Chapter

2 BASIC FINANCIAL
STATEMENTS

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 Introduction to Financial Statements
Companies prepare interim
financial statements and annual
financial statements.

2000

X
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 Introduction to Financial Statements

Balance Sheet Three primary

Income Statement
financial
statements.
Statement of Cash Flows
We will use a corporation
to describe these
statements.

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 Introduction to Financial Statements

Balance Sheet
Describes
where the
Income Statement enterprise
stands at a
Statement of Cash Flows
specific date.

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 Introduction to Financial Statements

Balance Sheet

Income Statement
Depicts the
revenue and
Statement of Cash Flows expenses for a
designated
period of time.

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 Introduction to Financial Statements

Revenues Expenses
result in result in
positive negative
cash flow. cash flow.

Either in the past, present, or future.

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 Introduction to Financial Statements

Balance Sheet

Income Statement
Net income (or
net loss) is
Statement of Cash Flows simply the
difference
between
revenues and
expenses.

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 Introduction to Financial Statements

Balance Sheet

Income Statement

Statement of Cash Flows

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

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 The Concept of the Business Entity

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

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 A Starting Point: Statement of
Financial Position
Vagabond Travel Agency
Balance Sheet
December 31, 2002
Assets 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 3,000
Land 100,000 Total liabilities $ 80,000
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000

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 Assets
Vagabond Travel Agency
Balance Sheet
December 31, 2002
Assets Liabilities & Owners' Equity
Cash Assets are
$ 22,500 Liabilities:
Notes receivable 10,000 economic resources
Notes payable $ 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 that are owned by
Salaries payable 3,000
Land
Building
100,000
the business and
Total liabilities
90,000 Owners' Equity:
$ 80,000

Office equipment 15,000 are expected to

Capital stock 150,000

Total
provide positive
Retained earnings
$ 300,000 Total
70,000
$ 300,000
future cash flows.
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 Assets

Cost Principle

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

Objectivity
Principle
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 Liabilities
Vagabond Travel Agency
Balance Sheet
December 31, 2002
Assets Liabilities & Owners' Equity
Liabilities are
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
debts that
Accounts receivable 60,500 Accounts payable 36,000
represent negative
Supplies
Land
2,000
100,000
Salaries payable
Total liabilities
3,000
$ 80,000
future cash flows
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
for the enterprise. Retained earnings 70,000
Total $ 300,000 Total $ 300,000

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 Owners’ Equity
Vagabond Travel Agency
Balance Sheet
December 31, 2002
Assets Liabilities & Owners' Equity
CashOwners’ equity $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
represents the
Accounts receivable 60,500 Accounts payable 36,000
owner’s claim to
Supplies
Land
2,000
100,000
Salaries payable
Total liabilities
3,000
$ 80,000
the assets of the
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
business. Retained earnings 70,000
Total $ 300,000 Total $ 300,000

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 Owners’ Equity
Changes in Owners’
Equity

•Owners’ •Payments
Investments to Owners
•Business •Business
Earnings Losses

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 The Accounting Equation
Assets =Vagabond
Liabilities + Agency
Travel Owners’ Equity
Balance Sheet
December 31, 2002
$300,000
Assets= $80,000 +Liabilities
$220,000
& 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 3,000
Land 100,000 Total liabilities $ 80,000
Building 90,000 Owners' Equity
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000

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 Let’s analyze
some
transactions for
JJ’s Lawn Care
Service.

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 On May 1, 2003, Jill Jones and her family
invested $8,000 in JJ’s Lawn Care Service and
received 800 shares of stock.
JJ's Lawn Care Service
Balance Sheet
May 1, 2003
Assets Owners' Equity
Cash $ 8,000 Capital Stock $ 8,000

Total $ 8,000 Total $ 8,000

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 On May 2, JJ’s purchased a riding lawn
mower for $2,500 cash.
JJ's Lawn Care Service
Balance Sheet
May 2, 2003
Assets Owners' Equity
Cash $ 5,500 Capital Stock $ 8,000
Tools & Equipment 2,500

Total $ 8,000 Total $ 8,000

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 On 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 $13,000.
JJ's Lawn Care Service
Balance Sheet
May 8, 2003
Assets Liabilities and Owners' Equity
Cash $ 3,500 Liabilities:
Tools & Equipment 2,500 Notes Payable $ 13,000
Truck 15,000 Owners' Equity:
Capital Stock 8,000

Total $ 21,000 Total $ 21,000

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

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 On May 11, JJ’s purchased some repair
parts for $300 on account.
JJ's Lawn Care Service
Balance Sheet
May 11, 2003
Assets Liabilities and Owners' Equity
Cash $ 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

Total $ 21,300 Total $ 21,300

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 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.

