Libby 10e Chap002 PPT Accessible

chapter 2 Investing and Financing
Decisions and the Accounting

System
Financial Accounting
10e
Libby • Libby • Hodge
©2020 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.
Learning Objectives
After studying this chapter, you should be able to:
2-1 Define the objective of financial reporting, the elements of the
balance sheet, and the related key accounting assumptions and
principles.
2-2 Identify what constitutes a business transaction and recognize
common balance sheet account titles used in business.
2-3 Apply transaction analysis to simple business transactions in terms
of the accounting model: Assets = Liabilities + Stockholders' Equity.
2-4 Determine the impact of business transactions on the balance
sheet using two basic tools: Journal entries and T-accounts.
2-5 Prepare a trial balance and simple classified balance sheet and
analyze the company using the current ratio.
2-6 Identify investing and financing transactions and demonstrate how
they impact cash flows.
©2020 McGraw-Hill Education. 2-2
Understanding the Business
To understand
amounts appearing
What on a company’s
Business activities balance sheet:
cause changes in the
balance sheet?
How do specific
activities affect each
balance? How do companies
keep track of balance
sheet amounts?

Learning Objective 2-1
2-1 Define the objective of financial reporting, the
elements of the balance sheet, and the related key
accounting assumptions and principles.

Exhibit 2.1 (1)
Financial Accounting and Reporting Conceptual Framework

Objective of Financial Reporting to External Users: (in Ch. 2)
To provide financial information about the reporting entity that is useful to existing and potential
investors, lenders, and other creditors in making decisions about providing resources to the entity
• Pervasive Cost-Benefit Constraint: Benefits of providing information should outweigh its costs
Fundamental Qualitative Characteristics of Useful Information: (in Ch. 2)
Relevance (including materiality) and Faithful Representation
Attributes That Enhance Qualitative Characteristics:

Comparability (including consistency), Verifiability, Timeliness, and Understandability

Exhibit 2.1 (2)
Financial Accounting and Reporting Conceptual Framework

Objective of Financial Reporting to External Users: (in Ch. 2)
To provide financial information about the reporting entity that is useful to existing and potential
investors, lenders, and other creditors in making decisions about providing resources to the entity.
• Pervasive Cost-Benefit Constraint: Benefits of providing information should outweigh its costs
Fundamental Qualitative Characteristics of Useful Information: (in Ch. 2)
Relevance (including materiality) and Faithful Representation
Attributes That Enhance Qualitative Characteristics:
Comparability (including consistency), Verifiability, Timeliness, and Understandability
Elements to Be Measured and Reported:
Assets, Liabilities, Stockholders’ Equity, Investments by Owners, and Distributions to Owners (in
Ch. 2)
Revenues, Expenses, Gains, and Losses (in Ch. 3)
Comprehensive Income (in Ch. 5)
Recognition, Measurement, and Disclosure Concepts:
Assumptions: Separate Entity, Going Concern, and Monetary Unit (in Ch. 2)
Time Period (in Ch. 3)
Principles: Mixed-Attribute Measurement (in Ch. 2)
Revenue Recognition and Expense Recognition (in Ch. 3)
Full Disclosure (in Ch. 5)
Elements of the Balance Sheet
A = L + SE
Assets Liabilities Stockholders’ Equity
Economic resources Debts or obligations The financing
with probable future (claims to a company’s provided by the
benefits owned or resources) that result owners and the
controlled by the from a company’s past operations of the
entity. transactions and will business.
be paid with assets or
services. Entities that
a company owes
money to are called
creditors.

Exhibit 2.2
Chipotle Mexican Grill, Inc., Balance Sheet
*The information has

been adapted from
actual statements
and simplified for this
chapter.
©2020 McGraw-Hill Education. Access the text alternative for these images 2-8
Unrecorded but Valuable Assets and Liabilities
Many very valuable intangible

assets, such as trademarks, patents, FINANCIAL ANALYSIS
and copyrights are not reported on
the balance sheet.
Intangible assets not reported:
$$$
 Internally developed over
time
 Not purchased
Some liabilities, called off-balance-
sheet financing, are not reported as
liabilities on the balance sheet.
Off-balance-sheet financing:
 Some equipment or
building rentals

2-2 Identify what constitutes a business transaction and recognize
common balance sheet account titles used in business.

