Chapter 2: Financial Statements and the Accounting Process

1
Chapter 2 Financial Statements and the
Accounting Process

• I. Financial Statements
• A. Balance Sheet
• B. Statement of Owners Equity
• Statement of Stockholders Equity
• Statement of Retained Earnings
• C. Income Statement
• D. Statement of Cash Flows
• II. Transaction Analysis

2
I.A.The Balance Sheet (B/S)

• Based on the relationship
• Assets Sources of Assets
• Assets Claims to Assets
• Assets Liabilities Equity
• For proprietorships
• Assets Liabilities Owners Equity
• A L OE
• For corporations
• Assets Liabilities Stockholders Equity
• A L SE

3
A.The B/S Assets

• Assets are
• probable future economic benefits
• obtained or controlled by an entity
• result of past transactions or events.
• On B/S, classified in order of liquidity current
  and non-current.
• Current assets are expected to be converted to
  cash, sold, or used up within the next accounting
  period (usually defined as a year).

4
A.The B/S Assets

• Current assets
• Cash
• Short-term marketable securities
• Accounts receivable
• Inventory
• Prepaid expenses
• Property, plant, and equipment
• Long-term investments
• Intangible assets
• Patents
• Goodwill

5
A. The B/S Liabilities

• Liabilities are claims by creditors against the
  assets of a company.
• The creditors have a priority claim (before the
  owners) to the assets in liquidation.
• Liabilities are classified in terms of due dates
  current liabilities and non-current liabilities.
• Current liabilities will require the use of
  current assets or the creation of other current
  liabilities at maturity.

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A. The B/S Liabilities

• Current liabilities
• Accounts payable
• Wages payable
• Interest payable
• Short-term notes payable
• Unearned revenues
• Other payables
• Long-term liabilities
• Bonds payable
• Mortgage payable
• Long-term notes payable

7
A. The B/S Equity

• Equity represents the claims of the owners
  against the assets of a company.
• Corporations have a different form of ownership
  than proprietorships (individual owner), but the
  concept is the same.
• Most of the applications in this course will be
  for corporations, but some of the early material
  deals with proprietorships.

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A. The B/S Equity for Single Owner
(Proprietorship)

• Owners equity account consists of
• contributions by owner
• withdrawals by owner
• earnings of the proprietorship

9
A.The B/S Equity for Corporation

• Stockholders equity consists of
• Contributed capital
• Common Stock
• Preferred Stock (see Chapter 9)
• Additional paid in capital (see Chapter 9)
• Retained earnings
• Net income
• Dividends

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B. The Statement of Owners Equity

• Beginning owners equity
• Plus Investments by owners
• Plus Net income
• Less Withdrawals by owners
• Ending owners equity
• OEBegin I NI - W OEEnd

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B. The Statement of Stockholders Equity

• Beginning stockholders equity
• Plus issue of stock
• Plus Net income
• Less Dividends paid to stockholders
• Ending stockholders equity
• SEBegin I NI - D SEEnd

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B.The Statement of Retained Earnings

• Beginning retained earnings balance
• Plus Net income
• Less Dividends
• Ending retained earnings balance
• REBegin NI - D REEnd
• Note that the Statement of Retained Earnings is a
  subset of the Statement of Stockholders Equity.

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C.The Income Statement

• Revenues
• inflow of assets or settlement of liabilities
• from delivery of goods or services
• related to a companys central operations.
• Expenses
• outflow or consumption of assets or incurrence of
  liabilities
• from delivery of goods or services
• related to a companys central operations.

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C.The Income Statement

• Gains
• inflow of net assets
• from activities that are peripheral operations.
• Losses
• outflow of net assets
• from activities that are peripheral operations.
• Note that some items that fall into this category
  still have the title revenue or expense.
  Examples include interest revenue and interest
  expense.

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The Income StatementRevenues - Expenses Net
Income

• Revenue examples
• Sales
• Fees earned
• Other revenues and gains
• Expense examples
• Cost of goods sold
• Wage expense
• Rent expense
• Selling expense
• Depreciation expense
• Other expenses and losses

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D.The Statement of Cash Flows

• Cash flows from operating activities
• Usually cash flows related to income statement
  items (e.g., cash inflows from sales, cash
  outflows from interest payments).
• Cash flow from investing activities
• Usually cash flows related to non-current assets
  (e.g., cash outflow from purchase of equipment).
• Cash flow from financing activities
• Usually cash flows related to equity items or
  non-current liabilities (e.g., sale of stock,
  issuance of bonds).

