Accounting Notes: Chapter 2

Balance Sheet and the Flow of Costs: * When costs create an immediate benefit, company records it to be an expense on the income statement. * Example: Gasoline for delivery vehicles * When cost creates future economic benefit, the company records the cost on the balance sheet as an asset * Ex: Inventory to be resold * Ex: Equipment to be later used for manufacturing * Asset = future economic benefit * Remains on balance sheet until it is used up * When the asset is used up, there is no future economic benefit left so there is no asset left. * When this happens, the asset’s cost is transferred from balance sheet to income statement where it’s then labeled “expense” * Company “expense” certain costs rather than “asset”-ing it because even though it will likely bring future economic benefits, it can’t be accurately or reliably measured.

* Costs that are recorded on the balance sheet are capitalized costs * Assets are reduced when it is transferred into Income Statement as “expenses” * TRACKING THE FLOW OF COSTS FROM BALANCE SHEET TO INCOME STATEMENT IS IMPORTANT IN ACCOUNTING * Some corporations will have improper cost transfers on their statements to reflect fraudulent higher profit levels * This results in overstating assets on balance sheet when in fact, it has become an expense, and as a result, net income on the income statement is higher than it should be (because the expense is smaller than it should be to subtract it from its total revenue)

* Asset costs should transfer to the income statement when the asset no longer has any future economic benefit * Example: When inventory is purchased or manufactured, its cost is recorded on the balance sheet as an asset called inventories. * When it is sold, it is no longer contributing to the economic benefit to the company and their cost is then transferred to the income statement in an expense called cost of goods sold * Example: Equipment Costs – when a company acquires equipment, the cost of it is recorded on the balance sheet as an asset called equipment. When it is used in operations, a portion of the acquisition cost is transferred to the income statement to match against the sales the equipment helped generate. * Asset Costs = $100,000 10% is used up in operating activities * $10,000 is then transferred from balance sheet to income statement * Process is called: Depreciation and expense is called depreciation expense

Assets * To create shareholder value (equity) assets must yield income that is in excess of the cost of the funds used to acquire the assets * Assets must: * Be owned or controlled by the company * Implies company has legal title to asset such as title to property or has a lease on the property * Possess expected future economic benefits * Benefits can be cash inflows from the sale of an asset or from sales of products produced by the asset

Current Assets: * Balance sheet lists assets in order of decreasing liquidity * Decreasing Liquidity: refers to the ease of converting noncash assets into cash * Current Assets: Most liquid assets * Listed first in a balance sheet * Examples:

* Companies will seek to maintain only enough current assets to cover liquidity needs, but