What Business Activities Cause Changes in the
Financial Statement Amounts?
Transactions include two types of
events:
Nature of
External Events: Exchanges between Business
the entity and one or more parties. Transactions
Ex: Purchase of a machine from a
supplier.
Internal Events: Events that are not
exchanges between parties but that
have a direct and measurable effect
on the entity.
Ex: Using up insurance paid in
advance.
Accounts
Accounts are used by companies to accumulate
the dollar effect of transactions.
Cash Inventory
Equipment Notes
Payable

Exhibit 2.3
Typical Account Titles
2-3 Apply transaction analysis to simple business transactions in
terms of the accounting model: Assets = Liabilities +
Stockholders' Equity.

Principles of Transaction Analysis
Every transaction has at least two effects (dual effects) on

the basic accounting equation.
• Every transaction affects at least two accounts.
Correctly identifying those accounts and the direction of
the effect (whether an increase or a decrease) is critical!
• The accounting equation must remain in balance after each
transaction.
A = L + SE
Assets Liabilities Stockholders’
Equity

Balancing the Accounting Equation
The accounting equation must remain in balance after

each transaction.
Step 1: Ask - What was received and what was given?
• Identify each account affected by title
(e.g., Cash and Notes Payable). Make sure at least two accounts
change.
• Classify each account by type: Asset (A), Liability (L), or
Stockholders’ Equity (SE)
(e.g., Cash is an asset and Notes Payable is a liability).
• Determine the direction of the effect: The account increased
(+) or decreased (−)
(e.g., Cash increased and Notes Payable increased).
Step 2: Verify - Is the accounting equation in balance?
(A = L + SE)
Analyzing Chipotle’s Transactions 1
To illustrate the use of the transaction analysis process,

let’s consider transactions of Chipotle that are also
common to most businesses.
Assume that Chipotle engages in the following events
during the first quarter of 2018, the first three months
following the balance sheet in Exhibit 2.2.
Account titles are from that balance sheet. All amounts
are in millions, except per share data.

(a) Chipotle issued (sold) 100 additional shares of common

stock with a par value of $0.01 per share at a market value of
$3.00 per share, receiving $300 in cash from investors.
Step 1: What was received and what was given?
(account name, type of account, amount, and direction of effect)
Received: Cash (+A) $300
Given: Additional stock shares:
Common Stock (+SE) $1 (100 shares × $0.01 per share)
Additional Paid-in Capital (+SE) $299 (100 shares × $2.99 per share)
Assets = Liabilities + Stockholders’
Equity
Cash Investments Property Intangible Notes Dividends Common Additional Retained
and Assets Payable Payable Stock Paid-in Capital Earnings
Equipment
(a) +300 = +1 +299
Step 2: Is the accounting equation in balance?

Assets $300 = Liabilities $0 + Stockholders’ Equity $300
(b) Chipotle borrowed $2 from its local bank, signing a note to be

paid in three years (a noncurrent liability).

Received: Cash (+A) $2 Given: Long-Term Notes Payable (+L)
$2
Equity
Equipment
(a) +300 = +1 +299
(b) +2 = +2


(c) Chipotle purchased $8 in additional land, $34 in new buildings,

$10 in new equipment, and $3 in additional intangible assets; paid
$54 in cash and signed a $1 short-term note payable for the
remainder amount owed.
Received: Land (+A) Given: Cash (−A)
$8 $54
Buildings (+A) 34 Short-Term Notes Payable (+L) 1
Equipment (+A) 10
Intangible Assets (+A) 3
Equity
Equipment
(a) +300 = +1 +299
(b) +2 = +2
(c) –54 +52 +3 = +1

(d) Chipotle paid $1 on the short-term note payable in (c) above

(ignore any interest on the loan in this chapter).