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Relationships Among theFinancial Statements
Ending Balance Sheet
Beginning Balance Sheet
Statement of Cash Flows
Assets (Cash)
Assets (Cash)
Income Statement


Liabilities
Liabilities


Statement of O.E. or Statement of
R.E. or Statement of S.E.
Equity
Equity
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Ex. 2-14

• Indicate CA, PE, OA, CL, LTL, SE
• ___ Cash
• ___ Common Stock
• ___ Notes Payable
• ___ Prepaid Insurance
• ___ Accounts Receivable
• ___ Machinery and Equipment
• ___ Investments
• ___ Patents

CA
SE
CL/LTL
CA/OA
CA
PE
OA
OA
19
Ex. 2-14 - continued

• Indicate CA, PE, OA, CL, LTL, SE
• ___ Taxes Payable
• ___ Inventory
• ___ Wages Payable
• ___ Accounts Payable
• ___ Marketable Securities
• ___ Land
• ___ Goodwill
• ___ Interest Payable

CL
CA
CL
CL
CA/OA
PE
OA
CL
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Ex. 2-17 (20X1, 20X2, and 20X3)

• Use the following formulas to solve for the
  missing items
• A L SE
• SEBegin Issue NI - D SEEnd

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Ex. 2-17 (20X1, in 000s)

• (a) SE, 1/1/X1
• A L SE
• 100 60 SE
• 40 SE
• (b) SE, 12/31/X1
• SEBegin Issue NI - D SEEnd
• 40 18 20 - 20
  SEEnd
• 58
  SEEnd

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Ex. 2-17 (20X2, in 000s)

• (c) Liabilities, 1/1/X2
• A L SE
• 120 L 58
• 62 L
• (d) SE, 1/1/X2 SE,12/31/X1
• 58
• (e) SE, 12/31/X2 SE, 1/1/X3 75,000

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Ex. 2-17 (20X3, in 000s)

• (f) Assets, 1/1/X3
• A L SE
• A 72 75
• 147 72 75
• (g) Income or (loss)
• 57 75 17 (1)

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II. Transaction Analysis

• The foundation of financial accounting.
• Based on the accounting equation
• Assets Liabilities Equity
• Every economic transaction affects at least two
  items in the accounting equation.
• Illustration Ex. 2-44.

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Ex. 2-44 Worksheet

• Cash Parts A/R A/P
  C/S RE
• 9/3
• 9/9
• 9/12
• 9/18
• 9/20
• 9/26
• 9/29 _____ _____ _____ _____
  _____ _____

15,000
15,000
5,000
5,000
(2,500)
(2,500) exp.
2,200
2,200 rev.
(1,150)
(1,150) exp.
850
(850)
(1,000)
(1,000)

Tot. 12,350 3,850 1,350 4,000
15,000 (1,450)
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Ex. 2-44 Financial Statements

• Income Statement - Month of September
• Revenues ________
• Expenses ________
• Net Income (loss) ________
• Statement of Retained Earnings - September
• RE (beginning) ________
• Net Income (loss) ________
• Dividends ________
• RE (ending) ________

2,200
(3,650)
(1,450)
-0-
(1,450)
-0-
(1,450)
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Ex. 2-44 Financial Statements

• Balance Sheet - at September 30
• Assets
• Cash ________
• Parts ________
• A/R ________
• Total ________
• Liab. and S.E.
• A/P ________
• CS ________
• RE (ending) ________
• Total ________

12,350
3,850
1,350
17,550
4,000
15,000
(1,450)
17,550
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Ex. 2-44 Financial Statements

• Statement of Cash Flows - for September
• Cash flow from operating activities
• Cash collected from customers ________
• Cash paid to suppliers ________
• Cash paid for rent ________
• Cash flow from financing activities
• Cash from issue of stock ________
• Net increase in cash ________

850
(1,000)
(2,500)
15,000
12,350
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Ex. 2-45 Worksheet

• Nov. Cash A/R Supp N/P U.Rev
  C/S RE
• Bal. 7,500 2,000 2,200 300
  3,000 4,000
• 2
• 7
• 11
• 17
• 30 _____ _____ _____ _____
  _____ _____ _____

100
100 rev.
150
150 rev.
(200)
(200) exp.
(200)
200 rev.
(500)
(500) exp.
Tot. 7,400 150 1,500 2,200 100
3,000 3,750