Financial Statements

The 4 general purpose financial statements are:

1.Income Statement

2.Balance Sheet

3.Statement of Owner’s Equity

4.Statement of Cash Flows

Accounting Concept: Adequate Disclosure

Businesses communicate financial information to the public.

In order to better understand accounting as a language, there must be detailed analysis of financial statement.

Elements

The items reported in the financial statements are organized into classes or categories known as elements.

There are ten elements of financial statements:– Assets - Expenses– Liabilities - Distributions– Equity - Net Income– Common stock - Gains– Revenue - Losses

Accounts

Elements represent broad classifications as opposed to specific items.

The sub classification of these elements are called accounts.

Chart of Accounts

Accounts are organized into ledgers. A ledger is a group of accounts. A general ledger contains all accounts

needed to prepare a financial statement. Accounts are listed in the chart of accounts

and assigned an account number.

File Maintenance

The procedure for arranging accounts, assigning account numbers, and keeping records current.

Account numbers are assigned based on the account’s location in the general ledger.– Asset – 100 Revenue – 400 – Liability – 200 Expense – 500 – Owner’s Equity – 300

Existing accounts are numbered by 10’s to allow room for new accounts to be added.

Organization of accounts in thechart of accounts

Assets are organized by liquidity—the ease with which an asset can be converted into cash.

Liabilities are listed alphabetically. Owner’s equity – capital, then drawing Revenue – Sales Expenses – are listed alphabetically.

Sample Chart of Accounts

Financial Statements: 4 common reports

Income Statement Balance Sheet Statement of Owner’s Equity Statement of Cash Flows

Income Statement

The report of a company’s operating performance, in financial terms, over a period of time.

Reports information in 5 major sections:– Revenue– Costs of goods sold– Gross profit– Operating expenses – Net income or net loss

Income Statement Format

Income statement has 3-line heading. The income statement reporting date is for a

specified period of time. The time period covered by the financial

statements is called the accounting period.

Elements of an Income Statement

Revenue– Sales is the earnings from the

sale of goods or the performance of service

– Sales return and Allowances is the refunds or adjustments for unsatisfactory merchandise or service

Expenses– Cost of goods sold

Cost to the business for merchandise or goods sold

Calculated as Beginning inventory + purchases – ending inventory = cost of goods sold

Gross profit on sales– The difference between the net

sales and the cost of goods sold– Calculated as Revenue –

Expenses Operating Expenses

– Overhead or cost incurred in operating a business

– Calculated by adding up all the expenses

Net Income– Gross profit on sales – total

expenses

Tips

Single v. Double underline– Use a single underline for subtotals– Double underline for totals

Dollar signs– Dollar signs are included for the first amount on a

list of values and for the totals. Not necessary for each amount.

Statement of Owner’s Equity

Also referred to as Statement of Stockholder’s equity and Statement of Retained Earnings.

Reports the way that net income and distribution of dividends affects the company’s financial position during the accounting period.

OWNERS’ EQUITY STATEMENT

Lesson 16-3, page 405Lesson 16-3, page 405

1

4

2

3. First Partner’s Ending Capital

1. Heading

4. Second Partner’s Name

2. First Partner’s Name

5. Second Partner’s Ending Capital

6. Total Owners’ Equity

7. Double Lines

67

3

5

How to calculate Owner’s Equity on the balance sheet

To simplify the balance sheet, the capital figure represents capital, sales and expenses.

To calculate this: – ending capital + sales – expenses.

Balance Sheet

Describes the financial situation of a company at a specific point in time.

List the assets of a business and the sources of those assets.

The name ‘balance sheet’ comes from the accounting equation.

Can be prepared at any point in time to show the assets, liabilities and O.E. for a company.

Heading of Balance Sheet

Name of Business Name of Financial Statement Specific Date

Major Headings of Balance Sheet

Assets Liabilities Owner’s Equity

Accounting Equation– Assets = Liabilities + Owner’s Equity

Assets are on left; Liabilities & O.E. on right

Purpose of a Balance Sheet

To show the assets owned by a company. To show the liabilities owed by a company. To represent a company’s net worth.

Elements of a Balance Sheet

Assets– Current assets—turned into cash within 1 year– Long-term assets—Used in transacting business,

more long-term in nature. Ex: buildings, equipment.

– Recorded at the total cost to acquire the asset Liabilities

– Current liabilities—paid within 1 year– Long-term liabilities—paid in more than 1 year

Elements, cont.

Owner’s equity—represents the amount of financing provided by the owners of the business and earnings.– Contributed capital—invested by owner– Retained earnings—earnings/profits reinvested in

the business.

Statement of Cash Flows

A financial statement that reports the cash flows of a business for a fiscal period.

Useful to provide detailed information about the sources and uses of cash in a business.

Statement of Cash Flows (cont.)

Divides cash inflows (receipts) and outflows (payments) into three primary categories of cash flows in a typical business:– Cash flows from operating activities– Cash flows from investing activities– Cash flows from financing activities

Cash Flows from operating activities—reports the amount of cash generated from the sale of goods and services.

Cash Flows from investing activities—reports the cash used to purchase plant assets and other long-term assets.

Cash Flows from financing activities—reports the cash generated by issuing long-term debt and stock.

Relationship among financial statements (See p. 308)

The relationship among the financial statements is imperative to understanding the components of each statement.

– Net Income from the income statement results in an increase in ending capital on the statement of owner’s equity.

– Ending capital from the statement of owner’s equity is the value of owner’s equity on the balance sheet.

– The change in cash of the Statement of Cash Flows added to the beginning of the year in cash is equal to the end of the year cash on the balance sheet.

Assignment:

14.7.1 Matching Elements with Financial Statements.

14.7.2 Classifying Accounts 14.7.3 Computing Missing Amounts

Relationships

The net income from the income statement results in an increase in ending capital on the statement of owner’s equity.

Ending capital from the statement of owner’s equity is the value of owner’s equity on the balance sheet.

The change in cash of the Statement of Cash Flows added to the beginning of the year in cash is equal to the end of the year cash on the balance sheet.

Summary of Financial Statements

Financial Statement Purpose Structure Examples of Content See p. 309