Week 2 - Chapter 2

Week 2 –
Chapter 2
ACCT 6301
FALL 2019
8/21/2019 COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 1

Tonight’s
Topics Chapter 2 Lecture

Chapter 2 –
Constructing
Financial
Statements
ACCT 6301 – FINANCIAL ACCOUNTING – FALL 2019
8/21/2019 COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 1-3

Describe and
construct the
balance sheet
Learning Objective
LEARNING
OBJECTIVE 1 and understand
how it can be
used for
analysis.
COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS
Reporting Financial Condition
On February 2, 2019, Target’s balance sheet reports total assets of
$41,290 million, total liabilities of $29,993 million, and equity of
$11,297 million.
Assets = Liabilities + Stockholders’ Equity
Assets Liabilities Balance Sheet

$41,290 $29,993  Contains the accounting equation
Equity components
$11,297  Prepared at a point in time

Assets
Assets are resources that are expected to provide a company with future economic
benefits.
 Must be owned or controlled by the company
◦ Legal title or unrestricted right to use the asset
 Must possess expected future benefits that can be measured

◦ Benefits can be expected as cash receipts or a reduction of liabilities
◦ A monetary value must be assignable to assets
Characteristics required for an asset to be placed (capitalized) on the

balance sheet

Why do companies acquire assets?
◦ To yield a return for shareholders
◦ Assets generate revenue
◦ Directly through selling inventory, or
Assets ◦ Indirectly through manufacturing inventory that will be sold
Income in excess of the cost of funds used to

acquire assets creates shareholder value

Assets on Target’s Balance Sheet
Target Corp.’s balance sheet shows $41,290 M of assets at February 2, 2019. Note that
Target’s fiscal year end does not occur at December 31.
Target Corporation
Balance Sheet ($ million)
February 2, 2019
Assets
Cash and cash equivalents $ 1,556
Inventory 9,497
Other current assets 1,466
Current Assets 12,519
Property plant and equipment, net 25,533
Operating lease assets 1,965
Other noncurrent assets 1,273
Total Assets $41,290

Current Assets
Assets expected to be converted into cash or used
in operations within the next year, or within the
next operating cycle.
Categories Listed in order of liquidity
of Assets Noncurrent Assets

Listed after current assets on the balance sheet
Not expected to expire or be converted into cash
within one year, or within the next operating cycle.
Referred to as long-term assets

Common Current Assets
Cash—currency, bank deposits, certificates of deposit and other cash
equivalents
Marketable securities—short-term investments that can be quickly
sold to raise cash
Accounts receivable—amounts due to the company from customers
arising from the sale of products or services on credit
Inventory—goods purchased or produced for sale to customers
Prepaid expenses—costs paid in advance for rent, insurance, or
other services

Common Noncurrent Assets
Long-term financial investments—investments in debt securities or
shares of other firms that management does not intend to sell in the
near future
Property, plant and equipment (PPE)—land, factory buildings,
warehouses, office buildings, machinery, office equipment, and
other items used in the operations of the company
Intangible and other assets—patents, trademarks, franchise rights,
goodwill, and other items that provide future benefits, but do not
possess physical substance

Assets intended to be used are reported on the
balance sheet at historical cost
◦ Advantage: Historical cost is reliable
Measuring ◦ Disadvantage: Often significantly undervalued
Assets Some assets are reported at current fair value

◦ Example: Marketable securities
◦ Reliable and objective because obtained from real time stock
quotes

Liabilities and Equity
 Represent sources of capital to the company
 Used to finance the acquisition of assets
LIABILITIES EQUITY
Borrowed funds such as Capital that has been invested by

◦ Accounts payable shareholders, either
◦ Accrued liabilities ◦ Directly via stock purchase, or
◦ Obligations to lenders, bond investors, ◦ Indirectly in the form of retained
suppliers earnings that reflect earnings that are
reinvested in the business

Target’s Liabilities and Equity
Target Corporation
Balance Sheet ($ million)
February 2, 2019
Liabilities Liabilities
requiring payment Accounts payable $ 9,761
within one year
year Accrued and other current liabilities 4,201
Current portion of debt 1,052
Total Current Liabilities 15,014
Long-term debt 10,223
Liabilities
Liabilities NOT
NOT Other long-term liabilities 4,756
requiring payment Total Liabilities 29,993
within one year
year
Stockholders' Equity
Common stock 43
Retained Earnings 6,017
Additional paid-in capital 6,042
Other stockholder equity (805)
Total Stockholder Equity 11,297
Total liabilities and equity $41,290

