Basic Accounting

Concepts:
The Balance Sheet

Basic Concepts
1. Money Measurements
2. Entity
3. Going Concern
4. Cost
5. Dual Aspect
6. Accounting Period
7. Conservation
8. Realization
9. Matching
10.Consistency
11.Materiality

The Money Measurement

Concept
A business owns:
Cash
+ Raw Material
+ Trucks
+ Building
space
TOTAL

$30,000
6,000 lbs
6 units
50,000 sq. ft
?

The Money Measurement

Concept
A business owns:
Cash
+ Raw Material
+ Trucks
+ Building
space
TOTAL
Cash
+ Raw Material

$30,000
6,000 lbs
6 units
50,000 sq. ft
?
$30,000

$30,000

6,000 lbs

$9,000

6 units

$150,000

50,000 sq. ft

$4,000,000

+ Trucks
+ Building
space
TOTAL

$4,189,000

The Entity Concept

Entity is any organization or activity for
which accounting reports are prepared.
Example 1:
A business owner takes $100 from the
cash register:
The effect to the person is negligible
Due to entity concept, the accounting
records show that the business has less
cash

The Entity Concept

Example 2:
Retail store:
In law, an unincorporated business
has no distinction between the
resources of the store (business) and
the owner
In accounting, resources are distinct
and separate from the business and
that of the owner

The Entity Concept

For a corporation the distinction is
often quite easily made. A
corporation is a legal entity,
separate from the persons who own
it, and the accounts of many
corporations correspond exactly to
the scope of the legal entity.

The Going Concern Concept

Accounting assumes that an entity is a
going concern that it will continue
to operate for an indefinitely long
period in the future, unless there is
good evidence to the contrary.
It is assumed that the resources
currently available to the entity will
be used in its future operations.

The Going Concern Concept

It provides a more realistic value of
business assets.
It allows fixed assets to be written off
proportionally over their useful life.

The Going Concern Concept

Example:
At any given moment, a jeans manufacturer has
jeans in various stages of the production
process. If the business were liquidated
today, these partially completed jeans would
have little if any value. Accounting assumes
that the manufacturing process will be carried
through to completion, and therefore that the
amount for which the partially completed
jeans could be sold if the company were
liquidated today is irrelevant.

The Cost Concept

Assets economic resources of an entity.
They consist of:
1. Nonmonetary assets land, buildings,
machineries, and others whose cash
value is not fixed by contract
2. Monetary assets money and
marketable securities and others
whose cash value is fixed by contract

The Cost Concept

An asset is ordinarily entered initially in
the accounting records at the price
paid to acquire it at its cost.
In the case of nonmonetary assets, the
cost concept extends to their
accounting subsequent to
acquisition; cost continues to be the
basis for all subsequent accounting
for the asset

The Cost Concept

While in monetary assets, they are
accounted for at their fair value
subsequent to acquisition.
Fair value is the amount at which an asset
could be exchanged in a current
transaction between willing parties, other
than in a forced or liquidation sale.
Goodwill represents the value of the name,
reputation, clientele, etc of the purchase
company.

Examples
Nonmonetary asset:
$250,000 cost of a land will be recorded as
$250,000 as its historical cost, even if after
2 years you can sell it at a value of
$275,000.
Monetary Asset:
You have an investment of 100,000 shares of
the common stock. To determine the fair
value you need to wait for SE to close and
refer to the stock price reporting services.

The Dual-Aspect Concept

Terms:
Asset economic resources of an entity
Equities claims of various parties against
these assets
Liabilities claims of creditors
Owners equity claims of the owner on the
business
Transaction events that affect the numbers
in an entitys accounting records

The Dual-Aspect Concept

Fundamental accounting equation:
Assets = Equities
Assets = Liabilities + Owners Equity
Every transaction has a dual impact on
the accounting records. Accounting
systems are set up so as to record
both of these aspects of a transaction.

Example
Suppose you start a business and your first
act is to open a bank account in which
you deposited $40,000 from your own
money.
The dual aspect of this transaction is that
the business now has an asset, cash, of
$40,000, and you, the owner, has a
claim, also of $40,000, against this asset.
Assets (cash) $40,000 = Equities (owners)
$40,000

As its next transaction, the business

borrowed $15,000 from a bank, the
business accounting records would
change in two ways:
Cash

$55,000

Owed to bank
Owners equity

Total assets

$55,000

Total equities

$15,000
40,000
$55,000

The Balance Sheet

Balance sheet a financial position of
an accounting entity as of a
specified moment in time. Its more
formal name is a statement of
financial position. The balance
sheet is snapshot of an instant in
time, it is a status report rather than
a flow report.

