Basic Financial
Statements
Chapter 2
McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Introduction to Financial
Statements
Three primary
Balance Sheet
Income Statement financial
Statement of Cash Flows statements.
We will use a corporation to describe these
statements. 2-2
Introduction to Financial
Statements
Balance Sheet
Describes
where the
Income Statement enterprise
stands at a
Statement of Cash Flows
specific date.
2-3
Introduction to Financial
Statements
Balance Sheet
Income Statement
Depicts the
revenue and
Statement of Cash Flows expenses for a
designated
period of time.
2-4
Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the
ways cash has
changed during
a designated
period of time.
2-5
A Starting Point: Statement
of Financial Position
Balance Sheet
31 December 2009
Assets Liabilities & Equity
Land $ 100,000 Liabilities:
Building 90,000 Notes payable $ 41,000
Office equipment 15,000 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Notes receivable 10,000 Total liabilities $ 80,000
Accounts receivable 60,500 Equity:
Cash 22,500 Share capital 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
2-6
The Concept of the Business
Entity
A business
entity is
Vagabond separate from
Travel the personal
Agency
affairs of its
owner.
2-7
Assets
Fortune Travel Agency
Balance Sheet
31 December 2009
Assets Liabilities & Equity
Land $ 100,000 Liabilities:
Building 90,000 Notes payable $ 41,000
Office equipment 15,000 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Notes receivable 10,000 Total liabilities $ 80,000
Accounts receivable 60,500 Equity:
Cash 22,500 Share capital 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
Assets are resources that are controlled the business and are expected
to have future economic benefits flowed to the business.
2-8
Assets
These accounting principles support
cost as the basis for asset valuation.
Stable-Dollar Cost Principle
Assumption
Going-Concern
Objectivity Assumption
Principle
2-9
Liabilities
Fortune Travel Agency
Balance Sheet
31 December 2009
Assets Liabilities & Equity
Land $ 100,000 Liabilities:
Building 90,000 Notes payable $ 41,000
Office equipment 15,000 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Notes receivable 10,000 Total liabilities $ 80,000
Accounts receivable 60,500 Equity:
Cash 22,500 Share capital 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
Liabilities are debts that represent negative future cash flows
for the enterprise.
2-10
Owners’ Equity
Fortune Travel Agency
Balance Sheet
31 December 2009
Assets Liabilities & Equity
Land $ 100,000 Liabilities:
Building 90,000 Notes payable $ 41,000
Office equipment 15,000 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Notes receivable 10,000 Total liabilities $ 80,000
Accounts receivable 60,500 Equity:
Cash 22,500 Share capital 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
Equity represents
the owners’ claims on the assets of the business.
2-11
The Accounting Equation
Fortune Travel Agency
Balance Sheet
31 December 2009
Assets Liabilities & Equity
Land $ 100,000 Liabilities:
Building 90,000 Notes payable $ 41,000
Office equipment 15,000 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Notes receivable 10,000 Total liabilities $ 80,000
Accounts receivable 60,500 Equity:
Cash 22,500 Share capital 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
Assets = Liabilities + Equity
$300,000 = $80,000 + $220,000
2-12
Let’s analyze
transactions
for JJ’s Lawn
Care Service.
2-13
On 1 May, Jill Jones and her family
invested $8,000 in JJ’s Lawn Care Service
and received 800 shares of the company.
JJ's Lawn Care Service
Balance Sheet
1 May 2009
Assets Equity
Cash $ 8,000 Share capital $ 8,000
Total $ 8,000 Total $ 8,000
2-14
On 2 May, JJ’s purchased a riding lawn
mower for $2,500 cash.
JJ's Lawn Care Service
Balance Sheet
2 May 2009
Assets Equity
Tools & Equipment $ 2,500 Share capital $ 8,000
Cash 5,500
Total $ 8,000 Total $ 8,000
2-15
On 8 May, JJ’s purchased a $15,000 truck.
JJ’s paid $2,000 down in cash and issued a
note payable for the remaining $13,000.
JJ's Lawn Care Service
Balance Sheet
8 May 2009
Assets Liabilities and Equity
Tools & Equipment $ 2,500 Liabilities:
Truck 15,000 Notes Payable $ 13,000
Cash 3,500 Equity:
Share capital 8,000
Total $ 21,000 Total $ 21,000
2-16
On 11 May, JJ’s purchased some repair
parts for $300 on account.