Reporting Liabilities
Amounts are reported as liabilities on the balance sheet when three
conditions are met:
 A future sacrifice is probable
 The amount of the obligation is known or can be reasonably estimated
 The transaction or event that caused the obligation has occurred
Can be a future cash payment or an obligation to deliver goods or

services to a customer .
Executory Contract
When the first two conditions are satisfied, but not the third. No liability
is reported on balance sheet

Current liabilities
Reported as current liabilities on the balance sheet
if due within one year
Categories Listed in order of maturity
of Liabilities Noncurrent liabilities
Reported as long-term liabilities on the balance
sheet if not due within one year or one operating
cycle

Accounts payable—amounts owed to suppliers for
goods and services purchased on credit
Accrued liabilities—obligations for expenses that
have been recorded but not yet paid
Short-term borrowings—short-term debt payable
to banks or other creditors
Common
Deferred (unearned) revenue—an obligation
Current created when the company accepts payment in
Liabilities advance for goods or services it will deliver in the
future
Current maturities of long-term debt—the portion
of long-term debt that is due to be paid within one
year

Long-term debt—amounts borrowed from
creditors that are scheduled to be repaid more than
Common one year in the future
Noncurrent Other long-term liabilities—various obligations,
such as warranty and deferred compensation
Liabilities liabilities, long-term tax liabilities

Reporting Stockholders’ Equity
Reflects capital provided by the owners of the company; residual
interest.
Common stock—the par value or stated value of stock issued to
the primary owners of the company
Contributed Additional paid-in capital—amounts received from the primary
Capital owners in addition to the par value or stated value of the common
stock
Treasury stock—the amount paid to reacquire the company’s own
common stock
Retained earnings—the accumulated earnings that have not been
distributed to stockholders as dividends
Earned
Capital Accumulated other comprehensive income or loss—accumulated
changes in equity that are not reported in the income statement

Retained Earnings
Retained earnings links the income statement to the balance sheet.
Net income Beginning retained earnings

increases
retained
earnings.
+ Net income (or – Net loss)
A net loss will – Dividends
decrease
retained Ending retained earnings
earnings.
Reported on the balance sheet in the

stockholders’ equity section

Use the financial
statement
Learning Objective
LEARNING
OBJECTIVE 2 effects template
(FSET)to analyze
transactions.

Analyzing and Recording
Transactions
The balance sheet is the foundation of the accounting system.
Assets = Liabilities + Equity
Used to assess the financial impact of transactions.

Financial Statement Effects
Template
(FSET)
The FSET template is used to capture transactions and their effects on the four financial
statements.
Balance Sheet Income Statement

Transaction Cash + Noncash = Liabilities + Contrib. + Earned Revenues – Expenses = Net
Asset Asset Capital Capital Income
= ‒ =

What is an account?
◦ A record of increases and decreases for each asset,
liability, equity, revenue, or expense
◦ Chart of accounts
◦ Listing of account titles and identification codes
The Account The role of the account in transaction analysis

◦ What accounts are affected by the transaction?
◦ Must affect at least two accounts to maintain equality
◦ What is the direction and amount of each effect?
◦ Increase or decrease
◦ Dollar amount

Transaction Analysis:
Stock Issuance
1) On May 1, investors contributed $10,000 cash to start Jana Juice which sells energy drinks to retailers and
individuals, in exchange for 500 shares of stock.

Cash Noncash Contrib. Earned
Transaction + = Liabilities + + Revenues – Expenses = Net Income
Asset Asset Capital Capital
Issued stock +10,000 +10,000
for $10,000 Cash Common
cash = Stock – =
Both assets (cash) and equity (common stock) increase and the
accounting equation is in balance.

Bank Loan
2) On May 1, Jana Juice borrowed $4,000 cash by signing a note to be repaid on May 31 plus interest of
$40.

