0 Glencoe Accounting Unit 2 Chapter 9 Copyright © by The McGraw-Hill Companies, Inc. All rights...

Glencoe Accounting Unit 2 Chapter 9 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. 1

Unit 2The Basic Accounting Cycle

Chapter 3 Business Transactions and the Accounting Equation

Chapter 4 Transactions That Affect Assets, Liabilities, and Owner’s Capital

Chapter 5 Transactions That Affect Revenue, Expenses, and Withdrawals

Chapter 6 Recording Transactions in a General Journal

Chapter 7 Posting Journal Entries to General Ledger Accounts

Chapter 8 The Six-Column Work Sheet

Chapter 9 Financial Statements for a Sole Proprietorship

Chapter 10 Completing the Accounting Cycle for a Sole Proprietorship

Chapter 11 Cash Control and Banking Activities


Chapter 9Financial Statements for

a Sole Proprietorship

What You’ll Learn Explain the purpose of the income statement. Prepare an income statement. Explain the purpose of the statement of changes in

owner’s equity. Prepare a statement of changes in owner’s equity. Explain the purpose of a balance sheet. Prepare a balance sheet. Explain the purpose of the statement of cash flows. Explain the ratio analysis and compute ratios. Define the accounting terms introduced in this

chapter.


Chapter 9, Section 1The Income Statement

What Do You Think?How do people who read financial statements use the information?


Main IdeaThe income statement reports the net income or net loss for an accounting period.

You Will Learn the four financial statements prepared for a

business. how to prepare an income statement.

The Income StatementSECTION 9.1


Key Terms financial statements income statement



Financial statements summarize changes resulting from business transactions that occur during an accounting period. Preparing financial statements is the seventh step in the accounting cycle.





Financial StatementsThe financial statements often prepared for a sole proprietorship are:

the income statement. the balance sheet. the statement of changes in owner’s equity. the statement of cash flows.



The Income StatementThe income statement reports net income or net loss for a defined period of time. It is sometimes called a profit-and-loss statement or an earnings statement.



Income Statement SectionsThe income statement contains the following sections:

the heading the revenue for the period the expenses for the period the net income or net loss for the period



HeadingThe heading of an income statement has three parts:

the name of the business (Who?) the name of the report (What?) the period covered (When?)



Revenue SectionTo record revenue:

A - Write Revenue: on the first line at the left side.

B - Enter revenue account names beginning on the second line.

C - Enter the balance of each revenue account in the first amount column.

Enter the total revenue in the second amount column beneath the last revenue amount and write Total Revenue to the left.



Expenses SectionTo record expenses:

D - On the line following the revenue section, write Expenses: at the left side.

E - Enter expense account names beginning on the next line and enter the balances in the first amount column.

F - Draw a single rule line under the last balance.G - Write Total Expenses on the line beneath the

last expense account name.H - Add the balances for the expense accounts and

enter the amount in the second amount column below the last expense account balance.



Net Income SectionTo record net income:

I - Draw a single rule line under the total expenses amount.

J - Subtract total expenses from total revenue and enter the value in the second amount column under the total expenses amount.

K - To the left of this value, write Net Income.

L - If this amount matches the amount on the work sheet, draw a double rule beneath the net income amount.





Reporting a Net LossIf total expenses exceed total revenue, a net loss exists.

To record a net loss: Enter the net loss amount in the second amount

column beneath the total expenses amount. Write Net Loss to the left of this value.



Key Terms Review financial statements

Reports prepared to summarize the changes resulting from business transactions that occur during an accounting period.

income statement

A report of the net income or net loss for a specific period; sometimes called a profit-and-loss statement or earnings statement.



Chapter 9, Section 2 The Statement of Changes in

Owner’s Equity

What Do You Think?What decisions would an owner make based on the changes in owner’s equity for a period?


Main IdeaThe statement of changes in owner’s equity shows how the owner’s financial interest changed during the accounting period.

You Will Learn the purpose of the statement of changes in

owner’s equity. how to prepare the statement of changes in

owner’s equity.

The Statement of Changes in Owner’s Equity

SECTION 9.2


Key Term statement of changes in owner’s equity


SECTION 9.2


The Statement of Changes in Owner’s EquityThe statement of changes in owner’s equity summarizes the changes in the owner’s capital account as a result of business transactions that occur during the period.

