Chapter 2 - Investing and Financial Decisions and the Accounting System


Foundation of the semester

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  • 29 days ago by vince

Elements of the balance sheet

A = L + E

Equity = Contributed capital + Retained Earnings

Step 1: 1000 = 0 + 1000 (contributed capital)

Step 2: Net Income (Profits) = Revenue - Expense = 9000

Retained earnings = 9000

Step 3: 10k = 0 + (10k + 1k)

Step 4: Investors take out a dividend of 5k

5k = 0 + (1k + 4k)


Accounts are used by companies to accumulate total transactions -- will be found in the chart of accounts

  • Assets
    • Cash
    • Building
    • Land
    • Equipment
  • Liabilities
    • Accounts payable (what you owe a vendor)
    • Notes payable (loan from a bank, usually carries interest)
    • Unearned Revenue
  • Equity
    • Common Stock
    • Retained Earnings (Profits not paid out yet as dividends)
  • Revenues
    • Sales
    • Fees
    • Rent
    • Services
  • Expenses
    • Cost of goods sold
    • Wages
    • Rent paid
    • Depreciation
    • Insurance
    • Taxes


  • Every transaction has 2 effects on the basic accounting equation (double entry)

E.g. Chipotle sold shares for $300. This increases cash and increases equity

General Journal (chronological list of transactions) Posts into a General Ledger or T-accounts (a record of effects to and balances of each account)

If doing manually

Step 1: Record transaction (journal entry) in General journal
Step 2: Transfer transaction from Step 1 into General Ledger for that related account (enter account# in general journal as "post ref" and general journal page# as "post ref" in general ledger to keep track of what went where)
Step 3: The balance of the General Ledger goes into the T-account

    300   |
      2   |
          |  54

Cash (since it's an asset account) should normally have a debit balance as listed above. If it doesn't then it's a red flag and warrants checking

Debits and Credits

Debit increases accounts in Credit increases accounts in Debit increases accounts in
A LE - R E

Accounting cycle

During the period:
1. Analyze transactions
2. Record Journal entries
3. Post entries to the general ledger

End of the period:
1. Prepare trial balance etc

SleepHead Overview

Trial Balance

The trial balance lists the ending balance of each account in the general ledger. It's purpose is to make sure the debits and credits are equal

  1. List accounts in order (assets, liabilities, equity, revenues, expenses)
  2. Show debit or credit balance for each account

Current Ratio

Current Ratio = Current Assets / Current Liabilities

Tells you if a company has enough short term resources to pay it's short term debt. Good indication of how liquid a company is and lenders care about this ratio.