Signed a note +4,000 +4,000
and received Cash Note
$4,000 cash = Payable – =
Both assets (cash) and liabilities (note payable) increase and the

Rental Agreement
3) On May 1, Jana Juice signed a rental agreement for a store location and paid $1,800 as a security deposit.
Transaction Asset + Asset = Liabilities + Capital + Capital Revenues – Expenses = Net Income
Signed a rental –1,800 +1,800
agreement and Cash Security
paid an $1,800 Deposit = – =
deposit
Because the security deposit will likely be returned to Jana Juice in the future, it is an asset.
Assets (cash and security deposit) increase and decrease by the same
amount. The accounting equation is in balance.

Purchase Inventory
4) On May 1, Jana Juice purchased $2,000 of inventory on account, consisting of energy drinks.

Purchase +2,000 +2,000
inventory on Inventory Accounts
account for = Payable – =
$2,000
Both assets (inventory) and liabilities (accounts payable) increase and the

Jana Juice’s Balance Sheet
Assets Liabilities
Cash $12,200 Accounts payable $ 2,000
Inventory 2,000 Note payable 4,000
Security deposit 1,800 Total current liabilities 6,000
Total current assets 16,000 Equity
Common stock 10,000
Total liabilities & equity
Total assets $16,000 $16,000
No income statement transactions have occurred

so there is no income statement.

Describe and
construct the
income
Learning Objective statement
LEARNING and discuss how it
OBJECTIVE 3
can be used to
evaluate
management
performance.
Reporting Financial Performance
Income Statement
Reports the results of operations as net income or loss for a period of time
General income statement format
Revenues are increases

Revenues in net assets that result
from business activities.
– Cost of goods sold
Gross profit
– Expenses Expenses are the outflow
or use of assets to
= Net income (earnings)
generate revenues.

Target’s Income Statement
Target reported $22,057 million gross profit on its income statement
for the year ended February 2, 2019.
Target Corporation
Income Statement ($ million)
For Year Ended February 2, 2019
Net revenues $75,356
Cost of sales 53,299
Gross profit 22,057
Operating expenses 17,687
Income from continuing operations before income taxes 3,676
Income tax expense 746
Net income from continuing operations $ 2,930
Discontinued operations, net of tax 7
Net (loss)/income 2,937
Operating expenses are usual and customary costs incurred to support

the main business activities.
Operating Revenues and Expenses
Revenues
◦ Result from increases in net assets
◦ Caused by the company’s operating activities
Expenses
◦ Result from decreases in net assets
◦ Caused by the company’s revenue-generating activities
◦ Cost of products and services sold
◦ Operating costs
◦ Nonoperating costs
Revenues – Expenses = Net income (Net loss)

Relate to the company’s financing and investing
activities
Non- ◦ Interest revenue
operating ◦ Interest expense
Revenues Usually segregated as they offer different insights

and into company performance
Expenses Recurring items—persist in the future

Nonrecurring items—unlikely to arise in the future;
not relevant to future performance

Explain revenue
recognition,
accrual
Learning Objective
LEARNING
OBJECTIVE 4 accounting, and
their effects on
retained
earnings.
Accrual Accounting
Accrual accounting is required by U.S. GAAP and by IFRS, and states
that…
REVENUES EXPENSES
Increases in net assets that are Decreases in net assets from
earned by delivering goods and generating revenue and supporting
services to customers. operations.
Did these activities increase or decrease the net assets of the

company?

Accrual Accounting for Revenues
Revenue recognition requires that revenue be recognized (recorded)
only when earned.
Example 1: Target purchases inventories during May for $80,000, and sells half
during May for $140,000 cash. How much revenue will Target recognize during
May?
Revenue for May = $140,000
Example 2: If Target collected $130,000 during May and customers promised to pay
the $10,000 balance during June, how much revenue will Target recognize during
May?
Revenue for May = $140,000

Revenue is earned when delivered to the customer.

