Financial & Managerial Accounting Decision Makers

FINANCIAL & MANAGERIAL
ACCOUNTING
for Decision Makers 3e
DYCKMAN HANLON MAGEE PFEIFFER HARTGRAVES MORSE
CHAPTER 2
Constructing
Financial Statements
© Cambridge Business Publishers, 2018

Learning Objective 1
Describe and construct

the balance sheet and understand
how it can be used for analysis.
© Cambridge Business Publishers, 2018 2

Reporting Financial Condition
On January 31, 2015, Target’s balance sheet reports total

assets of $41,404 million, total liabilities of $27,407
million, and equity of $13,997 million.
Assets = Liabilities + Stockholders’ Equity
Balance Sheet
Liabilities  Contains the accounting equation
$27,407
Assets components
$41,404 Equity  Prepared at a point in time
$13,997

Assets
Assets are resources that are expected to provide a

company with future economic benefits.
Characteristics required for an asset to be placed
(capitalized) on the balance sheet.
 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

Assets
 Why do companies acquire assets?

 To yield a return for shareholders
 Assets generate revenue
 Directly through selling inventory, or
 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 $41,404 million of

assets at January 31, 2015. Note that Target’s fiscal year
end does not occur at December 31.
Target Corporation
Balance Sheet ($ million)
January 31, 2015
Assets
Cash and cash equivalents $ 2,210
Inventory 8,790
Assets of discontinued operations 1,333
Other current assets 1,754
Current Assets 14,087
Property plant and equipment, net 25,958
Noncurrent assets of discontinued operations 442
Other noncurrent assets 917
Total Assets $41,404

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

Measuring Assets
 Assets intended to be used are reported on the balance

sheet at historical cost.
 Advantage: Historical cost is reliable
 Disadvantage: Often significantly undervalued
 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
Capital invested by
Borrowed funds such as: shareholders, either:
 Accounts payable  Directly via stock purchases,
or
 Accrued liabilities
 Indirectly in the form of
 Obligations to lenders, bond
retained earnings that reflect
investors, suppliers
earnings that are reinvested
in the business

Target’s Liabilities and Equity
Target Corporation
Balance Sheet ($ million)
January 31, 2015
Liabilities
Liabilities requiring Accounts payable $ 7,759.
Accrued and other current liabilities 3,783.
payment within Liabilities of discontinued operations 103.
one year Current portion of debt 91.
Total Current Liabilities 11,736.
Long-term debt 12,705.
Liabilities NOT Other long-term liabilities 2,966.
Total Liabilities 27,407.
requiring payment
within one year Stockholders' Equity
Common stock 53.
Retained Earnings 9,644.
Additional paid-in capital 4,899.
Other stockholder equity (599)
Total Stockholder Equity 13,997.
Total liabilities and equity $41,404.

Reporting Liabilities
Amounts are reported as liabilities on the balance sheet

when three
 A future conditions
sacrifice are met.
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.
Categories of Liabilities
 Current liabilities
 Reported as current liabilities on the balance sheet if due
within one year
 Listed in order of maturity
 Noncurrent liabilities
 Reported as long-term liabilities on the balance sheet if not
due within one year or one operating cycle

Common Current Liabilities
 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
 Deferred (unearned) revenue—an obligation created
when the company accepts payment in 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
Common Noncurrent Liabilities
 Long-term debt—amounts borrowed from creditors

that are scheduled to be repaid more than one year in
the future
 Other long-term liabilities—various obligations such as
warranty and deferred compensation 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
Earned been distributed to stockholders as dividends
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 increases
retained earnings. Beginning retained earnings
A net loss + Net income (or – Net loss)
will decrease
retained earnings.
– Dividends
Ending retained earnings
Reported on the balance sheet

in the stockholders’ equity
section

Use the financial statement effects

template (FSET) to analyze
transactions.

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

Financial Statement Effects Template
FSET
Balance Sheet Income Statement

Cash Noncash Contrib. Earned Net
Transaction Asset + Asset = Liabilities + Capital + Capital Revenues – Expenses = Income
The FSET template is=used to capture transactions
– and
=
their effects on the four financial statements.


