Financial AFinancial AccountingccountingChapter 2Chapter 2

Basic Financial StatementsBasic Financial Statements

Financial AFinancial AccountingccountingChapter 2Chapter 2

Basic Financial StatementsBasic Financial Statements

Assets = Liabilities +

Cash +Accts. Rec. +

Tools & Equip. + Truck =

Notes Payable +

Accts. Pay. +

Capital Stock +

Retained 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$

Owners' Equity

Assets = Liabilities +

Cash +Accts. Rec. +

Tools & Equip. + Truck =

Notes Payable +

Accts. Pay. +

Capital Stock +

Retained 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$

Owners' Equity

Now, let’s prepare the Balance Sheet for JJ’s Lawn Care Service for May 31, 2007.

These balances will appear on the Balance

Sheet.

These balances will appear on the Balance

Sheet.

Assets = Liabilities +

Cash +Accts. Rec. +

Tools & Equip. + Truck =

Notes Payable +

Accts. Pay. +

Capital Stock +

Retained 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$

Owners' Equity

These transactions impact the Statement

of Cash Flows.

These transactions impact the Statement

of Cash Flows.

These transactions impact the Income

Statement.

These transactions impact the Income

Statement.

Let’s prepare the Income Statement and Statement of Cash Flows for JJ’s Lawn Care Service for the month ending May 31, 2007.

Learning Objective

LO6

To explain how the statement of cash flows presents the change in cash for a period of time in

terms of the company’s operating, investing, and

financing activities.

JJ's Lawn Care ServiceStatement of Cash Flows

For the Month Ended May 31, 2007Cash 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, 2007 - Cash balance, May 31, 2007 4,125$

JJ's Lawn Care ServiceStatement of Cash Flows

For the Month Ended May 31, 2007Cash 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, 2007 - Cash balance, May 31, 2007 4,125$

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

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

JJ's Lawn Care ServiceStatement of Cash Flows

For the Month Ended May 31, 2007Cash 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, 2007 - Cash balance, May 31, 2007 4,125$

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

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

JJ's Lawn Care ServiceStatement of Cash Flows

For the Month Ended May 31, 2007Cash 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, 2007 - Cash balance, May 31, 2007 4,125$

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

creditors.

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

creditors.

Assets = Liabilities +

Cash +Accts. Rec. +

Tools & Equip. + Truck =

Notes Payable +

Accts. Pay. +

Capital Stock +

Retained 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$

Owners' Equity

Now, let’s prepare the Balance Sheet for JJ’s Lawn Care Service for May 31, 2007.

These balances will appear on the Balance

Sheet.

These balances will appear on the Balance

Sheet.

Cash 4,125$ Notes payable 13,000$ Accounts receivable 75 Accounts payable 150 Tools & equipment 2,650 Truck 15,000 Capital stock 8,000

Retained earnings 700 Total assets 21,850$ Total liabilities & equity 21,850$

Assets Liabilities

Owners' Equity

JJ's Lawn Care ServiceBalance SheetMay 31, 2007

Assets = Liabilities + Owners’ Equity

$21,850 = $13,150 + $8,700

Assets = Liabilities + Owners’ Equity

$21,850 = $13,150 + $8,700

Financial Statement Articulation

JJ's Lawn Care ServiceStatement of Cash Flows

For the Month Ended May 31, 2007Cash 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, 2007 - Cash balance, May 31, 2007 4,125$

Cash 4,125$ Notes payable 13,000$ Accounts receivable 75 Accounts payable 150 Tools & equipment 2,650 Truck 15,000 Capital stock 8,000

Retained earnings 700 Total assets 21,850$ Total liabilities & equity 21,850$

Assets Liabilities

Owners' Equity

JJ's Lawn Care ServiceBalance SheetMay 31, 2007

JJ's Lawn Care ServiceIncome Statement

Sales Revenue 750$ Operating Expense: Gasoline Expense 50 Net Income 700$

For the Month Ended May 31, 2007

FINANCIAL STATEMENTSFINANCIAL STATEMENTS

After transactions are identified, recorded, and summarized, 4 financial statements are prepared from the summarized accounting data:1 An income statement presents the revenues and expenses and resulting net income or net loss for a specific period of time.2 An owner’s equity statement/ Retained earnings summarizes the changes in owner’s equity/ retained earnings for a specific period of time.3 A balance sheet reports the assets, liabilities, and owner’s equity at a specific date.4 A statement of cash flows summarizes information

about the cash inflows (receipts) and outflows (payments) for a specific period of time.

ILLUSTRATION ILLUSTRATION 1-11 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPSFINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE

Income Statement

For the Month Ended September 30, 2002

Revenues Service revenue $ 4,700 Expenses Salaries expense $ 900

Rent expense 600 Advertising expense 250

Utilities expense 200

Total expenses 1,950

Net income

2,750

Net income of $2,750 shown on the income statement is added to the beginning balance of owner’s capital in the owner’s equity statement.Net income of $2,750 shown on the income statement is added to the beginning balance of owner’s capital in the owner’s equity statement.

