BASIC FINANCIAL STATEMENTS - Walailak...

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Chapter

2BASIC FINANCIAL STATEMENTS

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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Learning ObjectiveLearning Objective

To explain the nature and general purpose of

financial statements.

LO1© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

LO1

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Introduction to Financial StatementsIntroduction to Financial Statements

Three primaryBalance Sheet

Three primary financial

Income Statement

St t t f C h Fl

statements.Statement of Cash Flows

We will use a corporation to describe these

statementsstatements.


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Describes where the

Balance Sheet

enterprise stands at a

Income Statement

S f C h Fl specific date.Statement of Cash Flows


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Depicts theBalance Sheet

Depicts the revenue and

expenses for a

Income Statement

S f C h Fl expenses for a designated

period of time

Statement of Cash Flows

period of time.


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Revenues result in

Expenses result in

positive cash flow.

negative cash flow.

Eith i th t t f t© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Either in the past, present, or future.

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Net income (orBalance Sheet

Net income (or net loss) is simply the

Income Statement

S f C h Fl simply the difference between


between revenues and

expensesexpenses.


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Balance Sheet

Income Statement

S f C h Fl Depicts the ways cash has


changed during a designated

period of time.


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A Starting Point: Statement of Financial PositionFinancial Position

Vagabond Travel AgencyBalance Sheet

December 31 2007December 31, 2007Assets Liabilities & Owners' Equity

Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Offi i t 15 000 C it l t k 150 000Office equipment 15,000 Capital stock 150,000

Retained earnings 70,000 Total 300,000$ Total 300,000$


, ,

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To explain certain accounting principles that are importantprinciples that are important

for an understanding of financial statements and how

professional judgment byprofessional judgment by accountants may affect the

application of those principles.


LO2

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The Concept of the Business EntityThe Concept of the Business Entity

A businessA business entity is

t fVagabond Travel

separate from the personal

Agencyp

affairs of its ownerowner.


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AssetsAssets



Cash 22,500$ Liabilities:Assets are iNotes receivable 10,000 Notes payable 41,000$

Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000

economic resources that are owned by Supplies 2,000 Salaries payable 3,000

Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Offi i t 15 000 C it l t k 150 000

ythe business and are expected toOffice equipment 15,000 Capital stock 150,000


are expected to benefit future


, ,operations.

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AssetsAssets

Cost PrincipleCost Principle

These accounting i i l t GoingGoing--ConcernConcern

AssumptionAssumptionStableStable--DollarDollarAssumptionAssumption

principles support cost as the basis

for asset valuation

Obj ti itObj ti it

for asset valuation.

Objectivity Objectivity PrinciplePrinciple


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LiabilitiesLiabilities



Cash 22,500$ Liabilities:Liabilities are Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000

debts that represent negativeSupplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Offi i t 15 000 C it l t k 150 000

represent negative future cash flows f th t iOffice equipment 15,000 Capital stock 150,000


for the enterprise.


, ,

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Owners’ EquityOwners Equity


December 31, 2007December 31, 2007Assets Liabilities & Owners' Equity

Cash 22,500$ Liabilities:N t i bl 10 000 N t bl 41 000$

Owners’ equity Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000

represents the owners’ claims onpp , p y ,

Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15 000 Capital stock 150 000

owners claims on the assets of the

b iOffice equipment 15,000 Capital stock 150,000 Retained earnings 70,000

Total 300,000$ Total 300,000$

business.


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Owners’ EquityOwners Equity

Changes in Owners’ EquityEquity

•Owners’ Investments

•Payments to Owners

•Business Earnings

•Business Lossesg


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To demonstrate how certain business

transactions affect the elements of the

accounting equation: Assets = Liabilities +

Owners’ Equity.


LO3

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The Accounting EquationThe Accounting Equation


December 31 2007

Assets = Liabilities + Owners’ Equity

$ $ $December 31, 2007Assets Liabilities & Owners' Equity

Cash 22,500$ Liabilities:

$300,000 = $80,000 + $220,000

Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' EquityOffi i t 15 000 C it l t k 150 000Office equipment 15,000 Capital stock 150,000



, ,

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Let’s analyzeLet s analyze some

transactions for JJ’s Lawn CareJJ s Lawn Care

Service.


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O M 1 Jill J d h f il i t dOn May 1, Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received

800 h f t kJJ's Lawn Care Service

800 shares of stock.

Balance SheetMay 1, 2007

Assets Owners' EquityAssetsCash 8,000$ Capital Stock 8,000$

Owners Equity

Total 8,000$ Total 8,000$



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On May 2 JJ’s purchased a riding lawnOn May 2, JJ’s purchased a riding lawn mower for $2,500 cash.