The Account
 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 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 Revenues – Expenses = Net
Transaction Asset Asset = Liabilities + Capital Capital Income
Issued stock for + 10,000 = +10,000 – =
$10,000 cash Cash Common
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
Balanceinterest
Sheet of $40. Income Statement
Cash + Noncash = Liabilities + Contrib. + Earned Revenues – Expenses = Net
Capital
Transaction
Asset Asset Capital Income
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 accounting equation is in balance.

Rental Agreement
3. On May 1, Jana Juice Balance

signedSheet a rental agreement
for a store
Income Statement
location and
Transaction
Cash paid
Asset + $1,800
Noncash
Asset = as
Liabilitiesa+ security
Contrib.
Capital + deposit.
Earned
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 consisting of

energy drinks, on account.
Transaction Asset + Asset = Liabilities + Capital + Capital Revenues – Expenses = Income
Purchase +2,000 = +2,000 – =
Inventory on Inventory Accounts
account for Payable
$2,000

Both assets (inventory) and liabilities (accounts payable)

increase and the accounting equation is in balance.

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 assets $16,000 Total liabilities & equity $16,000
Assets = Liabilities + Equity
No income statement transactions have occurred

so there is no income statement.

Describe and construct

the income statement and discuss
how it can be used to evaluate
management performance.

Reporting Financial Performance
Income Statement
 Reports the results of operations as net income
Revenues areor loss
Revenues
for a period of time
increases in net assets
that result from
– Cost of goods sold
 General income statement format business activities.
Gross profit
– Expenses Expenses are the
outflow or use of
= Net income (earnings)
assets to generate
revenues.

Target’s Income Statement
Target reported $21,340 million gross profit on its income
statement for the year ended January 31, 2015.
Target Corporation
Income Statement ($ million)
For Year Ended January 31, 2015
Net revenues $72,618
Cost of sales 51,278
Gross profit 21,340
Operating expenses 17,687
Income from continuing operations before income
taxes 3,653
Income tax expense 1,204
Net income from continuing operations $ 2,449
Discontinued operations, net of tax (4,085)
Net (loss)/income (1,636)
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)

Nonoperating Revenues and Expenses
 Relate to the company’s financing and investing

activities
 Interest revenue
 Interest expense
 Usually segregated as they offer different insights into
company performance
 Recurring items—persist in the future
 Nonrecurring items—unlikely to arise in the future; not
relevant to future performance

Explain revenue recognition,

accrual 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
Decreases in net assets
that are earned by
from generating revenue
delivering goods and
and supporting operations.
services to customers.
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
Revenues is earned when delivered to the customer.

Accrual Accounting for Expenses
Expenses are matched when incurred against the related

revenue amounts. Example
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 January 31, 2015
Retained Earnings, February 1, 2014 $12,599.
Net (loss) / income (1,636)
Dividends declared (1,273)
Repurchase of stock (46)
Retained earnings, January 31, 2015 $ 9,644
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
Assets Liabilities
Cash $12,200 Accounts payable $ 2,000
Returning to the Jana Juice startup company example,
Inventory
Security deposit
2,000
1,800
Note payable
Total current liabilities
4,000
6,000
we again present the balance sheet after the May 110,000
Total current assets 16,000 Equity
Common stock
transactions.
Total assets $16,000 Total liabilities & equity
$16,000
Assets = Liabilities + Equity

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

Balance Sheet
during
Income Statement
May.
Transaction
Cash
Asset +
Noncash
Asset = Liabilities +
Contrib.
Capital +
Earned
Net
Income
Pay $900 cash for –900 = –900 – +900 = –900
May advertising. Cash Retained Advertising
Earnings Expense
Costs are recognized as expenses when incurred/used.

Paid Amounts Due
6. Jana Juice paid $1,500Balance

for inventory
Sheet
previously

purchased
Income Statement
on
account. Asset
Transaction
+ Asset = Liabilities + Capital + Capital Revenues – Expenses = Income
Paid $1,500 cash –1,500 = –1,500 – =
as partial payment Cash Accounts
to suppliers Payable
Assets (cash) and liabilities (accounts payable)

decrease by $1,500.