JJ's Lawn Care Service

Balance Sheet
May 18, 2003
Assets Liabilities and Owners' Equity
Cash $ 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 8,000

Total $ 21,300 Total $ 21,300

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

JJ's Lawn Care Service

Balance Sheet
May 25, 2003
Assets Liabilities and Owners' Equity
Cash $ 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

Total $ 21,300 Total $ 21,300

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 On May 28, JJ’s pays $150 of its accounts
payable.
JJ's Lawn Care Service
Balance Sheet
May 28, 2003
Assets Liabilities and Owners' Equity
Cash $ 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

Total $ 21,150 Total $ 21,150

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 On May 29, JJ’s recorded lawn care services
provided during May of $750. All clients paid in
cash.
JJ's Lawn Care Service
Balance Sheet
May 29, 2003
Assets Liabilities and Owners' Equity
Cash $ 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
Retained Earnings 750
Total $ 21,900 Total $ 21,900

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 On May 31, JJ’s purchased gasoline for the
lawn mower and the truck for $50 cash.
JJ's Lawn Care Service
Balance Sheet
May 31, 2003
Assets Liabilities and Owners' Equity
Cash $ 4,125 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
Retained Earnings 700
Total $ 21,850 Total $ 21,850
Now, let’s review how JJ’s transactions
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 Assets = Liabilities + Owners' Equity
Accts. Tools & Notes Accts. Capital Retained
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + 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

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 Let’s prepare the Income Statement and
Statement Assets of Cash Flows
= for JJ’s+ Lawn
Liabilities Owners'Care
Equity
Service
Accts.
for the
Tools &
month ending
Notes
May
Accts.
31,
Capital
2003.
Retained
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + Earnings
May 1 $ 8,000 $ 8,000
Balances $ 8,000 $ 8,000
May 2 (2,500) These transactions
$ 2,500
Balances $ 5,500 $ 2,500 $ 8,000
May 8 (2,000) impact
$ 15,000 the
$ 13,000
Balances $ 3,500 $ 2,500Statement
$ 15,000 of Cash
$ 13,000 $ 8,000
May 11 300 $ 300
Balances $ 3,500 $ 2,800 Flows.
$ 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 These transactions 750
Balances $ 4,175 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 $ 750
May 31 (50) impact the Income (50)
Balances $ 4,125 $ 75 $ 2,650
Statement.
$ 15,000 $ 13,000 $ 150 $ 8,000 $ 700

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 JJ's Lawn Care Service
Income Statement
For the Month Ended May 31, 2003

Sales Revenue $ 750

Operating Expense:
Gasoline Expense 50
Net Income $ 700

Investments by and payments to the owners

are not included on the Income Statement.
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 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2003
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 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, May 1, 2003 -
Cash balance, May 31, 2003 $ 4,125

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 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2003
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:
Operating
Purchase activities include$ the
of lawn mower cash
(2,500)
effects
Purchase of truckof revenue and expense (2,000)
Collection for sale of repair parts 75
transactions.
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, May 1, 2003 -
Cash balance, May 31, 2003 $ 4,125

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 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2003
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 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:
Investing
Investment activities include the cash8,000
by owners
effects
Increase ofmonth
in cash for purchasing and selling $ 4,125
Cash balance, May 1, 2003 -
Cash balance, May 31, 2003 assets. $ 4,125

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 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2003
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)
Financing
Purchase of truck activities include the cash
(2,000)
effects for
Collection ofsale
transactions
of repair parts with the owners
75
Payment for repair parts (150)
and creditors.
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, May 1, 2003 -
Cash balance, May 31, 2003 $ 4,125

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 Relationships Among Financial
Statements

Beginning End of
of period Time period

Balance Balance
Sheet Sheet

Income Statement
Statement of Cash Flows
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 Practice Qs.
1)Foster, Inc., purchased a truck by paying $5,000 and borrowing
the remaining $25,000 required to complete the transaction. Briefly
state how this transaction affects the company’s basic accounting
equation.
2)Wiley Company had total revenues of $300,000 for a recent
month. During the month the company incurred operating expenses
of $205,000 and purchased land for $45,000. Compute the amount
of Wiley’s net income for the month.

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 Solution-1: Cash decrease by 5000
Truck increase 30000---- Overall Assets will
increase by 25000
Liability- Accounts Payable increase by 25000

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 Practice Qs.
3)Xavier Company had the following transactions during the
current year:
• Earned revenues of $100,000 and incurred expenses of $56,000,
all in cash.
• Purchased a truck for $20,000.
• Sold land for $10,000.
• Borrowed $15,000 from a local bank.
What was the total change in cash during the year?

