Basic Financial

Statements
Chapter 2

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin

Copyright 2012 The McGraw-Hill Companies,21

Introduction to Financial
Statements
Balance Sheet

Three primary
Income Statement
financial
Statement of Cash Flows statements.

We will use a corporation to describe these

statements.
22

Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows

Describes
where the
enterprise
stands at a
specific date.

23

Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows

Depicts the
revenue and
expenses for a
designated
period of time.

24

Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows

Depicts the
ways cash has
changed during
a designated
period of time.

25

A Starting Point:
Statement of Financial
Position

26

The Concept of the

Business Entity

Vagabond
Travel
Agency

A business
entity is
separate from
the personal
affairs of its
owner.

27

Assets

Assets are
economic
resources that are
owned by the
business and are
expected to benefit
future operations.
28

Assets
These accounting principles support
cost as the basis for asset valuation.
Stable-Dollar
Assumption

Cost
Principle

Objectivity
Principle

Going-Concern
Assumption

29

Liabilities

Liabilities are
debts that
represent
negative future
cash flows for
the enterprise.
210

Owners Equity

Owners equity
represents the
owners claims
on the assets of
the business.
211

The Accounting Equation

Assets
Assets == Liabilities
Liabilities ++ Owners
OwnersEquity
Equity

$300,000
$300,000 ==

$80,000
$80,000 ++

$220,000
$220,000

212

Lets analyze
transactions
for JJs Lawn
Care Service.

213

On May 1, Jill Jones and her family

invested $8,000 in JJs Lawn Care Service
and received 800 shares of stock.

214

On May 2, JJs purchased a riding lawn

mower for $2,500 cash.

215

On May 8, JJs purchased a $15,000 truck.

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

216

On May 11, JJs purchased some repair

parts for $300 on account.

217

Jill realized she had purchased more repair parts than

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

218

On May 25, ABC Lawns pays JJs $75 as a

partial settlement of its accounts
receivable.

219

On May 28, JJs pays $150 of its accounts

payable.

220

On May 29, JJs recorded lawn care

services provided during May of $750. All
clients were paid in cash.

221

On May 31, JJs purchased gasoline for

the lawn mower and the truck for $50 cash.

222

May 1
Balances
May 2
Balances
May 8
Balances
May 11
Balances
May 18
Balances
May 25
Balances
May 28
Balances
May 29
Balances
May 31
Balances

Cash
$ 8,000
$ 8,000
(2,500)
$ 5,500
(2,000)
$ 3,500

Assets
Accts.
Tools &
+ Rec. + Equip. +

Truck

Liabilities
+
Owners' Equity
Notes
Accts.
Capital
Retained
= Payable + Pay. + Stock + Earnings
$ 8,000
$ 8,000

$ 2,500
$ 2,500

$ 3,500
$ 3,500
75
$ 3,575
(150)
$ 3,425
750
$ 4,175
(50)
$ 4,125

$ 150
$ 150
(75)
$ 75
$ 75

$ 2,500
300
$ 2,800
(150)
$ 2,650

$ 8,000
$ 15,000
$ 15,000

$ 13,000
$ 13,000

$ 8,000

$ 15,000

$ 13,000

$ 300
$ 300

$ 15,000

$ 13,000

$ 300

$ 8,000

$ 2,650

$ 15,000

$ 13,000

$ 8,000

$ 2,650

$ 15,000

$ 13,000

$ 300
(150)
$ 150

$ 8,000

$ 8,000

$ 75

$ 2,650

$ 15,000

$ 13,000

$ 150

$ 8,000

$ 75

$ 2,650

$ 15,000

$ 13,000

$ 150

$ 8,000

750
750
(50)
700

223

Lets prepare the Income Statement and

Statement
for JJs+ Lawn
Assets of Cash Flows
=
Liabilities
Owners'Care
Equity
Accts.
Tools &
Notes
Accts.
Capital
Retained
Service
for
the
month
ending
May
31,
2011.
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + Earnings
May 1
Balances
May 2
Balances
May 8
Balances
May 11
Balances
May 18
Balances
May 25
Balances
May 28
Balances
May 29
Balances
May 31
Balances

$ 8,000
$ 8,000
(2,500)
$ 5,500
(2,000)
$ 3,500
$ 3,500
$ 3,500
75
$ 3,575
(150)
$ 3,425
750
$ 4,175
(50)
$ 4,125

These
These transactions
transactions
impact
the
impact
the
$ 15,000
$ 13,000
$ 2,500Statement
$ 15,000
$ 13,000
of
Statement
of Cash
Cash
300
$ 300
$ 2,800
$ 15,000
$ 13,000
$ 300
Flows.
Flows.
(150)
$ 2,500
$ 2,500

$ 150
$ 150
(75)
$ 75
$ 75

$ 8,000
$ 8,000
$ 8,000
$ 8,000
$ 8,000

$ 2,650

$ 15,000

$ 13,000

$ 300

$ 8,000

$ 2,650

$ 15,000

$ 13,000

$ 8,000

$ 2,650

$ 15,000

$ 13,000

$ 300
(150)
$ 150

$ 75

$ 2,650

$ 75

$ 2,650

$ 8,000

These
transactions
These
transactions
$ 15,000
$ 13,000
$ 150
$ 8,000
impact
impact the
the Income
Income
$ 15,000
$ 13,000
$ 150
$ 8,000
Statement.
Statement.