Received: Reduction in amount due: Given: Cash (−A)
$1
Short-Term Notes Payable (−L) $1

Equity
Equipment
(a) +300 = +1 +299
(b) +2 = +2
(c) –54 +52 +3 = +1
(d) −1 = −1

Assets –$1 = Liabilities −$1 + Stockholders’ Equity $0
(e) Chipotle purchased the stock of other companies as investments,

paying $44 cash; of this, $9 was in short-term investments and $35
was in long-term investments
Received: Short-Term Investments (+A) $9Given: Cash (−A)
$44
Long-Term Investments (+A) 35
Equity
Equipment
(a) +300 = +1 +299
(b) +2 = +2
(c) –54 +52 +3 = +1
(d) −1 = −1
(e) −44 +44 =

(f) Chipotle does not pay dividends but instead reinvests profits into growing
the business. However, for illustration purposes, assume Chipotle’s board of
directors declared that the Company will pay $2 in cash as dividends to
shareholders next quarter.
Received: Lower undistributed earnings Given: Dividends Payable (+L)
Retained Earnings (−SE) $2 $2
Assets = Liabilities + Stockholders’ Equity
Cash Investments Property and Intangible Notes Dividends Common Additional Paid-in Retained
Equipment Assets Payable Payable Stock Capital Earnings
(a) +300 = +1 +299
(b) +2 = +2
(c) –54 +52 +3 = +1
(d) −1 = −1
(e) −44 +44 =
(f) +2 −2
+230 +44 +25 +3 = +2 +2 +1 +299 −2

Assets $0 = Liabilities $2 + Stockholders’ Equity −$2
Overall effects of (a)–( f): Assets $302 = Liabilities $4 + Stockholders’ Equity $298
$302 = $302
2-4 Determine the impact of business transactions on the
balance sheet using two basic tools: Journal entries
and T-accounts.

How Do Companies Keep Track of Account
Balances?

Exhibit 2.4
The Accounting Cycle
Exhibit 2.5
Basic Transaction Analysis Model
Debits and Credits
In Summary:
The Journal Entry
(a) Chipotle issued (sold) 100 additional shares of common stock

with a par value of $0.01 per share at a market value of $3.00 per
share, receiving $300 in cash from investors.
Account Titles: Amounts:
Debited accounts on top. Debited amounts on left.
Credited accounts on bottom, Credited amounts on right.
usually indented.
Debit Credit
(a) Cash (+A) 300
Common stock (+SE) 1
Additional paid-in capital (+SE) 299
Reference: Letter,
number, or date.
Exhibit 2.6
Posting Transaction Effects from the Journal to the Ledger
Exhibit 2.7
T-Accounts Illustrated
Inferring Business Activities from T-Accounts
FINANCIAL ANALYSIS
$$$
Solution:
Beginning Purchases Cash Payments Ending
+ − =
Balance on Account to Suppliers Balance
$600 + $1,500 − ? = $ 300
$2,100 − ? = $ 300
? = $1,800
Access the text alternative for these images

Transaction Analysis Illustrated 1
(a) Chipotle issued (sold) 100 additional shares of common stock

with a par value of $0.01 per share at a market value of $3.00 per
share, receiving $300 in cash from investors.
Debit Credit
(a) Cash (+A) 300
Common stock (+SE) 1
Additional paid-in capital (+SE) 299

(b) Chipotle borrowed $2 from its local bank, signing a note to be

paid in three years (a noncurrent liability).
Debit Credit
(b) Cash (+A) 2
Notes payable (+L) 2

After analyzing all transactions from (a)–(f), the balance in our T-

accounts will appear as follows:

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Data Analytics
Big data analytics With today’s technology,

examines large amounts of it’s possible to analyze
data to uncover hidden your data and get
$$$
patterns, correlations and answers from it almost
other insights. immediately!
These decisions can

Companies are reduce costs and Data Analytics has
making more data- transform the exploded in the past
driven decisions. business for the several years.
future.