ILLUSTRATION ILLUSTRATION 1-11 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPSFINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE

Owner’s Equity/ Retained Earnings Statement

For the Month Ended September 30, 2002

Capital/ Retained earnings, September 1 $ –0– Add: Investments/ $ 15,000 Net income 17,750 17,750 Less: Drawings/ Dividends (1,300) Capital/ Retained earnings , September 30 $ 16,450

2,750

Net income of $2,750 is determined from the information in the owner’s equity column of the Summary of Transactions (Illustration 1-7).

Net income of $2,750 is determined from the information in the owner’s equity column of the Summary of Transactions (Illustration 1-7).

ILLUSTRATION ILLUSTRATION 1-11 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPSFINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE

Owner’s Equity Statement

For the Month Ended September 30, 2002

Capital, September 1 $ –0– Add: Investments $ 15,000 Net income 2,750 17,750 17,750 Less: Drawings 1,300 Capital, September 30

$16,450

Net income of $2,750 carried forward from the income statement to the owner’s equity statement. The owner’s capital of $16,450 at the end of the reporting period is shown as the final total of the owner’s equity column of the Summary of Transactions (Illustration 1-7).

Net income of $2,750 carried forward from the income statement to the owner’s equity statement. The owner’s capital of $16,450 at the end of the reporting period is shown as the final total of the owner’s equity column of the Summary of Transactions (Illustration 1-7).

ILLUSTRATION ILLUSTRATION 1-11 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPSFINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

Owner’s capital of $16,450 at the end of the reporting period shown in the owner’s equity statement is shown on the balance sheet.Owner’s capital of $16,450 at the end of the reporting period shown in the owner’s equity statement is shown on the balance sheet.

SOFTBYTE

Balance Sheet

September 30, 2002

Assets Cash $ 8,050 Accounts receivable 1,400 Supplies 1,600 Equipment 7,000 Total assets $ 18,050

Liabilities and Owner’s Equity Liabilities Accounts payable $ 1,600 Owner’s equity R. Neal, capital Total liabilities and owner’s equity $ 18,050

16,450

ILLUSTRATION ILLUSTRATION 1-11 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPSFINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

Cash of $8,050 on the balance sheet is reported on the statement of cash flows.Cash of $8,050 on the balance sheet is reported on the statement of cash flows.

SOFTBYTE

Balance Sheet

September 30, 2002

Assets Cash $ 8,050 Accounts receivable 1,400 Supplies 1,600 Equipment 7,000 Total assets $ 18,050

Liabilities and Owner’s Equity Liabilities Accounts payable $ 1,600 Owner’s equity R. Neal, capital Total liabilities and owner’s equity $ 18,050

ILLUSTRATION ILLUSTRATION 1-11 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPSFINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE

Statement of Cash Flows

For the Month Ended September 30, 2002

Cash flows from operating activities Cash receipts from revenues $ 3,300 Cash payments for expenses (1,950) Net cash provided by operating activities 1,350 Cash flows from investing activities Purchase of equipment (7,000) Cash flows from financing activities Investment by owners $ 15,000 Withdraws by owners (1,300) Net cash provided by financing activities 13,700 Net increase in cash 8,050 Cash at the beginning of the period –0– Cash at the end of the period

$ 8,050

Cash of $8,050 on the balance sheet and statement of cash flows is shown as the final total of the cash column of the Summary of Transactions (Illustration 1-7).Cash of $8,050 on the balance sheet and statement of cash flows is shown as the final total of the cash column of the Summary of Transactions (Illustration 1-7).

Forms of Business Organization

Sole Proprietorships

Sole Proprietorships PartnershipsPartnerships CorporationsCorporations

Reporting Ownership Equity in the Statement of Financial

PositionOwner's equity:

Jill Jones, capital 8,000$ Sole

Proprietorships

Sole Proprietorships

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

PartnershipsPartnerships

Owners' equity Capital stock 7,000$ Retained earnings 1,000 Total stockholders' equity 8,000$

CorporationsCorporations

The Use of Financial Statements by External Parties

Creditors

Investors

Two concerns:Liquidity

Profitability

Two concerns:Liquidity

Profitability

The Need for Adequate Disclosure

Notes to the financial statements often

provide facts necessary for the

proper interpretation of the

statements.

Notes to the financial statements often

provide facts necessary for the

proper interpretation of the

statements.

Income Statement

Balance Sheet

Statement of Cash Flows

Income Statement

Net income

Income Statement

Net income

Statement of Retained Earnings

Beginning Retained Earnings+ Net income– Dividends

Ending retained earnings

Statement of Retained Earnings

Beginning Retained Earnings+ Net income– Dividends

Ending retained earnings

Balance Sheet

Ending Balance Retained Earnings

Balance Sheet

Ending Balance Retained Earnings

Order of Preparation

Income statement—A summary of the revenue and expenses for a specific period of time.

Statement of retained earnings – a summary of the changes in the retained earnings that have occurred during a specific period of time.

Balance sheet—A list of the assets, liabilities, and owner’s equity as of a specific date.

Review

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.