The information to prepare this statement is found in: the work sheet the income statement the owner’s capital account in the general ledger


SECTION 9.2


Completing the Statement of Changes in Owner’s EquityFollow the steps below to complete this financial statement:

A - On the first line, write Beginning Capital followed by a comma and the first day of the period.

B - Enter the balance of the capital account in the second column (found on general ledger).

C - Enter the increases to the capital account.D - Enter the total investment in the first amount

column.E - Enter the words Net Income, the net income

amount and draw a single rule under the net income amount.


SECTION 9.2


Completing the Statement of Changes in Owner’s Equity

F - Write Total Increase in Capital beneath the increases and enter the total increases in the second amount column.

G - Write Subtotal on the next line and enter the beginning capital added to the total increase.

H - List the decreases to the capital account beginning on the next line. Enter the withdrawals amount and draw a single rule under the withdrawals amount.

I - Write Ending Capital on the next line followed by a comma and the last day of the period.

J - Subtract the withdrawals amount from the subtotal to get the ending balance of the capital account.


SECTION 9.2


Completing the Statement of Changes in Owner’s Equity

Below is an example of a completed statement.


SECTION 9.2


Statement of Changes in Owner’s Equity for an Ongoing BusinessFor an ongoing business, the capital account balance on the work sheet may not be the balance at the beginning of the period. There are two ways to determine the owner’s capital account balance:

Look at the ledger. Subtract additional investments from the balance

shown on the work sheet.


SECTION 9.2


Statement of Changes in Owner’s Equity for an Ongoing BusinessThe statement of changes in owner’s equity for an ongoing business with a net loss can look like this:


SECTION 9.2


Key Term Review statement of changes in owner’s equity

A financial statement that summarizes changes in the owner’s capital account as a result of business transactions during the period.


SECTION 9.2


Chapter 9, Section 3The Balance Sheet and the

Statement of Cash Flows

What Do You Think?What decisions would you make if you had information showing how much money you spent last month?


Main IdeaThe balance sheet reports the financial position at a specific point in time. The statement of cash flows reports the sources and uses of cash during the accounting period.

You Will Learn how to prepare a balance sheet. the purpose of a statement of cash flows. how to perform ratio analysis.

The Balance Sheet and the Statement of Cash Flows

SECTION 9.3


Key Terms balance sheet report form statement of cash flows ratio analysis profitability ratio return on sales current assets current liabilities working capital liquidity ratio current ratio quick ratio


SECTION 9.3


The Balance SheetThe balance sheet is a report of balances in the permanent accounts at the end of the period. The balance sheet summarizes the following information:

what a business owns what a business owes what a business is worth


SECTION 9.3


The Sections of a Balance SheetThe balance sheet contains the following sections:

the heading the assets section the liabilities and owner’s equity sections


SECTION 9.3


HeadingThe heading includes:

The name of the business (Who?) The name of the financial statement (What?) The date of the balance sheet (When?)


SECTION 9.3


Assets SectionA balance sheet can be recorded in report form, listing the balance sheet sections one under the other.

To complete the assets section of the balance sheet:

A - Write Assets on the first line in the center of the account name column.

B - List each asset account name and draw a single rule under the last balance.

C - On the next line, write Total Assets and enter the total of the individual asset balances in the second amount column.


SECTION 9.3


Liabilities and Owner’s Equity SectionsThis information is taken from the work sheet and the statement of changes in owner’s equity and is recorded as follows:

D - Write Liabilities beneath Total Assets in the center of the column containing account names.

E - List the liability account names and balances and draw a single rule beneath the last account balance.

F - Write Total Liabilities on the next line and enter the total of the individual liability balances in the second amount column.


SECTION 9.3


Liabilities and Owner’s Equity SectionsG - On the next line, write Owner’s Equity in the

center of the account name column.

H - On the next line, write the name of the capital account and enter the ending balance of the capital account in the second amount column.


SECTION 9.3



SECTION 9.3

(continued)



SECTION 9.3

Example of a completed balance sheet.


Proving the Equality of the Balance SheetTo prove the equality of the balance sheet, follow these steps:

Draw a single rule beneath the capital account balance and write Total Liabilities and Owner’s Equity on the next line.

Add the total liabilities amount and the ending capital balance and enter this value in the second amount column.

Draw a double rule under the total assets amount and under the total liabilities and owner’s equity amount if the two values are equal.