Selling to Customers
7. Jana Juice sold $600 of energy drinks to customers

Balance Sheet
for $2,400
Income Statement
cash during
Transaction
CashMay.
Asset +
Noncash
Asset = Liabilities +
Contrib.
Capital +
Earned
Net
Income
Sold drinks for +2,400 = +2,400 +2,400 – = +2,400
$2,400 cash Cash Retained Sales
Earnings Revenue
Record $600 for –600 = –600 – +600 = –600

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

Balance Sheet
for $2,900 to a
Income Statement
convenience
Transaction
Cash store
Asset + during
Noncash
Asset = May.
Liabilities +
Contrib.
Capital +
Earned
Net
Income
Sold drinks +2,900 = +2,900 +2,900 – = +2,900
for $2,900 Accounts Retained Sales
on account Receivable Earnings Revenue
Record $700 for –700 = –700 – +700 = –700

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.Transaction
Jana Juice paid wages totaling $1,300 to employees during May.
Cash
Asset + Noncash
Asset = Liabilities + Contrib. +
Capital
Earned Revenues – Expenses = Net
Capital Income
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 to Online Health Program
10. During May, Jana Juice received $300 from customers in

exchange for a three month membership (June, July and Aug) to
an online
Transaction
health
Cash +
program.
Noncash = Liabilities + Contrib. + Earned
Revenues – Expenses = Net
Asset Asset Capital Capital Income
Sold $300 +300 = +300 – =
3-month Cash Unearned
memberships to Revenue
online program
An 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.
Capital
Transaction + = Liabilities + + Revenues – Expenses =
Collected $1,200 +1,200 –1,200 = – =
as partial payment Cash Accounts
from customers Receivable
Assets (cash and accounts receivable) increase and

decrease by the same amount.

Paid Principal and Interest on a Loan

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

by $40, and liabilities decrease by $4,000.

Paid for Insurance in Advance

13. Jana
Transaction
Juice paid
Cash
+
$800
Noncash for a 4-month
= Liabilities +
Contrib. insurance
+
Earned policy.
Paid $800 for a –800 +800 = – =
4-month insurance Cash Prepaid
policy. Insurance
Assets (cash) decrease by $800 and

increase (prepaid insurance) by $800.

Paid Rent

14. Jana Juice paid
Cash Noncash for rent in
$700 May.
Contrib. Earned Net
Capital
Paid $700 for rent –700 = –700 – +700 = –700
for the current Cash Retained Rent
month, May. Earnings Expense
Assets (cash) decrease 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, 2016
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

and the statement of
stockholders’ equity.

Equity Transactions:
Paid Dividends

15. Jana
Transaction
Juice paid
Cash
+
$400
Noncash for dividends
= Liabilities +
Contrib. to
+
shareholders
Earned during May.
Paid $400 for –400 = –400 – =
dividends Cash Retained
Earnings
Assets (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, 2016
Contributed Capital Earned Capital Total Equity
Balance, April 30, 2015 $ -- $ -. $ --.
Net income -- 1,060. 1,060.
Common stock issued 10,000 -. 10,000.
Cash dividends -- (400) (400)
Balance, May 31, 2016 $ 10,000 $ 660. $ 10,660.
 Net income is $1,060 for the month.

 Dividends paid are $400 for the month.
 Total equity increased from zero to $10,660 by the end of May.
Use journal entries and T-accounts

to analyze and record transactions.

T-Accounts
Account Title
Always on Debits Credits Always on
Accountants
the Left (Dr) representation
use a graphic (Cr) of an account,
the Right
called a T-Account.