Accrual Accounting for Expenses
Expenses are matched when incurred against the related revenue
amounts.
Example 1: Target purchased inventories during May for $80,000. It sold $70,000 of
the inventory for $120,000 during May. How much cost of goods sold expense
should Target recognized during May?
Expenses for May = $70,000

Cost of goods sold expenses are matched against the revenue they helped to earn.
If Target had paid for $65,000 of the $80,000 inventory purchase, and planned to
pay the $15,000 balance during June, how much expense will Target recognize
during May?
Expenses for May = $70,000

Retained Earnings Articulation
Financial statements are linked within and across accounting
periods. This linkage is called articulation.
Target Corporation
Retained Earnings Reconciliation ($ million)
For Year Ended February 2, 2019
Retained Earnings, February 3, 2018 $6,495
Net (loss)/ income 2,937
Dividends declared (1,347)
Repurchase of stock (2,068)
Retained earnings, February 2, 2019 $6,017
Net income from the income statement is added to retained earnings in

the Statement of Stockholders’ Equity, linking retained earnings
between the income statement and balance sheet.

Jana Juice’s Balance Sheet
Now let’s return to the Jana Juice startup company example. Again,
we present the balance sheet after the May 1 transactions.
Assets Liabilities
Cash $12,200 Accounts payable $ 2,000
Inventory 2,000 Note payable 4,000
Security deposit 1,800 Total current liabilities 6,000
Total current assets 16,000 Equity
Common stock 10,000
Total liabilities & equity
Total assets $16,000 $16,000

Payment of Expenses
5) Jana Juice paid $900 to advertise in the local newspaper during May.

Cash Noncash Contrib. Earned Net
Transaction + = Liabilities + + Revenues – Expenses =
Pay $900 cash –900 –900 +900 ‒900
for May Cash Retained Advertising
advertising = Earnings – Expense =
Costs are recognized as expenses when incurred/used.

Paid Amounts Due
6) Jana Juice paid $1,500 for inventory previously purchased on account.

Paid $1,500 –1,500 –1,500
cash as partial Cash Accounts
payment to = Payable – =
supplies
Assets (cash) and liabilities (accounts payable) decrease by $1,500.

Selling to Customers
7) Jana Juice sold $600 of energy drinks to customers for $2,400 cash during May.

Sold drinks for +2,400 +2,400 +2,400 +2,400
$2,400 cash Cash Retained Sales
= Earnings Revenue – =
Record $600 –600 –600 +600 –600

for cost of Inventory Retained Cost of
merchandise = Earnings – Goods Sold =
Revenue is earned and cost of goods sold expense is recognized when

delivery is made to the customer.

Selling to Customers
8) Jana Juice sold $700 of energy drinks on account for $2,900 to a convenience store during May.

Sold drinks for +2,400 +2,900 +2,900 +2,900
$2,900 on Accounts Retained Sales
account Receivable = Earnings Revenue – =
Record $700 –700 –700 +700 –700

for cost of Inventory Retained Cost of
merchandise = Earnings – Goods Sold =
Revenue is earned and cost of goods sold expense is recognized when

delivery is made to the customer.
Paid Wages
9) Jana Juice paid wages totaling $1,300 to employees during May.

Paid wages –1,300 –1,300 +1,300 –1,300
totaling $1,300 Cash Retained Wages
= Earnings – Expense =
An asset (cash) decreases and retained earnings decreases for wages expense
by $1,300.

Sold Membership
10) During May, Jana Juice received $300 from customers in exchange for a three month membership (June,
July and Aug) to an online health program.

Sold $300 of +300 +300
3-month Cash Unearned
memberships Revenue
to online = – =
health program
Asset (cash) and liabilities (unearned revenue) increase by $300.

Customer Payments
11) Jana Juice collected $1,200 of the amount owed by customers during May.

Collected $1,200 +1,200 –1,200
as partial Cash Accounts
payment from Receivable = – =
customers
Asset (cash) and accounts receivable) increase and decrease by the same
amount.

Paid Principal and Interest on a
Loan
12) Jana Juice paid $40 for interest and repaid the $4,000 note payable.

Paid $40 for –4,040 –4,000 –40 +40 –40
interest and paid Cash Note Retained Interest
the $4,000 loan = Payable Earnings – Expense =
Asset (cash) decrease by $4,040, retained earnings decreases by $40, and

liabilities decrease by $4,000.

Paid for Insurance in Advance
13) Jana Juice paid $800 for a four-month insurance policy

Paid $800 for –800 +800
a 4-month Cash Prepaid
insurance policy Insurance = – =
Asset (cash) decreases by $800 and assets increase (prepaid insurance) by

$800.

Paid Rent
14) Jana Juice paid $700 in rent for May.

