© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin BASIC FINANCIAL STATEMENTS Chapter 2

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Companies prepare interim financial statements and annual financial statements X

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Three primary financial statements. Income Statement Balance Sheet Statement of Cash Flows We will use a corporation to describe these statements.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Describes where the enterprise stands at a specific date. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Depicts the revenue and expenses for a designated period of time. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Revenues result in positive cash flow. Expenses result in negative cash flow. Either in the past, present, or future.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Net income (or net loss) is simply the difference between revenues and expenses. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Depicts the ways cash has changed during a designated period of time. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Concept of the Business Entity Vagabond Travel Agency A business entity is separate from the personal affairs of its owner.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin A Starting Point: Statement of Financial Position

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Assets Assets are economic resources that are owned by the business and are expected to provide positive future cash flows.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Assets Cost Principle Going-Concern Assumption Objectivity Principle Stable-Dollar Assumption These accounting principles support cost as the basis for asset valuation.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Accounting principles Going – concern (entity will continue in operation for a period of time to carry out its existing commitments.) Stable – dollar (money is basic measuring unit for financial reporting, dollar- value undergoes not too much changes, supplementary information disclosing the effects of inflation upon financial statements.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Accounting principles Objectivity principle (measurements that are unbiased and subject to verification by independent experts.(invoices, paid receipts, physical count of inventory etc.) Cost principle Cost principle (assets : historical cost=cost – dep)

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Accounting principles Consistency principle : a particular accounting method once adopted, will not be changed from period to period. Assists in interpreting the changes in financial position and in net income. Increases comparability in financial statements like Depreciation methods, inventory methods

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Accounting principles Disclosure principle: All material and relevant facts concerning financial position and the results of operations are communicated to users. Accounting methods, changes in any method and its effect. Materiality principle : The relative importance of the item How much it influence the decisions of users of fin. Statements. Supplies Vs plant

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Liabilities Liabilities are debts that represent negative future cash flows for the enterprise.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Owners Equity Owners equity represents the owners claim to the assets of the business.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Owners Equity Changes in Owners Equity Owners Investments Business Earnings Payments to Owners Business Losses

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Accounting Equation Assets = Liabilities + Owners Equity $300,000 = $80,000 + $220,000 Assets = Liabilities + Owners Equity $300,000 = $80,000 + $220,000

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Lets analyze some transactions for JJs Lawn Care Service.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 1, 2003, Jill Jones and her family invested $8,000 in JJs Lawn Care Service and received 800 shares of stock.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 2, JJs purchased a riding lawn mower for $2,500 cash.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 11, JJs purchased some repair parts for $300 on account.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 25, ABC Lawns pays JJs $75 as a partial settlement of its accounts receivable.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 28, JJs pays $150 of its accounts payable.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin On May 29, JJs recorded lawn care services provided during May of $750. All clients paid in cash.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Now, lets review how JJs transactions affected the accounting equation. On May 31, JJs purchased gasoline for the lawn mower and the truck for $50 cash.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin These transactions impact the Statement of Cash Flows. These transactions impact the Income Statement. Lets prepare the Income Statement and Statement of Cash Flows for JJs Lawn Care Service for the month ending May 31, 2003.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Investments by and payments to the owners are not included on the Income Statement.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Operating activities include the cash effects of revenue and expense transactions.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Investing activities include the cash effects of purchasing and selling assets.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Financing activities include the cash effects of transactions with the owners and creditors.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Relationships Among Financial Statements Beginning of period End of period Balance Sheet Time Income Statement Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Forms of Business Organizations Sole Proprietorship Partnership Corporation

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Reporting Ownership Equity in the Balance Sheet Sole Proprietorship Partnership Corporation

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Use of Financial Statements by Outsiders Creditors Investors Two concerns: Solvency Profitability Two concerns: Solvency Profitability

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Need for Adequate Disclosure Notes to the financial statements often provide facts necessary for the proper interpretation of the statements. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Abc manager report 8 pm thursday Assets Cash19,000 Jhon capital48,000 Automobiles96, ,000 Net worth Acc rec41,000 Acc payable24,000 Notes payable86,000 Interest payable5000 Supplies7, ,000

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Accounting equation Sep 1 Began the business by depositing 180,000 in a company bank account. Sep 2 Purchased land for 141,000 Sep 5 Purchased abuilding for 36,000, paying 15,000 cash incurring a liability of 21,000. Sep 10 Sold part of the land at a price equal to the cost 11,000, collectible within 3 months. Sep 14 Purchased office equipment on credit for Sep 20 Received 1500 cash as partial collection of the 11,000 account receivable. Sep 30 Paid 3000 on account payable.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin End of Chapter 2