JJ's Lawn Care ServiceBalance SheetBalance Sheet

May 2, 2007Assets

Cash 5 500$ Capital Stock 8 000$Owners' Equity

Cash 5,500$ Capital Stock 8,000$ Tools & Equipment 2,500



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On May 8 JJ’s purchased a $15 000 truckOn May 8, JJ s purchased a $15,000 truck.

JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13 000for the remaining $13,000.

JJ's Lawn Care ServiceBalance Sheet

May 8, 2007Assets Liabilities and Owners' EquityAssets

Cash 3,500$ Liabilities: Tools & Equipment 2,500 Notes Payable 13,000$ T k 15 000 O ' E it

Liabilities and Owners Equity

Truck 15,000 Owners' Equity:Capital Stock 8,000

Total 21,000$ Total 21,000$


Total 21,000$ Total 21,000$

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On May 11 JJ’s purchased some repairOn May 11, JJ s purchased some repair parts for $300 on account.

JJ's Lawn Care ServiceBalance SheetBalance SheetMay 11, 2007

AssetsCash 3 500$ Liabilities:

Liabilities and Owners' EquityCash 3,500$ Liabilities: Tools & Equipment 2,800 Notes Payable 13,000$ Truck 15,000 Accounts Payable 300

Total Liabilities 13,300$ Owners' Equity:Capital Stock 8,000 p ,

Total 21,300$ Total 21,300$


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Jill realized she had purchased more repair parts than needed.Jill realized she had purchased more repair parts than needed.

On May 18, JJ’s was able to sell half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. JJ’s will receive the cash within 30 days.


AssetsC h 3 500$ Li biliti

Liabilities and Owners' EquityCash 3,500$ Liabilities: Accounts Receivable 150 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 300 Truck 15,000 Total Liabilities 13,300$

Owners' Equity:Capital Stock 8,000Capital Stock 8,000

Total 21,300$ Total 21,300$


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On May 25 ABC Lawns pays JJ’s $75 as a partialOn May 25, ABC Lawns pays JJ’s $75 as a partial settlement of its accounts receivable.



Liabilities and Owners' EquityCash 3,575$ Liabilities: Accounts Receivable 75 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 300 Truck 15,000 Total Liabilities 13,300$

Owners' Equity:Capital Stock 8,000 p ,

Total 21,300$ Total 21,300$


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On May 28 JJ’s pays $150 of its accountsOn May 28, JJ’s pays $150 of its accounts payable.



Liabilities and Owners' EquityCash 3,425$ Liabilities: Accounts Receivable 75 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 150 Truck 15,000 Total Liabilities 13,150

Owners' Equity:Capital Stock 8,000 p ,

Total 21,150$ Total 21,150$


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On May 29 JJ’s recorded lawn care servicesOn May 29, JJ s recorded lawn care services provided during May of $750. All clients were

paid in cashJJ's Lawn Care Service

Balance Sheet

paid in cash.



Liabilities and Owners' EquityCash 4,175$ Liabilities: Accounts Receivable 75 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 150 Truck 15,000 Total Liabilities 13,150

Owners' Equity:Capital Stock 8,000 p ,Retained Earnings 750

Total 21,900$ Total 21,900$


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To explain how the statement of financial

position, often referred to as the balance sheet, is an expansion of the

basic accounting gequation.


LO4

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On May 31 JJ’s purchased gasoline for theOn May 31, JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.

JJ's Lawn Care ServiceBalance SheetMay 31, 2007


Liabilities and Owners' EquityCash 4,125$ Liabilities: Accounts Receivable 75 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 150 T k 15 000 T t l Li biliti 13 150Truck 15,000 Total Liabilities 13,150

Owners' Equity:Capital Stock 8,000 Retained Earnings 700

Total 21,850$ Total 21,850$

N l t’ i h JJ’ t ti© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Now, let’s review how JJ’s transactions affected the accounting equation.