2-5 Prepare a trial balance and simple classified balance sheet and
analyze the company using the current ratio.

Trial Balance
CHIPOTLE MEXICAN GRILL—TRIAL BALANCE
(based on hypothetical investing and financing transactions
The trial balance is a only during the first quarter ended March 31, 2018)
(in millions) Debit Credit
listing of the ending Cash
Short-term investments
389
333
balance in each account Accounts receivable
Supplies
49
20
in the general ledger. Prepaid expenses
Land
51
21
Buildings 1,711
List accounts in Equipment 637
Accumulated depreciation 979
financial statement Long-term investments 35
Intangible assets 81
order (assets, liabilities, Accounts payable 82
Unearned revenue 64
stockholders’ equity, Dividends payable 2
Income taxes payable 18
revenues and Wages payable 83
Utilities payable 77
expenses). Notes payable (current) 0
Notes payable (noncurrent) 80
The purpose of the trial Other liabilities
Common stock
279
2
balance is to make sure Additional paid-in capital
Treasury stock 2,334
1,604
the debits and credits Retained earnings

Total 5,661
2,391
5,661
are equal.
Classified Balance Sheet
Assets and liabilities

are classified into two
categories: current
and noncurrent.
Current assets are those to be used or

turned into cash within the upcoming year,
whereas noncurrent assets are those that
will last longer than one year.
Current liabilities are those obligations to be

paid or settled within the next 12 months
with current assets.
Exhibit 2.8 (1)
CHIPOTLE MEXICAN GRILL, INC.

Consolidated Balance Sheets* (in millions of dollars, except per share data)
March 31, 2018 December 31, 2017
Chipotle Mexican ASSETS
Grill’s First Quarter Current Assets:
Cash $ 389 $ 186
2018 Balance Sheet Short-term investments 333 324
(based on investing and Accounts receivable 49 49
Supplies 20 20
financing activities only) Prepaid expenses 51 51
Total current assets 842 630
Property and equipment:
Land 21 13
Buildings 1,711 1,677
Equipment 637 627
Total cost 2,369 2,317
Accumulated depreciation (979) (979)
Net property and equipment 1,390 1,338
Long-term investments 35 —
Intangible assets 81 78
Total assets $ 2,348 $ 2,046
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable $ 82 $ 82
Unearned revenue 64 64
Dividends payable 2 —
Income taxes payable 18 18

Exhibit 2.8 (1)

Grill’s First Quarter Accrued expenses payable:
Wages payable 83 83
2018 Balance Sheet Utilities payable 77 77
(based on investing and Total current liabilities 326 324
Notes payable 80 78
financing activities only) Other liabilities 279 279
Total liabilities 685 681
Stockholders’ Equity:
Common stock ($0.01 par value per share) 2 1
Additional paid-in capital 1,604 1,305
Treasury stock (2,334) (2,334)
Retained earnings 2,391 2,393
Total stockholders’ equity 1,663 1,365
Total liabilities and stockholders’ equity $ 2,348 $ 2,046

Exhibit 2.8 (2)

Grill’s First Quarter Current Assets:
Cash $ 389 $ 186
2018 Balance Sheet Short-term investments 333 324
(based on investing and Accounts receivable 49 49
Supplies 20 20
financing activities only) Prepaid expenses 51 51
Total current assets 842 630
Property and equipment:
Land 21 13
Buildings 1,711 1,677
Equipment 637 627
Total cost 2,369 2,317
Accumulated depreciation (979) (979)
Net property and equipment 1,390 1,338
Long-term investments 35 —
Intangible assets 81 78
Total assets $ 2,348 $ 2,046

Exhibit 2.8 (3)