SECTION 9.3


The Statement of Cash FlowsThe statement of cash flows covers one accounting period and summarizes the following information:

the amount of cash the business took in the sources of cash the amount of cash the business paid out the uses of cash


SECTION 9.3


Ratio AnalysisRatio analysis is the process of evaluating the relationship between various amounts in the financial statements.


SECTION 9.3


Profitability RatiosProfitability ratios are used to evaluate the earnings performance of the business during the accounting period.

A commonly used ratio is return on sales. To calculate return on sales, divide net income by sales.


SECTION 9.3


Liquidity MeasuresCurrent assets are used up or converted to cash during the normal operating cycle and current liabilities are debts that must be paid within the next accounting period.

Working capital is calculated using current assets and liabilities:

Current Assets – Current Liabilities = Working Capital

Liquidity is the ease with which an asset can be converted to cash and a liquidity ratio tells the ability a business has to pay its current debts and to provide for an unexpected need for cash.


SECTION 9.3


Current RatioThe current ratio shows the relationship between current assets and current liabilities. A ratio of 2:1 or higher is favorable. It is calculated by dividing current assets by current liabilities:


SECTION 9.3


Quick RatioThe quick ratio shows the relationship between short-term assets and current liabilities. A ratio of 1:1 is considered adequate. It is calculated by dividing the total cash and receivables by total current liabilities:


SECTION 9.3


Key Terms Review balance sheet

A report of the balances in the permanent accounts on a specific date.

report form

A balance sheet format that lists classifications one under another.

statement of cash flows

A financial statement that summarizes the cash receipts and cash payments resulting from business activities during a period.


SECTION 9.3


Key Terms Review ratio analysis

The process of evaluating the relationship between various amounts in the financial statements.

profitability ratio

A ratio used to evaluate the earnings performance of a business during the accounting period.

return on sales

A ratio that examines the portion of each sales dollar that represents profit; calculated by dividing net income by sales.


SECTION 9.3


Key Terms Review current assets

The assets that are either used up or converted to cash during the normal operating cycle of the business.

current liabilities

The debts of the business that must be paid within the next accounting period.

working capital

The amount by which current assets exceed current liabilities.


SECTION 9.3


Key Terms Review liquidity ratio

The measure of a business’s ability to pay its current debts as they become due and to provide for unexpected needs of cash.

current ratio

The relationship between current assets and current liabilities; calculated by dividing current assets by current liabilities.

quick ratio

A measure of the relationship between short-term assets and current liabilities; calculated by dividing the total cash and receivables by the current liabilities.


SECTION 9.3


Question 1Indicate with an I for income statement, a B for balance sheet, and an S for statement of changes in owner’s equity in which financial statement(s) you would most likely find the following.

1. Net Income __________

2. Salaries Expense __________

3. Accounts Payable—Abler Trucking __________

4. Maria Sanchez, Capital June 1, 2009__________

5. Guide Services Revenue __________

6. Office Equipment __________

7. Maria Sanchez, Withdrawals __________

8. Advertising Expense __________

9. Land __________

Chapter 9 ReviewCHAPTER 9



Answer 11. Net Income: I,S

Net income is calculated on the income statement. It also appears in the statement of changes in owner’s equity as an addition to the beginning capital.

2. Salaries Expense: I

The income statement summarizes all revenue and expense accounts.



Answer 13. Accounts Payable—Abler Trucking: B

The balance sheet lists all asset, liability, and owner’s equity permanent accounts.

4. Maria Sanchez, Capital June 1, 2009: S

The date indicates a beginning capital account balance that must be adjusted on the statement of changes in owner’s equity.



Answer 15. Guide Services Revenue: I


6. Office Equipment: B

The balance sheet lists all asset, liability, and owner’s equity permanent accounts.



Answer 17. Maria Sanchez, Withdrawals: S

Withdrawals are reductions in owner’s capital and are subtracted from owner’s capital on the statement of changes in owner’s equity. The capital listed on the balance sheet is the end-of-period balance after deduction of withdrawals.

8. Advertising Expense: I




Answer 19. Land: B

The balance sheet lists all asset, liability, and owner’s equity permanent accounts. Land is an asset.


Question 2How would you use the profitability and liquidity ratios to determine whether the business is moving in a positive direction?



Answer 2A ratio is most useful when it is compared to the same ratio prepared at several different times for the same company or compared to the same ratio prepared for the industry of which the business is part.

Comparing to the industry average will let the owner or manager know how the business is performing in comparison to its competition.



Resources

Glencoe Accounting Online Learning Center

English Glossary

Spanish Glossary

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