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Assets = Liabilities + Owners' EquityAssets Liabilities

Cash +Accts. Rec. +

Tools & Equip. + Truck =

Notes Payable +

Accts. Pay. +

Capital Stock +

Retained Earnings

May 1 8,000$ 8,000$

Owners Equity

Balances 8,000$ 8,000$ May 2 (2,500) 2,500$

Balances 5,500$ 2,500$ 8,000$ May 8 (2 000) 15 000$ 13 000$May 8 (2,000) 15,000$ 13,000$

Balances 3,500$ 2,500$ 15,000$ 13,000$ 8,000$ May 11 300 300$

Balances 3,500$ 2,800$ 15,000$ 13,000$ 300$ 8,000$ ,$ ,$ ,$ ,$ $ ,$May 18 150$ (150)

Balances 3,500$ 150$ 2,650$ 15,000$ 13,000$ 300$ 8,000$ May 25 75 (75)

Balances 3,575$ 75$ 2,650$ 15,000$ 13,000$ 300$ 8,000$ May 28 (150) (150)

Balances 3,425$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ May 29 750 750May 29 750 750

Balances 4,175$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 750$ May 31 (50) (50)

Balances 4,125$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 700$


,$ $ ,$ ,$ ,$ $ ,$ $

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Assets = Liabilities + Owners' Equity

Let’s prepare the Income Statement and Statement of Cash Flows for JJ’s Lawn Care Assets Liabilities

Cash +Accts. Rec. +

Tools & Equip. + Truck =

Notes Payable +

Accts. Pay. +

Capital Stock +

Retained Earnings

May 1 8,000$ 8,000$

Owners Equity

Service for the month ending May 31, 2007.

Balances 8,000$ 8,000$May 2 (2,500) 2,500$

Balances 5,500$ 2,500$ 8,000$ May 8 (2 000) 15 000$ 13 000$

These transactions impact the May 8 (2,000) 15,000$ 13,000$

Balances 3,500$ 2,500$ 15,000$ 13,000$ 8,000$ May 11 300 300$

Balances 3,500$ 2,800$ 15,000$ 13,000$ 300$ 8,000$

pStatement of Cash

Flows.,$ ,$ ,$ ,$ $ ,$May 18 150$ (150)

Balances 3,500$ 150$ 2,650$ 15,000$ 13,000$ 300$ 8,000$ May 25 75 (75)

Balances 3,575$ 75$ 2,650$ 15,000$ 13,000$ 300$ 8,000$May 28 (150) (150)

Balances 3,425$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ May 29 750 750These transactionsMay 29 750 750

Balances 4,175$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 750$ May 31 (50) (50)

Balances 4,125$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 700$

These transactions impact the Income

Statement© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

,$ $ ,$ ,$ ,$ $ ,$ $Statement.

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To explain how the income statement reports anstatement reports an enterprise’s financial

performance for a period of time in terms of the

relationship of revenues and e pensesexpenses.


LO5

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JJ's Lawn Care ServiceIncome StatementIncome Statement

For the Month Ended May 31, 2007

Sales Revenue 750$ Operating Expense:Gasoline Expense 50 Gasoline Expense 50

Net Income 700$

Investments by and payments to the owners t i l d d th I St t t


are not included on the Income Statement.

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To explain how the statement of cash flowsstatement of cash flows

presents the change in cash for a period of time in terms of the company’s operating,

investing, and financing acti itiesactivities.


LO6

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JJ's Lawn Care ServiceStatement of Cash Flows

For the Month Ended May 31, 2007Cash flows from operating activities:Cash flows from operating activities: Cash received from revenue transactions 750$ Cash paid for expenses (50) Net cash provided by operating activities 700$ Cash flows from investing activities:

Purchase of lawn mower (2 500)$ Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities:Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ C h b l M 1 2007


Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125$

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Purchase of lawn mower (2 500)$Operating activities include the cash Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75

p geffects of revenue and expense

transactions Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities:

transactions.

Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ C h b l M 1 2007



2-37



Purchase of lawn mower (2 500)$ Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities:I ti ti iti i l d th hCash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ C h b l M 1 2007

Investing activities include the cash effects of purchasing and selling


Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125$ assets.

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Purchase of lawn mower (2 500)$Fi i i i i i l d h h Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75

Financing activities include the cash effects of transactions with the owners

Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities:

and creditors.Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ C h b l M 1 2007



2-39

Now let’s prepare the Balance Sheet for JJ’sAssets = Liabilities +

Accts. Tools & Notes Accts. Capital Retained Owners' Equity

Now, let s prepare the Balance Sheet for JJ s Lawn Care Service for May 31, 2007.

Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + EarningsMay 1 8,000$ 8,000$

Balances 8,000$ 8,000$ May 2 (2 500) 2 500$May 2 (2,500) 2,500$

Balances 5,500$ 2,500$ 8,000$ May 8 (2,000) 15,000$ 13,000$

Balances 3,500$ 2,500$ 15,000$ 13,000$ 8,000$Balances 3,500$ 2,500$ 15,000$ 13,000$ 8,000$May 11 300 300$

Balances 3,500$ 2,800$ 15,000$ 13,000$ 300$ 8,000$ May 18 150$ (150)

Th b l illBalances 3,500$ 150$ 2,650$ 15,000$ 13,000$ 300$ 8,000$May 25 75 (75)

Balances 3,575$ 75$ 2,650$ 15,000$ 13,000$ 300$ 8,000$ May 28 (150) (150)

These balances will appear on the

B l Sh tMay 28 (150) (150)Balances 3,425$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$

May 29 750 750 Balances 4,175$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 750$

Balance Sheet.


