Investing And Financing Decisions And The Balance Sheet

Investing and Financing Decisions and the Balance Sheet Chapter 2

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© 2009 The McGraw-Hill Companies, Inc.

The Conceptual Framework Objective of Financial Reporting

To provide useful economic information to external users for decision making and for assessing future cash flows.

Qualitative QualitativeCharacteristics Characteristics Relevancy Relevancy Reliability Reliability Comparability Comparability Consistency Consistency

Elements Elementsof ofStatements Statements Asset Asset Liability Liability Stockholders’ Stockholders’Equity Equity Revenue Revenue Expense Expense Gain Gain Loss Loss

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Slide 2

The Conceptual Framework Assumptions Assumptions

Separate Separateentity: entity:Activities Activitiesof ofthe thebusiness businessare are separate separatefrom from activities activitiesof ofowners. owners. Continuity: Continuity:The Theentity entitywill willnot notgo goout outof of business businessininthe thenear near future. future. Unit-of-measure: Unit-of-measure:Accounting Accountingmeasurements measurementswill willbe beininthe thenational national monetary monetaryunit unit(i.e., (i.e.,$$ininthe theU.S.). U.S.).

Principle Principle

Historical Historical cost: cost: Cash Cashequivalent equivalent cost cost given givenup up isisthe thebasis basisfor forthe theinitial initialrecording recordingof of elements. elements.

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Slide 3

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 (Assets)

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(Liabilities)

(Stockholders’ Equity)

Slide 4

Balancing the Accounting Equation Step 1: 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. 

Step 2: Balancing 

Verify that the accounting equation (A = L + SE) remains in balance.

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Slide 5

Analyzing Transactions Papa John’s issues $2,000 of additional common stock to new investors for cash. Identify Identify&&Classify Classify the theAccounts Accounts 1. 1. Cash Cash(asset). (asset). 2. 2. Contributed ContributedCapital Capital (equity). (equity). Determine Determine the the Direction Direction of of the the Effect Effect 1. 1. Cash Cashincreases. increases. 2. 2. Contributed Contributed Capital Capital increases. increases.

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Slide 6

Analyzing Transactions Papa John’s issues $2,000 of additional common stock to new investors for cash. (a)

Effect

Cash 2,000

Investments

2,000

Equip.

Notes Receivable

Notes Payable

=

Contributed Capital 2,000

Retained Earnings

2,000

A = L + SE

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Slide 7

Analyzing Transactions The company borrows $6,000 from the local bank, signing a three-year note. Identify Identify &&Classify Classifythe theAccounts Accounts 1. 1. Cash Cash (asset). (asset). 2. 2. Notes NotesPayable Payable(liability). (liability).

Determine Determinethe theDirection Directionof ofthe theEffect Effect 1. 1. Cash Cashincreases. increases. 2. 2. Notes Notes Payable Payable increases. increases. McGraw-Hill/Irwin

Slide 8

The Accounting Cycle During the period:

Analyze transactions. Record journal entries in the general journal. Post amounts to the general ledger.

End of the period:

Adjust revenues and expenses and related balance sheet accounts.

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Close revenues, gains, expenses and losses to retained earnings.

Prepare a complete set of financial statements. Disseminate statements to users.

Slide 9

The Debit-Credit Framework

A = L + SE ASSETS

LIABILITIES

EQUITIES

Debit Credit for for Increase Decrease

Debit Credit for for Decrease Increase

Debit Credit for for Decrease Increase

Remember that Stockholders’ Equity includes Contributed Capital and Retained Earnings. McGraw-Hill/Irwin

Slide 10

The Asset Section of a Classified Balance Sheet Papa John's International, Inc. and Subsidiaries Consolidated Balance Sheet (dollars in thousands) January 31, 2007 ASSETS Current assets Cash Accounts receivable Supplies Prepaid expenses Other current assets Total current assets Long-term investments Property, and equipment (net of accumulated depreciation of $189,000) Long-term notes receivable Intangibles Other assets Total assets

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$

$

15,000 23,000 27,000 8,000 14,000 87,000 2,000 208,000 15,000 67,000 17,000 396,000

December 28, 2006

$

$

13,000 23,000 27,000 8,000 14,000 85,000 1,000 198,000 12,000 67,000 17,000 380,000

Slide 11

Liabilities and Stockholders’ Equity Section of the Balance Sheet Papa John's International, Inc. and Subsidiaries Consolidated Balance Sheet (dollars in thousands) January 31, 2007 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Accounts payable $ 29,000 Dividends payable 3,000 Accrued expenses payable 73,000 Total current liabilities 105,000 Unearned franchise fees Long-term notes payable Other long-term liabilities Total liabilities Stockholders' equity Contributed capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity

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$

December 28, 2006

$

29,000 73,000 102,000

7,000 110,000 27,000 249,000

7,000 96,000 27,000 232,000

3,000 144,000 147,000 396,000

1,000 147,000 148,000 380,000

$

Slide 12

Key Ratio Analysis Financial Leverage Ratio

=

Average Total Assets Average Stockholders’ Equity

(Beginning Balance + Ending Balance) ÷ 2

The 2006 financial leverage ratio for Papa John’s was: ($351,000 + $380,000) ÷ 2 ($161,000 + $148,000) ÷ 2

=

2.37

The ratio tells us how well management is using debt to increase assets the company employs to earn income. McGraw-Hill/Irwin

Slide 13

Focus on Cash Flows Operating activities (Covered in the next chapter.) Investing Activities Purchasing long-term assets and investments for cash Selling long-term assets and investments for cash Lending cash to others Receiving principal payments on loans made to others Financing Activities Borrowing cash from banks Repaying the principal on borrowings from banks Issuing stock for cash Repurchasing stock with cash Paying cash dividends

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– + – + + – + – –

Slide 14

End of Chapter 2

© 2009 The McGraw-Hill Companies, Inc.