The Balance Sheet

The Balance Sheet

Definition of Terms
1. Assets- economic resources that are
controlled by an entity and whose cost
(or fair value) at the time of acquisition
could be objectively measured. Cash
and other assets that are expected to be
realized in cash or consumed during the
normal operating cycle of the entity or
within one year are called current assets

Balance Sheet
Cash consists of funds that are
readily available for disbursement
Marketable securities-investments
that are both readily marketable and
expected to be converted into cash
within a year. Ex. Bankers
acceptance, treasury bills

Balance Sheet
Accounts receivable amounts owed to the
entity by its customers. Amounts owed to the
entity by parties other than customers would
appear under the heading notes receivable or
other receivables.
Inventories aggregate of items that are
either held for sale in the ordinary course of
business, in the process of production for
such sale or soon to be consumed in the
production of goods that will be available for
sale.

Balance Sheet
Prepaid expenses represent certain
assets, usually of an intangible
nature, whose usefulness will expire
in the near future. Example is an
insurance policy
Property, Plant and Equipment
consists of assets that are tangible
and relatively long-lived. They are
called fixed assets.

Balance Sheet
Investments- securities of one company
owned by another either in order to
control the other company or in
anticipation of earning a long-term return
from the investment. Investments are
noncurrent assets
Intangible assets include goodwill,
patents, copyrights, franchises and similar
valuable but nonphysical things controlled
by the business.

Balance Sheet
2. Liabilities obligations to transfer
asstes or provide services to outside
parties arising from events that
have already happened. Liabilities
that are expected to be satisfied or
extinguished during the normal
operating cycle or within one year
are called current liabilities.

Balance Sheet
Accounts payable claims of suppliers
arising from their furnishing goods or
services to the entity for which they
have not yet been paid. Such suppliers
are often called vendors. Amounts
owed to financial institutions are called
notes or short-term loans.
Taxes payable amount that the entity
owes government agencies for taxes.

Balance Sheet
Accrued expenses amounts earned
by outside parties but have not yet
been paid by the entity.
Deferred (unearned) revenues
represent the liability that arises
because the entity has received
advance payment for a service it
has agreed to render in the future.

Balance Sheet
Current portion of long-term debt
part of a long-term debt that is due
within the next 12 months.
Other liabilities obligations that do
not meet the criteria for being
classified as current liabilities.
Sometimes called noncurrent
liabilities or long-term debt

Balance Sheet
Owners equity shows the amount the
owners have invested in the entity. In a
corporation, the ownership interest is
evidenced by shares of stock, and the
owners equity section of the balance sheet
is called a shareholders equity or
stockholders equity. It is also called net
assets because the amount shown for
owners equity is equal to assets net of
(minus) liabilities. The FASB defines it as the
residual interest in the assets of an entity
that remains after deducting its liabilities.

Balance Sheet
2 Categories of shareholders equity:
1. Paid-in capital or contributed capital
amount the owners have invested
directly int he business by purchasing
shares of stock as these shares were
issued by the corporation. Paid-in
capital in most corporations is
subdivided into capital stock and
additional paid-in capital.

Balance Sheet
Garsden Corporation has outstanding 1
million shares of common stock with a
par value of $1 per share. Investors
actually paid into the corporation $5
million for these shares.
Paid-in capital:
common stock at par $1,000,000.00
additional paid-in capital $4,000,000.00
total paid-in capital $5,000,000.00

Balance Sheet
2. Retained Earnings difference
between the total earnings of the
entity from its inception to date and
the total amount of dividends paid
out to its shareholders over its
entire life. If the difference is
negative, the item is called deficit.

Balance Sheet
Unincorporated Businesses
Different terminology is used in the owners
equity section.
In a proprietorship- a business owned by
one person- the owners equity is
customarily shown as a single number
such as Lee Jones Capital
In a partnership- a business owned jointly
by several persons- there is a capital
account for each partner.

Balance Sheet
Example:
Jane Davis, capital
$75,432
Wayne Smith, capital
$75,432
Total partners capital $ 150,864

Balance Sheet
A proprietorship or partnership balance
sheet also may show a reconciliation
of the beginning and ending balance
in each owners capital account.

Balance Sheet
Example:
Lee Jones, capital, as of Jan 1, 2006
$180,000
Add: 2006 earnings
45,000
Deduct: 2006 drawings
(40,000)
Lee Jones, capital, as of Dec 31, 2006
$185,000

Balance Sheet
The fundamental accounting equation
can be expanded into:
Assets = Liabilities + paid-in capital +
retained earnings

Balance Sheet
Current ratio the ratio of current
assets to current liabilities. A current
ratio of at least 2 to 1 is believed to
be desirable in a typical
manufacturing company.
Garsden company has current assets of
$22,651,072 and current liabilities of
$9,119,089. The current ratio is 2.5
to 1, which is satisfactory

Balance Sheet Changes

Although in practice a balance sheet is
prepared only at prescribed
intervals, in learning the accounting
process it is useful to consider the
changes one by one.