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 as described as debits and

credits. Double-entry accounting requires that debits
equal credits.
Accounts that increase on Accounts that increase on

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

Posting to T-Accounts
Specific Increases in the T-accounts are labeled by letter

transactions Cash account abbreviations for type
+ Cash (A) –
Beg. balance 2,500
(a) 4,000 1,500 (b)
(d) 200 500 (c)
1,000 (e)
End. balance 3,700

Decreases in the
Cash account
Ending Cash balance

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.
(1) Cash (+A) 10,000
 Amounts arestock
Common posted
(+SE) to T-accounts from the journal
10,000
entry.
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
Record Credit account names Debit amounts go Credit amounts go

debits first. are indented from the in the left column in the right column
1. On May 1, investors contributed $10,000 cash
left margin. to start Jana Juice
which sells energy drinks to retailers and individuals, in exchange
(1) for 500
Cash shares of stock.
(+A) 10,000
Common stock (+SE) 10,000
Cash (A) Common Stock (SE)

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


Obtain Loan
(2) Cash (+A) 4,000

Notes payable (+L) 4,000
2. On May 1, Jana Juice borrowed $4,000 cash by signing a note to

be
repaid on May
Cash (A) 31, plus interest
of $40.
Notes Payable (L)
(2) 4,000 4,000 (2)


Rental Agreement
(3) Security deposit (+A) 1,800

Cash (–A) 1,800
3. Jana Juice signed a rental agreement for its store location and
paid
$1,800
Securityas a security
Deposit (A) deposit.
Cash (A)
(3) 1,800 1,800 (3)


Purchase Inventory
(4) Inventory (+A) 2,000

Accounts payable (+L) 2,000
4. Jana Juice purchased $2,000 of inventory, consisting of energy

drinks,
onInventory
account. (A) Accounts Payable (L)
(4) 2,000 2,000 (4)


Payment of Advertising
(5) Advertising Expense (+E, –SE) 900

Cash (–A) 900
5. Jana Juice paid $900 to advertise in the local newspaper during

May.
Advertising Expense (E) Cash (A)
(5) 900 900 (5)


Pay Amounts Due
(6) Accounts payable (–L) 1,500

Cash (–A) 1,500
6. Jana Juice paid $1,500 for inventory previously purchased on

account.
Accounts Payable (L) Cash (A)
(6) 1,500 1,500 (6)


Sell to Customers for Cash
(7) Cash (+A) 2,400

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

7. Jana Juice sold $600
Inventory (–A) of energy drinks to customers for $2,400
600
cash
duringCash
May.(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) Accounts receivable (+A) 2,900

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

8. Jana Juice sold $700
Inventory (–A) of energy drinks to a convenience store
700 on
account
for $2,900,
Accounts Receivableduring
(A) May. Sales Revenue (R)
(8) 2,900 2,900 (8)

Cost of Goods Sold (E) Inventory (A)

(8) 700 700 (8)


Pay Wages
(9) Wages expense (+E, –SE) 1,300

Cash (–A) 1,300
9. Jana
Juice paid
Wages wages
Expense (E) totaling
$1,300
to employees
Cash (A) during
May.
(9) 1,300 1,300 (9)


Sold Membership to Online Health Program
(10) Cash (+A) 300

Unearned revenue (+L) 300
10. During May, Jana Juice received $300 from customers in
exchange for a 3-month membership (June, July, August) to an
online health program.
Cash (A) Unearned Revenue (L)
(10) 300 300 (10)


Customer Collections
(11) Cash (+A) 1,200

Accounts receivable (–A) 1,200

during May.
Cash (A) Accounts Receivable (A)
(11) 1,200 1,200 (11)


Paid Principal and Interest
(12) Note payable (–L) 4,000

Interest expense (+E, –SE) 40
Cash (–A) 4,040
12. Jana Juice paid $40 for interest and repaid the $4,000 note
payable.
Note Payable (L) Cash (A)
(12) 4,000 4,040 (12)

Interest Expense (E)

(12) 1,200


Paid for Insurance in Advance
(13) Prepaid Insurance (+A) 800

Cash (–A) 800
13. Jana Juice

Prepaidpaid $800(A)for a 4-month
Insurance insurance policy.
Cash (A)
(13) 800 800 (13)


Paid Rent
(14) Rent expense (+E, –SE) 700

Cash (–A) 700
14. Jana Juice

Rent paid $700
Expense (E) for rent for
May. Cash (A)
(14) 700 700 (14)


Pay Dividends
(15) Retained earnings (–SE) 400

Cash (–A) 400
15. Jana Retained

Juice paid $400
Earnings (SE)for dividends
to shareholders
Cash (A) during
May.
(15) 400 400 (15)


