Basic Financial Statements

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Chapter 2

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
 Introduction to Financial
Statements
Balance Sheet
Three primary
Income Statement financial
Statement of Cash Flows statements.

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.

2-3
 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
Balance Sheet

Income Statement

Statement of Cash Flows

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

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Basic Financial Statements
 Threetypes of financial statements are mandated by the
accounting and financial regulatory authorities:
1. Income statement – how much money you made last year?
 Revenue, expense, profits over a year or quarter.
1. Balance sheet – What’s your current financial situation?
a snap shot on a specific date of
 Assets (value of what the firm owns),
 Liabilities (value of firm’s debts), and
 Shareholder’s equity (the money invested by the company
owners)
1. Cash flow statement – How did the cash come and go?
cash received and cash spent by the firm over a period of time

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 A Starting Point: Statement of
Financial Position
Vagabond Travel Agency
Balance Sheet
December 31, 2009
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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The Concept of the Business
Entity

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

2-8
 Assets
Vagabond Travel Agency
Balance Sheet
December 31, 2009
Assets Liabilities & Owners' Equity
Cash Assets are
$ 22,500 Liabilities:
Notes receivable 10,000 economic
Notes payable $ 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 resources that are
Salaries payable 3,000
Land 100,000 owned by the
Total liabilities $ 80,000
Building 90,000 Owners' Equity:
Office equipment 15,000 business and are
Capital stock 150,000
expected to benefit
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
future operations.
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Assets
These accounting principles support
cost as the basis for asset valuation.

Cost Principle
Stable-Dollar
Assumption

Going-Concern
Objectivity Assumption
Principle

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 Liabilities
Vagabond Travel Agency
Balance Sheet
December 31, 2009
Assets Liabilities & Owners' Equity
Liabilities are
Cash $ 22,500 Liabilities:
debts that
Notes receivable
Accounts receivable
10,000
60,500
Notes payable
Accounts payable
$ 41,000
36,000
represent
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
negative future
Building 90,000 Owners' Equity:
cash flows for the
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
enterprise.
Total $ 300,000 Total $ 300,000

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 Owners’ Equity
Vagabond Travel Agency
Balance Sheet
December 31, 2009
Assets Liabilities & Owners' Equity
Owners’ equity
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
represents the
Accounts receivable 60,500 Accounts payable 36,000
owners’ claims
Supplies
Land
2,000
100,000
Salaries payable
Total liabilities
3,000
$ 80,000
on the assets of
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
the business. Retained earnings 70,000
Total $ 300,000 Total $ 300,000

2-12
 The Accounting
Assets
Assets Equation
== Liabilities
Liabilities ++ Owners’
Owners’ Equity
Equity

$300,000
$300,000 == $80,000
$80,000 ++ $220,000
$220,000
Vagabond Travel Agency
Balance Sheet
December 31, 2009
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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An Income Statement
 Sales
Minus Cost of Goods Sold
 = Gross Profit
 Minus Operating Expenses
Selling expenses
General and Administrative expenses
Depreciation and Amortization Expense
 = Operating income (EBIT)
 Minus Interest Expense
 = Earnings before taxes (EBT)
 Minus Income taxes

 = Net income (EAT)

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Sample Income Statement

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The Cash Flow Statement
 The Cash Flow Statement is used by firms to explain
changes in their cash balances over a period of time by
identifying all of the sources and uses of cash.
Source of cash is any activity that brings cash into the
firm. For example, sale of equipment.
Use of cash is any activity that causes cash to leave
the firm. For example, payment of taxes.

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Cash Flow Statement
 The format for a traditional cash flow statement is as follows:
Beginning Cash Balance
Plus: Cash Flow from Operating Activities
Plus: Cash Flow from Investing Activities
Plus: Cash Flow from Financing Activities
Equals: Ending Cash Balance
 Operating activities represent the company’s core business
including sales and expenses. Basically any activity that affects net
income for the period.
 Investing activities include the cash flows that arise out of the
purchase and sale of long-term assets such as plant and equipment.
 Financing activities represent changes in the firm’s use of debt and
equity such as issue of new shares, payment of dividends.

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 Financial Reporting and Financial
Statements
Financial statements are
just one source of
financial accounting Income
Statement
information. Balance
Sheet
Statement
of Cash
Flows

Other Information:
•Industry
•Competitors
•National economy

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End of Chapter 2

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