporate reporting in the United States ; it requires top managers of public companies to: i. S ign a report certifying their responsibilities for the financial statements , ii. M aintain an audited system of internal controls to ensure accuracy in the accounting reports, and Iii. M aintain an independent committee to ensure that managers cooperate with auditors. f. Ethical conduct is just as important for small private businesses as it is for large public companies. g . When faced with an ethical dilemma, follow a three - step process: The “Stoplight on Ethics” feature summarizes recent i . Identify who will benefit from the situation (often the manager or employee) and how others will be harmed (other employees, the company’s reputation, owners, creditors, and the public in general). scandals. ii . Identify the alternative courses of action. iii . Choose the alternative that is the most ethical ; that you would be proud to h ave reported in the news. IV. Supplement 1A – Careers That Depend o n Accounting Knowledge Overviewed in Exhibit 1S.1

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    1 - 10 Fundamentals of Financial Accounting, 5/e Supplemental Enrichment Activities Note: These activities would be suitable for individual or group activities. 1. Handout 1 – 1 Use this h andout for an in - class activity designed to review the classification of various account s, elements, or transactions on the financial statements. The solution follows the handout master. 2. Handout 1 – 2 Use this h andout for an in - class activity designed to review the classification of various account names on the balance sheet. The solution follows the handout master. 3. Handout 1 – 3 Use this h andout for an in - class activity designed to review the classification of various transactions on the statement of cash flows. The solution follows the handout master. 4. Handout 1 – 4 Use this h andout for an in - class activity designed to review the individual financial statements and the relationships among the financial statements. The solution follows the handout master. 5. Consider showing the first segment of the following video in class; most students will be able to identify with the “fraudster.” Lively discussion of the manner in which the fraud was perpetrated will follow. The Association of Certified Fraud Examiners produced a video in 1991 called “ Cooking the Books: What Every Accountant Should Know a bout Fraud .” It can be ordered by calling 1 - 800 - 245 - 3321 or visit ing the ACFE web site at www.cfenet.com . (Consider joining as an educator to obtain a discounted rate.) Three frauds are overviewed: ZZZZ Best Carpet, Regina Vacuum Cleaner Company, and ESM Group, Inc. (ESM Government Securities). ZZZZ Best Carpet might be the best one to use. Barry Minkow, the CEO and major stockholder, is interviewed in prison. The video segment discusses revenue overstatements, deferred costs, asset valuations, inadequate disclosures, and horizontal and vertical analysis. It is very well done. (Note that the discussion of ratio analysis and trends would also be appropriate for Chapter 13 — Measuring and Evaluat ing Financial Performance.).

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    Instructor’s Resource Manual, Chapter 1 1 - 11 HANDOUT 1 – 1 COMPONENTS OF FINANCIAL STATEMENTS Match each account, element, or transaction to the financial statement(s) on which it would be reported. Account or Element Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash Flows a. The amount of cash paid for equipment b. Cash c. Notes Payable d. Common Stock e. Supplies f . The amount of cash collected from customers g . Accounts Receivable h . Notes Payable i . Salaries and Wages Expense j . Equipment k . Dividends paid to stockholders l . Net Income

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    1 - 12 Fundamentals of Financial Accounting, 5/e HANDOUT 1 – 1 SOLUTION COMPONENTS OF FINANCIAL STATEMENTS Match each account, element, or transaction to the financial statement(s) on which it would be reported. Account or Element Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash Flows a. The amount of cash paid for equipment X b. Cash X c. Notes Payable X d. Common Stock X e. Supplies X f . The amount of cash collected from customers X g . Accounts Receivable X h . Notes Payable X i . Salaries and Wages Expense X j . Equipment X k . Dividends paid to stockholders X X l . Net Income X X

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    Instructor’s Resource Manual, Chapter 1 1 - 13 HANDOUT 1 – 2 BASIC BALANCE SHEET ELEMENTS Match each account to its classification on the balance sheet . Account Asset Liability Stockholders’ Equity a. Notes Payable b. Cash c. Common Stock d. Supplies e. Accounts Receivable f. Accounts Payable g. Equipment h. Notes Payable i. Retained Earnings