LIABILITIES AND STOCKHOLDERS’ EQUITY
Chipotle Mexican Current Liabilities:
Accounts payable $ 82 $ 82
Grill’s First Quarter Unearned revenue 64 64
2018 Balance Sheet Dividends payable 2 —
(based on investing and Income taxes payable 18 18
Accrued expenses payable:
financing activities only) Wages payable 83 83
Utilities payable 77 77
Total current liabilities 326 324
Notes payable 80 78
Other liabilities 279 279
Total liabilities 685 681
Stockholders’ Equity:
Common stock ($0.01 par value per 2 1
share)
Additional paid-in capital 1,604 1,305
Treasury stock (2,334) (2,334)
Retained earnings 2,391 2,393
Total stockholders’ equity 1,663 1,365
Total liabilities and stockholders’ equity $ 2,348 $ 2,046

International Perspective

Current Ratio
KEY RATIO ANALYSIS
Current Assets $$$
Current Ratio 
Current Liabilities
Does a company have the short-term
resources to pay its short-term debt?

2-6 Identify investing and financing transactions and
demonstrate how they impact cash flows.

Investing and Financing Activities
FOCUS ON CASH FLOWS

Companies report cash inflows (+) and outflows
(−) over a period in their statement of 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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chapter 2 Investing and Financing

Decisions and the Accounting

©2020 McGraw-Hill Education. 2-3

©2020 McGraw-Hill Education. 2-4

Financial Accounting and Reporting Conceptual Framework

Fundamental Qualitative Characteristics of Useful Information: (in Ch. 2)

Relevance (including materiality) and Faithful Representation

Attributes That Enhance Qualitative Characteristics:

©2020 McGraw-Hill Education. 2-5

Financial Accounting and Reporting Conceptual Framework

©2020 McGraw-Hill Education. 2-7

*The information has

Many very valuable intangible

©2020 McGraw-Hill Education. 2-9

©2020 McGraw-Hill Education. 2-10

©2020 McGraw-Hill Education. 2-12

©2020 McGraw-Hill Education. 2-14

Every transaction has at least two effects (dual effects) on

©2020 McGraw-Hill Education. 2-15

The accounting equation must remain in balance after

To illustrate the use of the transaction analysis process,

©2020 McGraw-Hill Education. 2-17

(a) Chipotle issued (sold) 100 additional shares of common

Step 2: Is the accounting equation in balance?

(b) Chipotle borrowed $2 from its local bank, signing a note to be

Step 1: What was received and what was given?

Step 2: Is the accounting equation in balance?

©2020 McGraw-Hill Education. 2-19

(c) Chipotle purchased $8 in additional land, $34 in new buildings,

Step 2: Is the accounting equation in balance?

(d) Chipotle paid $1 on the short-term note payable in (c) above

Step 1: What was received and what was given?

Assets = Liabilities + Stockholders’

Step 2: Is the accounting equation in balance?

(e) Chipotle purchased the stock of other companies as investments,

Step 2: Is the accounting equation in balance?

Step 2: Is the accounting equation in balance?

©2020 McGraw-Hill Education. 2-24

©2020 McGraw-Hill Education. 2-25

(a) Chipotle issued (sold) 100 additional shares of common stock

Access the text alternative for these images

(a) Chipotle issued (sold) 100 additional shares of common stock

Access the text alternative for these images

(b) Chipotle borrowed $2 from its local bank, signing a note to be

Access the text alternative for these images

After analyzing all transactions from (a)–(f), the balance in our T-

Access the text alternative for these images

Big data analytics With today’s technology,

These decisions can

©2020 McGraw-Hill Education. 2-36

©2020 McGraw-Hill Education. 2-37

the debits and credits Retained earnings

Assets and liabilities

Current assets are those to be used or

Current liabilities are those obligations to be

CHIPOTLE MEXICAN GRILL, INC.

©2020 McGraw-Hill Education. 2-40

CHIPOTLE MEXICAN GRILL, INC.

©2020 McGraw-Hill Education. 2-41

CHIPOTLE MEXICAN GRILL, INC.