General Ledger After May Transactions
Cash (A) Accounts Payable (L) Common Stock (SE)
(1) 10,000 1,800 (3) (6) 1,500 2,000 (4) 10,000 (1)
(2) 4,000 900 (5) 500 Bal 10,000 Bal
(7) 2,400 1,500 (6)
Retained Earnings (SE)
(10) 300 1,300 (9) Unearned Revenue (L) (15) 400
(11) 4,040 (12) Equity
1,200 300 (10) Bal 400
800 (13) 300 Bal
Assets 700 (14) Sales Revenue (R )
400 (15) 2,400 (7)
Note Payable (L)
Bal 6,460 2,900 (8)
(12) 4,000 4,000 (2)
5,300 Bal
0 Bal
Accounts Receivable (A) Cost of Goods Sold (E)
(8) 2,900 1,200 (11) (7) 600
Bal 1,700 (8) 700
Liabilities Bal 1,300
Inventory (A) Wages Expense (E)
(4) 2,000 600 (7) (9) 1,300
700 (8) Income Statement Bal 1,300
Bal 700
accounts Rent Expense (E)
(14) 700
Prepaid Insurance (A)
Bal 700
(13) 800
Bal 800 Advertising Expense (E)
(5) 900
Security Deposit (A) Bal 900
(3) 1,800 Interest Expense ( E)
Bal 1,800 (12) 40
Bal 40
Compute net working capital,

the current ratio, and the quick ratio,
and explain how they reflect liquidity.

Evaluation Liquidity
 Liquidity
 Ability to pay debts when due
 The larger current assets are when compared to current
liabilities, the more liquid the company.
 Measured by
 Net working capital
 Current ratio
 Quick ratio

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

by approximately 64% from 2012 to 2014.
Current Ratio
Current Ratio = Current Assets / Current Liabilities
Walgreens’
The currentCurrent
ratio isRatio
defined as the ratio of current assets
to current liabilities.
Walgreens’ current ratio is deemed to represent a strong

current liquidity position since it exceeds 1.0 for each year—
increasing slightly each year.
Walgreens in Context
Current ratio of several companies:

Quick Ratio
Quick Ratio = Quick Assets / Current Liabilities

 The ratio of quick assets to current liabilities.
Walgreens’ Quick Ratio
 Quick assets include cash, short-term securities, and
accounts receivable.
Based on its quick ratio, Walgreens’ liquidity has increased

each year from 2012 through 2014.

Walgreens in Context
Quick ratio of several companies:

Operating Cycle
 Operating cycle
 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.
The End

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FINANCIAL & MANAGERIAL

© Cambridge Business Publishers, 2018

Describe and construct

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On January 31, 2015, Target’s balance sheet reports total

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Assets are resources that are expected to provide a

 Must be owned or controlled by the company

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 Why do companies acquire assets?

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Target Corp.’s balance sheet shows $41,404 million of

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 Cash—currency, bank deposits, certificates of deposit

 Long-term financial investments—investments in debt

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 Assets intended to be used are reported on the balance

 Some assets are reported at current fair value.

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 Represent sources of capital to the company

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Amounts are reported as liabilities on the balance sheet

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 Long-term debt—amounts borrowed from creditors

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Reflects capital provided by the owners of the company;

Retained earnings links the income statement to the

Reported on the balance sheet

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Use the financial statement effects

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Balance Sheet Income Statement

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1. On May 1, investors contributed $10,000 cash to start Jana Juice

Both assets (cash) and equity (common stock) increase

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2. On May 1, Jana Juice borrowed $4,000 cash by signing a note to

Both assets (cash) and liabilities (note payable) increase

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3. On May 1, Jana Juice Balance

Because the security deposit will likely be returned to Jana Juice

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4. On May 1, Jana Juice purchased $2,000 of inventory consisting of

Both assets (inventory) and liabilities (accounts payable)

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Assets = Liabilities + Equity

No income statement transactions have occurred

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Describe and construct

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Operating expenses are usual and customary costs

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