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    1 - 14 Fundamentals of Financial Accounting, 5/e HANDOUT 1 – 2 SOLUTION BASIC BALANCE SHEET ELEMENTS Match each account to its classification on the balance sheet . Account Asset Liability Stockholders’ Equity a. Notes Payable X b. Cash X c. Common Stock X d. Supplies X e. Accounts Receivable X f. Accounts Payable X g. Equipment X h. Notes Payable X i. Retained Earnings X

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    Instructor’s Resource Manual, Chapter 1 1 - 15 HANDOUT 1 – 3 STATEMENT OF CASH FLOWS Match each activity to its classification on the statement of cash flows . Activity Operating Investing Financing a. Cash paid to employees and suppliers b. Cash used to buy equipment and software c. Cash dividends paid to stockholders d. Cash received from customers e. Cash received from selling equipment f. Cash borrowed from the bank

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    1 - 16 Fundamentals of Financial Accounting, 5/e HANDOUT 1 – 3 SOLUTION STATEMENT OF CASH FLOWS Match each activity to its classification on the statement of cash flows . Activity Operating Investing Financing a. Cash paid to employees and suppliers X b. Cash used to buy equipment and software X c. Cash dividends paid to stockholders X d. Cash received from customers X e. Cash received from selling equipment X f. Cash borrowed from the bank X

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    Instructor’s Resource Manual, Chapter 1 1 - 17 HANDOUT 1 – 4 TEAM PROJECT — OVERVIEW OF FINANCIAL STATMENTS Complete the following table. Financial Statement Purpose Equation Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash Flows RELATIONSHIPS AMONG FINANCIAL STATEMENTS Then, answer the following questions . 1. How does the income s tatement tie to the statement of retained earnings? 2. H ow does the statement of r etained earnings tie to the balance sheet? 3. How does the balance sheet tie to the statement of cash flows?

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    1 - 18 Fundamentals of Financial Accounting, 5/e HANDOUT 1 – 4 SOLUTION TEAM PROJECT — OVERVIEW OF FINANCIAL STATEMENTS Complete the following table. Financial Statement Purpose Equation Income Statement The financial performance of the business during the current accounting period. Revenues – Expenses = Net Income Statement of Retained Earnings The accumulation of earnings retained in the business during the current accounting period with that of prior periods. Beginning Retained Earnings + Net Income (this period) – Dividends (this period) = Ending Retained Earnings Balance Sheet The financial position of a business at a point in time. Assets = L iabilities + Stockholders ’ Equity Statement of Cash Flows Inflows (receipts) and outflows (payments) of cash during the current accounting period. +/ – Cash Flows from Operating Activities +/ – Cash Flows from Investing Activities +/ – Cash Flows from Financing Activities = Change in Cash + Beginning Cash = Ending Cash RELATIONSHIPS AMONG FINANCIAL STATEMENTS Then, answer the following question s. 1. How does the income statement tie to the statement of retained earnings? Net income , from the income statement, is a component in determining ending retained earnings on the statement of R etained E arnings . 2. How does the statement of retained earnings tie to the balance sheet? Ending r etained earnings on the statement of retained earnings is reported in the stockholders’ equity section of the balance sheet. 3. How does the balance sheet tie to the statement of cash flows? Cash on the balance sheet is equal to the ending Cash reported on the statement of cash flows.

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    Instructor’s Resource Manual, Chapter 2 2 - 1 C HAPTER 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 balanc e 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. † C ontinuing 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.