,$ $ ,$ ,$ ,$ $ ,$ $May 31 (50) (50)

Balances 4,125$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 700$

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JJ's Lawn Care Service

Assets Liabilities


Cash 4,125$ Notes payable 13,000$ Accounts receivable 75 Accounts payable 150 Tools & equipment 2 650 Owners' EquityTools & equipment 2,650 Truck 15,000 Capital stock 8,000

Retained earnings 700 T t l t 21 850$ T t l li biliti & it 21 850$

Owners Equity

Total assets 21,850$ Total liabilities & equity 21,850$

Assets = Liabilities + Owners’ EquityAssets = Liabilities + Owners’ Equity

$21 850 = $13 150 + $8 700© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

$21,850 = $13,150 + $8,700

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To explain the important relationships among the

statement of financial position, income statement,

and statement of cashand statement of cash flows, and how these

statements relate to each other.


LO7

2-42

Relationships Among Financial StatementsStatements

Date at Date atDate at beginning of period

Date at end of periodTimep p

Balance BalanceBalance Sheet

Balance Sheet

Income Statement




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Financial Statement ArticulationFinancial Statement ArticulationJJ's Lawn Care Service

Statement of Cash Flows JJ's Lawn Care ServiceFor the Month Ended May 31, 2007Cash flows from operating activities: Cash received from revenue transactions 750$ Cash paid for expenses (50)

Net cash provided by operating activities 700$

JJ s Lawn Care ServiceIncome Statement

For the Month Ended May 31, 2007

Net cash provided by operating activities 700$ Cash flows from investing activities: Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75

Sales Revenue 750$ Operating Expense: Gasoline Expense 50 Net Income 700$

Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ JJ's Lawn Care Service

et co e 00$

,Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125$

Cash 4,125$ Notes payable 13,000$ Assets Liabilities

JJ s Lawn Care ServiceBalance SheetMay 31, 2007

Accounts receivable 75 Accounts payable 150 Tools & equipment 2,650 Truck 15,000 Capital stock 8,000

Retained earnings 700 T t l t 21 850$ T t l li biliti & it 21 850$

Owners' Equity


Total assets 21,850$ Total liabilities & equity 21,850$

2-44

Financial Reporting and Financial StatementsStatements

Financial statements are

Income

just one source of financial accounting

informationBalance

Sheet

Income Statementinformation.


Other Information:•Industry•Competitors


p•National economy

2-45


To explain common forms of business ownership—sole proprietorship, partnership,

and corporation—and demonstrate how they differ indemonstrate how they differ in terms of their presentation in

the statement of financial position.


LO8

2-46

Forms of Business OrganizationForms of Business Organization

Sole Partnerships CorporationsProprietorships Partnerships Corporations


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Reporting Ownership Equity in the Statement of Financial PositionStatement of Financial Position

Ow ner's equity: Jill Jones, capital 8,000$

Sole Proprietorships

Partners' equityJill J it l 4 000$ Jill Jones, capital 4,000$

Bill Jones, capital 4,000 Total partners' equity 8,000$

Partnerships Total partners equity 8,000$

Owners' equityOwners equity Capital stock 7,000$ Retained earnings 1,000 Corporations


g Total stockholders' equity 8,000$

2-48

The Use of Financial Statements by The Use of Financial Statements by External PartiesExternal Parties

Two concerns:Creditors Liquidity

Profitability

Investors© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Investors

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The Need for Adequate DisclosureThe Need for Adequate Disclosure

Notes to the financial

Balance Sheet

financial statements often

id f t

Income Statement

S f C h Fl provide facts necessary for the


proper interpretation of pthe statements.


2-50


To discuss the importance of financial statements to a company and its investors

and creditors and why management may takemanagement may take

steps to improve the appearance of the company pp p yin its financial statements.


LO9

2-51

Management’s Interest in Financial Management’s Interest in Financial StatementsStatements

Creditors are more likely to extend credit if financial statements show a strong statement of financial

iti th t i l ti l littl d bt d lposition—that is, relatively little debt and large amounts of liquid assets.

Window dressing occurs when management takes measures to make the company appear as strong


measures to make the company appear as strong as possible in it financial statements.

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End of Chapter 2End of Chapter 2


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