Paid $700 for –700 –700 +700 –700
rent for the Cash Retained Rent
current month, = Earnings – Expense =
May
Asset (cash) decreases by $700, retained earnings decreases by $700, and

expenses increase by $700.

Reporting Performance
on Jana Juice’s Income
Statement
Jana Juice
Income Statement
For Month Ended May 31, 2019
Sales revenue $5,300
Cost of goods sold 1,300
Gross profit 4,000
Operating Expenses
Wages expense 1,300
Rent expense 700
Advertising expense 900
Operating income 1,100
Interest expense 40
Net income $1,060
Jana Juice reported profit of $1,060 in its first month of

operations.

Illustrate equity
transactions
Learning Objective
LEARNING and the
statement of
OBJECTIVE 5
stockholders’
equity.
Paid Dividends
15) Jana Juice paid $400 for dividends to shareholders during May.

Paid $400 for –400 –400
dividends Cash Retained
= Earnings – =
Asset (cash) and retained earnings decrease by $400.

Dividends have no effect on net income.
They are a distribution of profits.

Jana Juice’s New Balance Sheet
Retained Earnings began with a zero balance on May 1. Net income
of $1,060 is added and dividends of $400 are subtracted to give a
new balance of $660 at May 31.
Assets Liabilities
Cash $6,460 Accounts payable $ 500
Accounts receivable 1,700 Unearned revenue 300
Inventory 700 Total current liabilities 800
Prepaid insurance 800
Security deposit 1,800 Equity
Total current assets 11,460 Common stock 10,000
Retained earnings 660
Total assets $11,460 Total liabilities & equity $11,460

Reporting Stockholders’ Equity
The statement of stockholders’ equity is a reconciliation of the
beginning and ending balances of stockholders’ equity accounts.
Jana Juice
Statement of Stockholders’ Equity
For Month Ended May 31, 2019
Contributed Earned Total
Capital Capital Equity
Balance, April 30, 2019 $ - $ - $ -
Net income - 1,060 1,060 Net income is $1,060 for
10,000 the month.
Common stock issued - 10,000
Cash dividends - (400) (400) Dividends paid are $400
Balance, May 31, 2019 $ 10,000 $ 660 $ 10,660 for the month.
Total equity increased from zero to $10,660 by the end of May.

Use journal
entries and T-
Learning Objective
LEARNING accounts to
analyze and
OBJECTIVE 6
record
transactions.
T-Accounts
Accountants use a graphic representation of an account called a T-account.
Account Title
Always on Debits Credits Always on
the Left the Right
(Dr) (Cr)

One side of the T-account is used to record increases to the account and the
other side is used to record decreases.

Debit Credit System
Increases and decreases are described as debits and credits. Double-
entry accounting requires that debits equal credits.
Accounts that increase on the Accounts that increase on the

debit side have a normal debit credit side have a normal credit
balance. balance.

Expanded Accounting Equation
The equity section is expanded to reflect increases from common
stock and revenues, and decreases from dividends and expenses.

Summary of Debits and Credit

Posting to T-Accounts
T-accounts are labeled by letter
abbreviations for type Specific transactions
+ Cash (A) –
Beg. balance 2,500
(a) 4,000 1,500 (b)
Increases in
(d) 200 500 (c)
the Cash 1,000 (e)
account
End. balance 3,700
Ending Decreases in the

Cash balance Cash account

Post to T-Accounts:
Stock Issuance
T-Accounts
◦ An abbreviated representation of a ledger, which is a listing of all accounts and their dollar balances
Amounts are posted to T-accounts from the journal entry.
(1) Cash (+A) 10,000

Common stock (+SE) 10,000
Cash (A) Common Stock (SE)

(1) 10,000 10,000 (1)

Each posting is accompanied by the number (or letter) of the

transaction for easier tracking.

