Chapter

2 BASIC FINANCIAL
STATEMENTS

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

2000

X
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 Introduction
Introduction to
to Financial
Financial Statements
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
Introduction to
to Financial
Financial Statements
Statements
Balance Sheet
Describes
where the
Income Statement enterprise
stands at a
Statement of Cash Flows
specific date.

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 Introduction
Introduction to
to Financial
Financial Statements
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
Introduction to
to Financial
Financial Statements
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
Introduction to
to Financial
Financial Statements
Statements
Balance Sheet

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

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

 Introduction
Introduction to
to Financial
Financial Statements
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
The Concept
Concept of
of the
the Business
Business Entity
Entity

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

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 A
A Starting
Starting Point:
Point: Statement
Statement of
of
Financial
Financial Position
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
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
Retained earnings 70,000
Total
provide positive
$ 300,000 Total $ 300,000
future cash flows.
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 Assets
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
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’
Owners’ Equity
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’
Owners’ Equity
Equity
Changes in Owners’
Equity

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

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 The
The Accounting
Accounting Equation
Equation
Assets
Assets ==Vagabond
Liabilities ++ Agency
Travel
Liabilities Owners’
Owners’ Equity
Equity
Balance Sheet
December 31, 2002
$300,000
Assets=
$300,000 = $80,000
$80,000 +Liabilities
+ $220,000
$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.
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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affected the accounting equation.
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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
$ 2,500These transactions
transactions
Balances $ 5,500 $ 2,500 $ 8,000
May 8 (2,000) impact
impact
$ 15,000 the
the
$ 13,000
$ 2,500Statement of
Balances
May 11
$ 3,500
300
$ 15,000
Statement of Cash
$ 13,000
Cash
$ 300
$ 8,000

Balances $ 3,500 $ 2,800 Flows.

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
These transactions
transactions 750
Balances $ 4,175 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 $ 750
May 31 (50) impact
impact the the Income
Income (50)
Balances $ 4,125 $ 75 $ 2,650
Statement.
$ 15,000 $ 13,000
Statement.
$ 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
Investments by by and
and payments
payments to to the
the owners
owners
are
are not
not included
included on
on the
the Income
Income Statement.
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
Operating
Purchase activities
activities include
of lawn mower include$ the
the cash
(2,500)cash
effects
Purchase of truckof revenue and expense
effects of revenue and (2,000)
expense
Collection for sale of repair parts 75
transactions.
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

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

 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
Investing
Investment activities
activities include
by owners include the
the cash
cash 8,000
effects
Increase
effects of
in cash for
of purchasing
month
purchasing and
and selling
selling$ 4,125
Cash balance, May 1, 2003 -
Cash balance, May 31, 2003 assets.
assets. $ 4,125

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

 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
of truck activities
Financing
Purchase activities include
include the
the cash
(2,000)cash
effects
Collection
effects of
for
of transactions
sale of repair parts with the owners
transactions with the 75
owners
Payment for repair parts (150)
and
and creditors.
Net cash used by investing creditors.
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
Relationships Among
Among Financial
Financial
Statements
Statements

Beginning End of
of period Time period

Balance Balance
Sheet Sheet

Income Statement
Statement of Cash Flows
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 Forms
Forms of
of Business
Business Organizations
Organizations

Sole
Sole Partnership
Partnership Corporation
Corporation
Proprietorship
Proprietorship

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

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

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

Two
Two concerns:
concerns:
Creditors Solvency
Solvency
Profitability
Profitability

Investors
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 The
The Need
Need for
for Adequate
Adequate Disclosure
Disclosure
Balance Sheet Notes
Notes to
to the
the
Income Statement
financial
financial
statements
statements often
often
Statement of Cash Flows
provide
provide facts
facts
necessary
necessary forfor the
the
proper
proper
interpretation
interpretation of of
the
the statements.
statements.

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 End
End of
of Chapter
Chapter 22

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