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    2 - 2 Fundamentals of Financial Accounting, 5/e 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 - 1 9 LO 2 - 3 Use journal entries and T - accounts to show how transactions affect the balance sheet. 2 - 20 through 2 - 3 4 LO 2 - 4 Prepare a trial balance and a classified balance sheet. 2 - 35 through 2 - 3 7 LO 2 - 5 Interpret the balance sheet using the current ratio and an understanding of related concepts. 2 - 3 8 through 2 - 40 Animated Builds and Animated Solutions PowerPoint® Slides Mini - Exercise 2 - 13 2 - 42 through 2 - 4 3 Mini - Exercise 2 - 15 2 - 4 4 through 2 - 4 5 Mini - Exercise 2 - 17 2 - 46 through 2 - 4 7 Mini - Exercise 2 - 19 2 - 4 8 through 2 - 4 9 Exercise 2 - 4 2 - 50 Exercise 2 - 6 2 - 51 through 2 - 52

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    Instructor’s Resource Manual, Chapter 2 2 - 3 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 w hether current assets are sufficient to pay current liabilities .

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    2 - 4 Fundamentals of Financial Accounting, 5/e • A higher ratio means better ability to pay .

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    Instructor’s Resource Manual, Chapter 2 2 - 5 Chapter Outline Teaching Notes I. Understand the Busines s LO 2 - 1 Identify financial effects of common business activities that affect the balance sheet. A . Building a Balance Sheet 1. Asset – – R esources presently owned by a business that generate future economic benefits. In this chapter, the R etained 2. Liabilities –– A mounts presently owed by a business E arnings account has a zero 3. Stockholders’ e quity –– A mount 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 obtain ed through owners’ contributions and reinvestments of profit ; business is not legally obligated to repay . b. Debt financing –– Money obtain ed 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 (b asic feature of all business activities ) . c. Determines a d ollar 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 . F undamental idea of business is to create value through exchange . ii. A ny 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 – – A t 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.

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    2 - 6 Fundamentals of Financial Accounting, 5/e Chapter Outline Teaching Notes B . Transactions and Other Activities 1. Tr ansaction – – 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 t wo 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 occur red . 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 activitie s. 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 ; t wo 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 s ummary 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.

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    Instructor’s Resource Manual, Chapter 2 2 - 7 Chapter Outline Teaching Notes 3 . SonicGateway ’s Business Activities Stress that students should (a) Issue Stock to Owners –– Scott incorporates SonicGateway and t he company issues common stock to Scott and Angus as evidence of their contribution of $1 0,000 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 $1 0,000 cash. SonicGateway issues $1 0,000 of common stock . • Analyze: Assets = Liabilities + Stockholders’ Equity Cash (A) + 1 0,000 = Common Stock (SE) + 1 0,000 (b) Invest in Equipment –– SonicGateway pays $ 3 00 cash for the company’s logo. • Name : SonicGateway has received a logo costing $300. SonicGateway gave $3 00 cash. • Analyze: Assets = Liabilities + Stockholders’ Equity Cash (A) − 3 00 + Logo/Trademarks (A) + 3 00 = 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, 201 7 ) . 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 p eriods longer than one year, and (c) are documented using • Analyze: Assets = Liabilities + Stockholders’ Equity Cash (A) + 20,000 = N ote 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 $ 9,6 00 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) + 9,6 00 = Accounts Payable + 9,6 00

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    2 - 8 Fundamentals of Financial Accounting, 5/e Chapter Outline Teaching Notes (e) P ay Supplier –– SonicGateway pays $ 5,0 00 of its promise to the equipment supplier in (d). Stress that the company would typically wait until the • Name : SonicGateway has received back its $ 5,00 0 promise to pay on account. SonicGateway gave $ 5,0 00 cash . end of the month to pay the amount owed to the supplier. • Analyze: Assets = Liabilities + Stockholders’ Equity Cash – 5,0 00 = Accounts Payable – 5,0 00 (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 c hange = No c hange (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 soft ware 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 + Soft ware (A) + 9,00 0 = 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

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    Instructor’s Resource Manual, Chapter 2 2 - 9 Chapter Outline Teaching Notes B. Steps 2 a nd 3: Record a nd 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. T hree - 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. F ocus 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. L edger –– U sed to summarize the effects of journal entries on each account ; o rganized 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 scal e that tips at the equals sign; a ssets are put on the left side of the scale and l iabilities 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 (d ecreases 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.