Journalize and Post:
Issue Stock
1) On May 1, investors contributed $10,000 cash to start Jana Juice which sells energy drinks to retailers
and individuals, in exchange for 500 shares of stock.
Credit account names are Debit amounts go Credit amounts go

Record debits indented from the left in the left column in the right column
first. margin.
(1) Cash (+A) 10,000

Common stock (+SE) 10,000
Cash (A) Common Stock (SE)

(1) 10,000 10,000 (1)


Obtain Loan
2) On May 1, Jana Juice borrowed $4,000 cash by signing a note to be repaid on May 31 plus interest of
$40.
(2) Cash (+A) 4,000

Notes payable (+L) 4,000
Cash (A) Notes Payable ( L )

(2) 4,000 4,000 (2)


Rental Agreement
3) Jana Juice signed a rental agreement for its store location and paid $1,800 as a security deposit.
(3) Security Deposit (+A) 1,800

Cash (–A) 1,800
Security Deposit (A) Cash (A)

(3) 1,800 1,800 (3)


Purchase Inventory
4) Jana Juice purchased $2,000 of inventory on account, consisting of energy drinks.
(4) Inventory (+A) 2,000

Accounts payable (+L) 2,000
Inventory (A) Accounts Payable (L)

(4) 2,000 2,000 (4)


Payment of Advertising
5) Jana Juice paid $900 to advertise in the local newspaper during May.
(5) Advertising expense (+E, –SE) 900

Cash (–A) 900
Advertising Expense (E) Cash (A)

(5) 900 900 (5)


Pay Amounts Due
6) Jana Juice paid $1,500 for inventory previously purchased on account.
(6) Accounts payable (–L) 1,500

Cash (–A) 1,500
Accounts Payable ( L ) Cash (A)

(6) 1,500 1,500 (6)


Sell to Customers for Cash
7) Jana Juice sold $600 of energy drinks to customers for $2,400 cash during May.
(7) Cash (+A) 2,400

Sales revenue (+R, +SE) 2,400
(7) Cost of goods sold (+E, –SE) 600

Inventory (–A) 600
Cash (A) Sales Revenue (R)

(7) 2,400 2,400 (7)

Cost of Goods Sold (E) Inventory (A)

(7) 600 600 (7)


Sell to Customers on Account
8) Jana Juice sold $700 of energy drinks on account for $2,900 to a convenience store during May.
(8) Accounts receivable (+A) 2,900

Sales revenue (+R, +SE) 2,900
(8) Cost of goods sold (+E, –SE) 700

Inventory (–A) 700
Accounts Receivable (A) Sales Revenue (R)

(8) 2,900 2,900 (8)

Cost of Goods Sold (E) Inventory (A)

(8) 700 700 (8)


Pay Wages
9) Jana Juice paid wages totaling $1,300 to employees during May.
(9) Wage expense (+E, –SE) 1,300

Cash (–A) 1,300
Wage Expense (E) Cash (A)

(9) 1,300 1,300 (9)


Sold Membership
10) During May, Jana Juice received $300 from customers in exchange for a three month membership (June,
July and August) to an online health program.
(10) Cash (+A) 300

Unearned revenue (+L) 300
Cash (A) Unearned Revenue (L)

(10) 300 300 (10)


Customer Collections
11) Jana Juice collected $1,200 of the amount owed by customers during May.
(11) Cash (+A) 1,200

Accounts receivable (–A) 1,200
Cash (A) Accounts Receivable (A)

(11) 1,200 1,200 (11)


Paid Principal and Interest
12) Jana Juice paid $40 for interest and repaid the $4,000 note payable.
(12) Note payable (–L) 4,000

Interest expense (+E, –SE) 40
Cash (–A) 4,040
Interest Expense (E)

(12) 40

Cash (A) Notes Payable (L)

4,040 (12) (12) 4,000


Paid for Insurance in Advance
13) Jana Juice paid $800 for a four-month insurance policy.
(13) Prepaid insurance (+A) 800

Cash (–A) 800
Prepaid Insurance (A) Cash (A)

(13) 800 800 (13)


Paid Rent
14) Jana Juice paid $700 for rent for May.
(14) Rent expense (+E, –SE) 700

Cash (–A) 700
Rent Expense (E) Cash (A)

(14) 700 700 (14)


Paid Dividends
15) Jana Juice paid $400 for dividends to shareholders during May.
(15) Retained earnings (–SE) 400

Cash (–A) 400
Retained Earnings (SE) Cash (A)

(15) 400 400 (15)