JJ's Lawn Care Service
Balance Sheet
11 May 2009
Assets Liabilities and Equity
Tools & Equipment $ 2,800 Liabilities:
Truck 15,000 Notes Payable $ 13,000
Cash 3,500 Accounts Payable 300
Total Liabilities $ 13,300
Equity:
Share capital 8,000
Total $ 21,300 Total $ 21,300
2-17
Jill realized she had purchased more repair parts
than needed.
On 18 May, 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.
JJ's Lawn Care Service
Balance Sheet
18 May 2009
Assets Liabilities and Equity
Tools & Equipment $ 2,650 Liabilities:
Truck 15,000 Notes Payable $ 13,000
Accounts Receivable 150 Accounts Payable 300
Cash 3,500 Total Liabilities $ 13,300
Equity:
Share capital 8,000
Total $ 21,300 Total $ 21,300
2-18
On 25 May, ABC Lawns pays JJ’s $75 as a
partial settlement of its accounts
receivable.
JJ's Lawn Care Service
Balance Sheet
25 May 2009
Assets Liabilities and Equity
Tools & Equipment $ 2,650 Liabilities:
Truck 15,000 Notes Payable $ 13,000
Accounts Receivable 75 Accounts Payable 300
Cash 3,575 Total Liabilities $ 13,300
Equity:
Share capital 8,000
Total $ 21,300 Total $ 21,300
2-19
On 28 May, JJ’s pays $150 of its accounts
payable.
JJ's Lawn Care Service
Balance Sheet
28 May 2009
Assets Liabilities and Equity
Tools & Equipment $ 2,650 Liabilities:
Truck 15,000 Notes Payable $ 13,000
Accounts Receivable 75 Accounts Payable 150
Cash 3,425 Total Liabilities 13,150
Equity:
Share capital 8,000
Total $ 21,150 Total $ 21,150
2-20
On 29 May, JJ’s recorded lawn care
services provided during May of $750. All
clients were paid in cash.
JJ's Lawn Care Service
Balance Sheet
29 May 2009
Assets Liabilities and Equity
Tools & Equipment $ 2,650 Liabilities:
Truck 15,000 Notes Payable $ 13,000
Accounts Receivable 75 Accounts Payable 150
Cash 4,175 Total Liabilities 13,150
Equity:
Share capital 8,000
Retained Earnings 750
Total $ 21,900 Total $ 21,900
2-21
On 31 May, JJ’s purchased gasoline for the
lawn mower and the truck for $50 cash.
JJ's Lawn Care Service
Balance Sheet
31 May 2009
Assets Liabilities and Equity
Tools & Equipment $ 2,650 Liabilities:
Truck 15,000 Notes Payable $ 13,000
Accounts Receivable 75 Accounts Payable 150
Cash 4,125 Total Liabilities 13,150
Equity:
Share capital 8,000
Retained Earnings 700
Total $ 21,850 Total $ 21,850
Now, let’s review how JJ’s transactions
affected the accounting equation.
2-22
Assets = Liabilities + Equity
Accts. Tools & Notes Accts. Share Retained
Cash + Rec. + Equip. + Truck = Payable + Pay. + Capital + Earnings
May 1 $ 8,000 $ 8,000
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
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 29 750 750
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
2-23
Let’s prepare the Income Statement and Statement of Cash Flows for
JJ’s Lawn Care Service for the month ending 31 May 2009.
Assets = Liabilities + Equity
Accts. Tools & Notes Accts. Share Retained
Cash + Rec. + Equip. + Truck = Payable + Pay. + Capital + Earnings
May 1 $ 8,000 $ 8,000
These transactions impact the Statement of Cash Flows.
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
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 29 750 750
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.
2-24
JJ's Lawn Care Service
Income Statement
For the Month Ended 31 May 2009
Sales Revenue $ 750
Operating Expense:
Gasoline Expense 50
Profit $ 700
Investments by and payments to the owners
are not included on the Income Statement.
2-25
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended 31 May 2009
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash from 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
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
Cash balance, 1 May 2009 -
Cash balance, 31 May 2009 $ 4,125
2-26
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended 31 May 2009
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash from 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
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
Cash balance, 1 May 2009 -
Cash balance, 31 May 2009 $ 4,125
Operating activities include the cash effects of revenue and expense transactions.