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    2 - 10 Fundamentals of Financial Accounting, 5/e 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 . L iabilities and stockholders’ equity account s 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 –– In dicate 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 ; c redits 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 account s . 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 i n 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 –– S implified 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 normal ly 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.

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    Instructor’s Resource Manual, Chapter 2 2 - 11 Chapter Outline Teaching Notes d. To find ending account balance , express the T - account as equations: Start with beginning balance Add “+” side Subtract “ – ” side Equals ending balance “Spotlight on Financial Reporting” feature addresses the impact of needing extra time to prepare financial statements e. Ending balance is double underscored to distinguish it. E . SonicGateway ’s Accounting Records (a) Issue Stock to Owners –– Scott incorporates SonicGateway and the company issues common stock to Scott and Angus as evidence of their contribution of $1 0,000 cash , which is deposited in the company’s bank account . 1. Analyze: Assets = Liabilities + Stockholders’ Equity Cash (A) + 1 0,000 = Common Stock (SE) + 1 0,000 Refer to illustrations of transactions (a) through (g) 2. Record: in textbook for Step 3 — Debit Credit Cash ( + A) 1 0,000 Common Stock ( + SE) 1 0,000 Summarize (which includes posting to T - accounts). (b) Invest in Equipment –– SonicGateway pays $ 300 cash for the company’s logo. 1. Analyze: Assets = Liabilities + Stockholders’ Equity Cash (A) – 3 00 ; Logo and Trademarks (A) + 3 00 = 0 2. Record: Debit Credit Logo and Trademarks ( + A) 3 00 Cash ( – A) 300 (c) Obtain Loan from Bank –– SonicGateway borrows $20,000 from a bank and signs a formal agreement to repay the loan in two years (on September 1, 201 7 ) . 1. Analyze: Assets = Liabilities + Stockholders’ Equity Cash (A) + 20,000 = Note Payable (long - term) (L) + 20,000 2. Record: Debit Credit Cash ( + A) 20 ,000 Note Payable (long - term) (+L) 20 ,000 (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 $ 9,6 00 at the end of the month. 1. Analyze: Assets = Liabilities + Stockholders’ Equity Equipment (A) + 9,6 00 = Accounts Payable + 9 ,6 00 2. Record: Debit Credit Equipment ( + A) 9,600 Accounts Payable ( +L ) 9,600

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    2 - 12 Fundamentals of Financial Accounting, 5/e Chapter Outline Teaching Notes (e) P ay Supplier –– SonicGateway pays $ 5 ,000 to the equipment supplier in (d). 1. Analyze: Assets = Liabilities + Stockholders’ Equity Cash – 5 ,000 = Accounts Payable – 5 ,000 2. Record: Debit Credit Accounts Payable ( – L ) 5 ,000 Cash ( – A) 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. 1. Analyze: Assets = Liabilities + Stockholders’ Equity No c hange = No c hange 2. Record –– No journal entry is needed. (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. 1. Analyze: Assets = Liabilities + Stockholders’ Equity Cash (A) – 4,000 + Soft ware (A) + 9,000 = Accounts Payable (L) + 5,000 2. Record: Debit Credit Software ( + A) 9,000 Cash ( – A) 4,000 Accounts Payable ( +L ) 5,00 0 (h) Receive Supplies –– SonicGateway receives supplies costing $600 on account. 1. Analyze: Assets = Liabilities + Stockholders’ Equity Supplies (A) +600 = Accounts Payable (L) + 600 2. Record: Debit Credit Supplies ( + A) 600 Accounts Payable ( +L ) 600 LO 2 - 4 Prepare a trial balance and a classified balance sheet. F . Preparing a Trial Balance and a Balance Sheet ✓ Activity #6 1. The trial balance lists the ending balance in every T - account and then computes total debits and total credits; when the column totals are equal, a balance sheet can be prepared. 2 . C lassified balance sheet –– A balance sheet that shows a subtotal for current assets and current liabilities. a . Current assets – – To be used up or converted into cash within 12 months of the balance sheet date.

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