Balance Sheet Changes

Original Capital Contribution Jan. 1 John Smith starts an
incorporated CD and tape store
called Music Mart, Inc. He
does this by depositing $25,000 of his own funds in a bank
account that he has opened in the name of the business entity
and taking $25,000 of stock
certificates in
return. He is
the sole owner of the
corporation. The balance sheet of
Music Mart, Inc. will be:

Music Mart
Balance Sheet
As of January 1
Assets Liabilities and Owners Equity
Cash $25,000

Paid-in capital

$25,000

Balance Sheet Changes

Bank Loan Jan 2 Music Mart borrows $12,500 from a bank;
the loan
is evidenced by a legal document called a
note. This
transaction increases the asset,
cash, and the business
incurs a liability to the bank
called notes payable. The
balance sheet will be:

Cash
Total

Music Mart
Balance sheet
As of Jan 2
Assets
Liabilities and Owners Equity
$37,500
Notes payable
$12,500
_______
Paid-in capital
25, 000
$37,500
Total
$37,500

Balance Sheet Changes

Purchase of Merchandise Jan 3 The business buys inventory
(merchandise
it intends to sell) in the amount of
$5,000, paying
cash. This transacton decreases
cash and increass
another asset, inventory. The
balance sheet will
be:
Music Mart
Balance sheet
As of Jan 3
Assets
Liabilities and Owners Equity
Cash
$32,500
Notes payable
$12,500
Inventory 5,000
Paid-in capital
25, 000
Total
$37,500
Total
$37,500

Balance Sheet Changes

Sale of Merchandise Jan 4 For $750 cash, the store sells merchandise
that costs $500. The effect of this transaction is to decrease
inventory by $500, increase cash by $750,
and increase owners
equity by the difference,
$250. The $250 is the profit on this sale.
To distinguish it from the paid-in capital portion of the owners
equity, it is recorded as retained earnings.
The balance sheet is:
.
Music Mart
Balance sheet
As of Jan 4
Assets Liabilities and Owners Equity
Cash $33,250 Notes payable
$12,500
Inventory 4,500 Paid-in capital 25, 000
Retained earnings
250
Total

$37,750

Total

$37,750

Case 2-1: Maynard

Company (A)
Diane Maynard made the following request of a
friend:
My bookkeeper has quit, and I need to see the
balance sheets of my company. He has left
behind a book with the numbers already
entered in it. Would you be willing to prepare
balance sheets for me? Also, any comments
you care to make about the numbers would be
appreciated. The cash account is healthy,
which is a good sign, and he has told me that
the net income in June was $19,635.

Case 2-1: Maynard

Company (A)
The book contained a detailed record of
transactions, and from it the friend was
able to copy off the balances at the
beginning of the month and at the end of
the month as shown in Exhibit 1. Diane
Maynard owned all the stock of Maynard
Company. At the end of June. Diane
Maynard paid herself an $11,700
dividend and used the money to repay
her loan from the company

Exhibit 1: Maynard
Company (A)

Accountspayable
Accountsreceivable
Accruedwagespayable
Accumulateddepreciationonbuilding
Accumulateddepreciationonequipment
Banknotespayable
Building
Capitalstock
Cash
Equipment(atcost)
Land
Merchandiseinventory
Notereceivable,DianeMaynard
Othernoncurrentassets
Othernoncurrentliabilities
Prepaidinsurance
Retainedearnings
Suppliesonhand
Taxespayable

June1
$8,517.00
$21,798.00
$1,974.00
$156,000.00
$5,304.00
$8,385.00
$585,000.00
$390,000.00
$34,983.00
$13,260.00
$89,700.00
$29,835.00
$11,700.00
$4,857.00
$2,451.00
$3,150.00
$221,511.00
$5,559.00
$5,700.00

June30
$21,315.00
$26,505.00
$2,202.00
$157,950.00
$5,928.00
$29,250.00
$585,000.00
$390,000.00
$66,660.00
$36,660.00
$89,700.00
$26,520.00
$-
$5,265.00
$2,451.00
$2,826.00
$229,446.00
$6,630.00
$7,224.00

Case 2-1: Maynard

Company (A)
Questions:
1. Prepare balance sheets as of June 1 and as of
June 30, in proper format.
2. Make comments about how the financial
condition as of the end of June compared with
that at the beginning of June.
3. Why do retained earnings not increase by the
amount of June net income?
4. As of June 30, do you feel that Maynard
Company is worth the amount in Shareholders
Equity, $619,446? Explain.

As of June 1:

Difference,
Total asset =
$43,350
30:

As of June

As of June 1:

Difference,
Total
liabilities
30: =
$35,415

As of June

As of June 1:

Difference,
owners
equities
30: =
$7,935

As of June

3. Why do retained earnings not

increased by the amount of June
net income?

Net income for June = $19,635

Retained earning June 30 = $229,446
Retained earning June 1 = $221,511
Dividend = $11,700

Retained earning June 30 =

Retained earning June 1 + Net income Dividend
= 221,711 + 19,635 11,700
= 229,446

4. As of June 30, do you feel that Maynard

Company is worth the amount in
Shareholders Equity, $619,446? Explain
Net income for June =
$19,635
Assume it is the net
monthly income, then
Jan-Jun net income =
$117,810
Companys worth =
619,446
+ 117,810
$ 737,256