2-27
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended 31 May 2009
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash from 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
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
Cash balance, 1 May 2009 -
Cash balance, 31 May 2009 $ 4,125
Investing activities include the cash effects of purchasing and selling assets.
2-28
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended 31 May 2009
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash from 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
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
Cash balance, 1 May 2009 -
Cash balance, 31 May 2009 $ 4,125
Financing activities include the cash effects of transactions with the owners and creditors.
2-29
Now, let’s prepare the Balance Sheet for JJ’s Lawn
Care Service= for May
Assets
31, 2009.
Liabilities + Equity
Accts. Tools & Notes Accts. Share Retained
Cash + Rec. + Equip. + Truck = Payable + Pay. + Capital + Earnings
May 1 $ 8,000 $ 8,000
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
Balances $ 3,500 $ 2,500 $ 15,000 $ 13,000 $ 8,000
May 11 300 $ 300 These
balances
Balances $ 3,500 $ 2,800 $ 15,000 $ 13,000 $ 300 $ 8,000 will
May 18 $ 150 (150) appear
Balances $ 3,500 $ 150 $ 2,650 $ 15,000 $ 13,000 $ 300 $ 8,000 on the
May 25 75 (75) Balance
Balances $ 3,575 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 300 $ 8,000 Sheet.
May 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
May 31 (50) (50)
Balances $ 4,125 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 $ 700
2-30
JJ's Lawn Care Service
Balance Sheet
31 May 2009
Assets Liabilities
Tools & equipment $ 2,650 Notes payable $ 13,000
Truch 15,000 Accounts payable 150
Account receivable 75 Equity
Cash 4,125 Share capital 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850
Assets = Liabilities + Equity
$21,850 = $13,150 + $8,700
2-31
Relationships Among Financial
Statements
Date at Date at
beginning of end of
period period
Time
Balance Balance
Sheet Sheet
Income Statement
Statement of Cash Flows
2-32
Financial Statement Articulation
JJ's Lawn Care Service
Statement of Cash Flows
JJ's Lawn Care Service
For the Month Ended 31 May 2009
Cash flows from operating activities: Income Statement
Cash received from revenue transactions $ 750 For the Month Ended 31 May 2009
Cash paid for expenses (50)
Net cash from operating activities $ 700
Cash flows from investing activities:
Sales Revenue $ 750
Purchase of lawn mower $ (2,500) Operating Expense:
Purchase of truck (2,000) Gasoline Expense 50
Collection for sale of repair parts 75 Profit $ 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
Cash balance, 1 May 2009 -
Balance Sheet
Cash balance, 31 May 2009 $ 4,125
31 May 2009
Assets Liabilities
Tools & equipment $ 2,650 Notes payable $ 13,000
Truch 15,000 Accounts payable 150
Account receivable 75 Equity
Cash 4,125 Share capital 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850
2-33
Financial Reporting and
Financial Statements
Financial statements are
just one source of
financial accounting Income
Statement
information. Balance
Sheet
Statement
of Cash
Flows
Other Information:
• Industry
• Competitors
• National economy
2-34
Forms of Business
Organization
Sole
Proprietorships Partnerships Corporations
2-35
Reporting Ownership
Equity in theOw Statement
ner's equity:
of
Financial
ProprietorshipsPosition
Sole
Jill Jones, capital $ 8,000
Partners' equity
Jill Jones, capital $ 4,000
Partnerships
Bill Jones, capital 4,000
Total partners' equity $ 8,000
Equity
Share capital $ 7,000
Corporations
Retained earnings 1,000
Total shareholders' equity $ 8,000
2-36
The Use of Financial
Statements by External
Parties
Two concerns:
Creditors Liquidity
Profitability
Investors
2-37
The Need for Adequate
Disclosure
Balance Sheet Notes to the
financial
Income Statement
statements
Statement of Cash Flows often provide
facts necessary
for the proper
interpretation of
the statements.
2-38
Management’s Interest in
Financial Statements
Creditors are more likely to extend credit if
financial statements show a strong statement of
financial position—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 as possible in it financial statements.
2-39
End
2-40