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 Forms of Business Organizations

Sole
Partnership Corporation
Proprietorship

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 Sole Proprietorship –
A business form for which there is one owner.
This single owner has unlimited liability for all
debts of the firm.
• Oldest form of business organization.
• Business income is accounted for on your
personal income tax form.
form

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 Advantages Disadvantages
• Simplicity • Unlimited liability
• Low setup cost • Hard to raise
• Quick setup additional capital
• Transfer of
ownership
difficulties

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 Partnership – A business form in which two or
more individuals act as owners.
Business income is accounted for on each
partner’s personal income tax form.
All partners have unlimited liability and are
liable for all obligations of the partnership.

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 Advantages Disadvantages
• Can be simple • Unlimited liability
• Low setup cost, higher • Difficult to raise
than sole proprietorship additional capital, but
• Relatively quick setup easier than sole
proprietorship
• Transfer of ownership
difficulties

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 Corporation - (Company)
A business form legally separate from its
owners
• An artificial entity that can own assets and incur
liabilities.
• Business income is accounted for on the income
tax form of the corporation.

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 Advantages Disadvantages
• Limited liability • Double taxation
• Easy transfer of • More difficult to
ownership establish
• Unlimited life • More expensive to set up
• Easier to raise large and maintain
quantities of capital

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 Reporting Ownership Equity in the
Balance Sheet
Sole Ow ner's equity:
Proprietorship Jill Jones, capital $ 8,000

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

Owners' equity
Capital stock $ 7,000
Corporation
Retained earnings 1,000
Total stockholders' equity $ 8,000
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 The Use of Financial Statements by
Outsiders

Two concerns:
Creditors Solvency
Profitability

Investors
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 The Need for Adequate Disclosure

Balance Sheet Notes to the

Income Statement
financial
statements often
Statement of Cash Flows
provide facts
necessary for the
proper
interpretation of
the statements.

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 Examples:
 Unsettled Lawsuits against the company
 Due dates of major liabilities
 Assets pledged as collateral to secure loans
 Contractual commitments requiring large future cash
outlays.

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 Window Dressing:
 Measures taken by management to make the company
appear as strong as possible in its financial statements.

The more frequently financial statements are presented,

the less able management is to window-dress and make
a company look financially stronger than it actually is.

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 End of Chapter 2

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 Quiz of Ch 1
1. Discuss accounting as the language of business and the role of
accounting information in making economic decisions.
2. Explain the importance of financial accounting information for
external parties- primarily investors and creditors – in terms of
the objectives and the characteristics of that information.
3. What are the three primary financial statements with which we
communicate financial accounting information ?
4. What is the IASB and what is its role in external financial
reporting ?
5. List four users of accounting information.

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 Practice Qs.
Account balances for Crystal Auto Wash at September 30, 2011, are shown below. The figure for
retained earnings is not given, but it can be determined when all the available information is
assembled in the form of a balance sheet.
Accounts Payable. . . . . . . $14,000 Accounts Receivable . . . . . . . . 800
Buildings . . . . . . . . . . . . . . . . 52,000 Cash . . .. . . . . . . . . . . . . . . . 9,200
Capital Stock . . . . . . . . . . . . 100,000 Retained Earnings . . . . . . . . . . ?
Land . . . . . . . . . . . . . . . . . $68,000 Machinery & Equipment . .. . . 65,000
Notes Payable (due in
30 days) . . . . . . . . . . . . . . . 29,000 Salaries Payable . . . . . . . . . . . . . 3,000
Supplies . . . . . . . . . . . . . . . . . . . . 400

Required:
Prepare a balance sheet at September 30, 2011.

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 Practice Qs.
Compute the missing amounts in the following table:

Assets Liabilities Owners’ Equity

a. $578,000 $342,000 ?
b. ? 562,500 $570,000
c. 307,500 ? 187,200

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 Assignment 2 Deadline:14-12-2021

Demonstration Problem
Brief Exercises: All
Exercises: 2.1, 2.2, 2.3, 2.5, 2.7, 2.8, 2.9, 2.11,
2.12, 2.13.
Problems: 2.1A, 2.3(A), 2.4(A)

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 Practice Qs.
A number of business transactions carried out by Smooth Manufacturing Company are as follows:
a. Borrowed money from a bank.
b. Sold land for cash at a price equal to its cost.
c. Paid a liability.
d. Returned for credit some of the office equipment previously purchased on credit but not yet paid
for. (Treat this the opposite of a transaction in which you purchased office equipment on credit.)
e. Sold land for cash at a price in excess of cost. (Hint: The difference between cost and sales price
represents a gain that will be in the company’s income statement.)
f. Purchased a computer on credit.
g. The owner invested cash in the business.
h. Purchased office equipment for cash.
i. Collected an account receivable.
Indicate the effects of each of these transactions on the total amounts of the company’s assets,
liabilities, and owners’ equity. Organize your answer in tabular form, using the following column
headings and the code letters I for increase, D for decrease, and NE for no effect. The answer for
transaction a is provided as an example:
Transaction Assets Liabilities Owners’ Equity
(a) I I NE
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