General Ledger After May Transactions Common Stock (SE)
10,000 (1)
10,000 Bal
Cash (A)
(1)
Equity
10,000 1,800 (3) Retained Earnings (SE)
(2) 4,000 900 (5) (15) 400
(7) 2,400 1,500 (6) Bal 400
(10) 300 1,300 (9) Accounts Payable (L)
(11) Sales Revenue (R )
1,200 4,040 (12) (6) 1,500 2,000 (4)
800 (13) 2,400 (7)
500 Bal 2,900 (8)
Assets 700 (14)
5,300 Bal
400 (15) Unearned Revenue (L)
Bal 6,460 Cost of Goods Sold (E)
300 (10)
(7) 600
Accounts Receivable (A)
300 Bal
(8) 700
(8) 2,900 1,200 (11) Bal
Note Payable (L) 1,300
Bal 1,700
(12) 4,000 4,000 (2) Wages Expense (E)
(9) 1,300
Inventory (A) 0 Bal
Bal 1,300
(4) 2,000 600 (7)
700 (8) Rent Expense (E)
Bal (14)
700 Liabilities 700
Bal 700
Prepaid Insurance (A)
Income
statement Advertising Expense (E)
(13) 800 (5) 900
Bal 800 accounts Bal 900
Security Deposit (A) Interest Expense ( E)

(3) 1,800 (12) 40
Bal 1,800 Bal 40

Compute net
working capital,
the current ratio,
Learning Objective
LEARNING
OBJECTIVE 7 and the quick
ratio, and explain
how they reflect
liquidity.
Evaluating Liquidity
Liquidity
◦ Ability to pay debts when due
◦ The larger current assets are when compared to
current liabilities, the more liquid a company is.
Measured by
◦ Net working capital
◦ Current ratio
◦ Quick ratio

Net Working Capital
Net working capital is defined as the difference between current assets and current
liabilities.
Net Working Capital = Current Assets ‒ Current Liabilities
Walgreens’ Net Working Capital—

2015: $19,657 - $16,557 = $3,100
2016: $25,883 - $17,013 = $8,870
2017: $19,753 - $18,547 = $1,206
Walgreens’ net working capital increased in 2016 and decreased in 2017.

Current Ratio
The current ratio is defined as the ratio of current assets to current liabilities.
Current Ratio = Current Assets / Current Liabilities
Walgreens’ Current Ratio—
Walgreens’ current ratio is deemed to represent a strong current liquidity

position since it exceeds 1.0 for each year. But the decrease in 2017 may be a
concern.

Walgreens in Context
Current Ratio of Several Companies:

Quick Ratio
The ratio of quick assets to current liabilities
Quick assets include cash, short term securities and accounts
receivable.
Quick Ratio = Quick Assets / Current Liabilities
Walgreens’ Quick Ratio—
Based on its quick ratio, Walgreens’ liquidity increased in 2016 but decreased in
2017.

Walgreens in Context
Quick ratio of Several Companies:

Operating Cycle
Operating cycle is:
The time between paying cash for
goods or employee services
rendered and receiving cash from
the customers
The amount of working capital

required for a company’s
operations depends on the
operating cycle.

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Week 2 –

8/21/2019 COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 1

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Assets Liabilities Balance Sheet

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 Must possess expected future benefits that can be measured

Characteristics required for an asset to be placed (capitalized) on the

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Assets ◦ Indirectly through manufacturing inventory that will be sold

Income in excess of the cost of funds used to

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Categories Listed in order of liquidity

of Assets Noncurrent Assets

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Assets Some assets are reported at current fair value

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Borrowed funds such as Capital that has been invested by

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Can be a future cash payment or an obligation to deliver goods or

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Net income Beginning retained earnings

Reported on the balance sheet in the

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Balance Sheet Income Statement

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The Account The role of the account in transaction analysis

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Balance Sheet Income Statement

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Balance Sheet Income Statement

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Balance Sheet Income Statement

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Assets = Liabilities + Equity

No income statement transactions have occurred

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Revenues are increases

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Operating expenses are usual and customary costs incurred to support

Revenues – Expenses = Net income (Net loss)

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operating ◦ Interest expense

Revenues Usually segregated as they offer different insights

Expenses Recurring items—persist in the future

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Did these activities increase or decrease the net assets of the

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Revenue for May = $140,000

Revenue for May = $140,000

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Expenses for May = $70,000