$
$

750
750
(50)
700

224

Investments
Investments by
by and
and payments
payments to
to the
the owners
owners
are
are not
not included
included on
on the
the Income
Income Statement.
Statement.
225

226

Operating
Operating activities
activities include
include the
the cash
cash
effects
effects of
of revenue
revenue and
and expense
expense
transactions.
transactions.

227

Investing
Investing activities
activities include
include the
the cash
cash
effects
effects of
of purchasing
purchasing and
and selling
selling
assets.
assets.
228

Financing
Financing activities
activities include
include the
the cash
cash
effects
effects of
of transactions
transactions with
with the
the owners
owners
and
and creditors.
creditors.

229

Now, lets prepare the Balance Sheet for JJs

Lawn
for
May 31,
Assets Care Service
=
Liabilities
+ 2011.
Owners' Equity
May 1
Balances
May 2
Balances
May 8
Balances
May 11
Balances
May 18
Balances
May 25
Balances
May 28
Balances
May 29
Balances
May 31
Balances

Cash
$ 8,000
$ 8,000
(2,500)
$ 5,500
(2,000)
$ 3,500

Accts.
Tools &
+ Rec. + Equip. +

$ 2,500
$ 2,500

$ 3,500
$ 3,500
75
$ 3,575
(150)
$ 3,425
750
$ 4,175
(50)
$ 4,125

Truck

Notes
Accts.
Capital
Retained
= Payable + Pay. + Stock + Earnings
$ 8,000
$ 8,000

$ 150
$ 150
(75)
$ 75
$ 75

$ 2,500
300
$ 2,800
(150)
$ 2,650

$ 8,000
$ 15,000
$ 15,000
$ 15,000

$ 13,000
$ 13,000
$ 13,000

$ 8,000
$ 300
$ 300

These
balances
These
$ 15,000 balances
$ 13,000
$ 300
will
appear
on
the
will
appear
on
the
$ 2,650
$ 15,000
$ 13,000
$ 300
Balance
Balance Sheet.
Sheet. (150)
$ 2,650

$ 15,000

$ 13,000

$ 150

$ 8,000
$ 8,000
$ 8,000
$ 8,000

$ 75

$ 2,650

$ 15,000

$ 13,000

$ 150

$ 8,000

$ 75

$ 2,650

$ 15,000

$ 13,000

$ 150

$ 8,000

750
750
(50)
700
230

Assets
Assets == Liabilities
Liabilities ++ Owners
Owners Equity
Equity
$21,850
$21,850 ==

$13,150
$13,150 ++

$8,700
$8,700
231

Relationships Among
Financial Statements
Date at
beginning of
period

Time

Balance
Sheet

Date at
end of
period

Balance
Sheet

Income Statement
Statement of Cash Flows

232

Financial Statement
Articulation

233

Financial Reporting and

Financial Statements
Financial statements are
just one source of
financial accounting
information.

Income
Statement
Balance
Sheet

Statement
of Cash
Flows

Other Information:
Nonfinancial disclosures
Management interpretation
Industry
Competitors
National economy

234

Forms of Business
Organization
Sole
Sole
Proprietorships
Proprietorships

Partnerships
Partnerships

Corporations
Corporations

235

Reporting Ownership Equity

in the Statement of
Ow
ner's equity:
Financial
Position
Sole
Sole

Proprietorships
Proprietorships

Partnerships
Partnerships

Corporations
Corporations

Jill Jones, capital

8,000

Partners' equity
Jill Jones, capital $ 4,000
Bill Jones, capital
4,000
Total partners' equity

$ 8,000

Owners' equity
Capital stock
$ 7,000
Retained earnings
1,000
Total stockholders' equity

$ 8,000
236

The Use of Financial

Statements by External
Parties
Creditors

Two
Two concerns:
concerns:
Liquidity
Liquidity
Profitability
Profitability

Investors
237

The Need for Adequate

Disclosure
Balance Sheet
Income Statement
Statement of Cash Flows

Notes
Notes to
to the
the
financial
financial
statements
statements
often
often provide
provide
facts
facts necessary
necessary
for
for the
the proper
proper
interpretation
interpretation of
of
the
the statements.
statements.
238

Managements Interest in
Financial Statements
Creditors are more likely to extend credit if
financial statements show a strong statement
of financial positionthat is, relatively little
debt and large amounts of liquid assets.

Window dressing occurs when management

takes measures to make the company appear
as strong as possible in it financial statements.
239

End of Chapter 2

240