BASIC FINANCIAL

STATEMENTS

Dr. C. George
Introduction to Financial Statements

Companies prepare interim financial

statements and annual financial
statements.

2000

X
Introduction

• Financial accounting involves identifying, measuring, recording, and

communicating in dollar terms the economic events and status of an
organization.
• This information is summarized and presented in financial
statements—the three most important being:
1. the income statement,
2.the balance sheet, and
3.the statement of cash flows.
Role of Financial statements
• Financial statements help companies assess several aspects of the
business, from profitability (income statement) to how assets are
sourced (balance sheet), and cash inflows and outflows (cash flow
statement).
• Financial statements are also mandatory to companies for tax
purposes. They are also used by managers to assess the
performance of the business
• financial accounting is often called “the language of business.”
3 main documents that can be used to
represent an organization:
• Balance Sheet: it shows how assets have been acquired by a firm.
• Income Statement: it shows the P/L of a company’s (also called
bottom line or profit and loss statement).
• And Cash Flow Statement: it shows cash inflows and outflows of a
firm.
 Introduction to Financial Statements
Also
Alsocalled
calledStatement
Statement Three primary
Balance Sheet of
of Financial
FinancialPosition
Position
financial
Income Statement statements.
Statement of Cash Flows
We will use a corporation
to describe these
statements.
Introduction to Financial Statements

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

Balance Sheet

Income Statement
Depicts the
revenue and
Statement of Cash Flows expenses for a
designated
period of time.
Introduction to Financial Statements

Revenues Expenses
result in result in
positive negative
cash flow. cash flow.

Either in the past, present, or future.

Introduction to Financial Statements

Balance Sheet

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

Balance Sheet

Income Statement

Statement of Cash Flows

Depicts the
ways cash has
changed during
a designated
period of time.
Balance Sheet
• The purpose of the balance sheet is to report how the resources to
run the operations of the business were acquired.
• The Balance Sheet helps to assess the financial risk of a business
and the simplest way to describe it is given by the accounting
equation (assets = liability + equity).
• A classic balance sheet is comprised of three main accounts:
• Assets, Liability, and Equity.
Users of financial accounting information

• The predominant users of financial accounting information are those

parties who have a financial interest in the organization and hence
are concerned with its economic status.

• All organizations, whether not-for-profit or investor owned, have

stakeholders who have an interest in the business.

• Investors and managers are the predominant users of financial

accounting information as a result of their direct financial interest in
the organization.
Stakeholders
• In a not-for profit organization, such as a community hospital, the
stakeholders include managers, staff physicians, employees,
suppliers, creditors, patients, and even the community at large.
• Investor-owned organizations have essentially the same set of
stakeholders, plus owners. Because all stakeholders, by definition,
have an interest in the organization, all stakeholders have an
interest in its financial condition.
Income statement basics

• The income statement summarizes the operations (i.e., the activities)

of an organization with a focus on its revenues, expenses, and
profitability. Thus, the income statement is also called the statement
of operations or the statement of activities.
• the income statement contains operational results over a specified
period of time.

• The core components of the income statement are straightforward:

revenues, expenses, and profitability (i.e., net income).
Income statement basics

• Revenues, represent both cash received to date and the obligations

of payers for services provided during the period.
• For healthcare providers, the revenues result mostly from the
provision of patient services. To produce revenues, organizations
must incur costs, or expenses, which are classified as operating or
capital (financial).
• Operating costs consist of salaries, supplies, insurance, and other
costs directly related with providing services.
• Capital costs are the costs associated with the buildings and
equipment used by the organization, such as depreciation, lease, and
interest expenses.
Income statement basics

• Expenses decrease the profitability of a business, so expenses are

subtracted from revenues to determine an organization’s
profitability:

Revenues − Expenses = Net income.

• Net income may be positive or negative. When revenues exceed
expenses, the result is called net income. When expenses exceed
revenues, a net loss (negative net income) results.
The Concept of the Business Entity

A business
entity is
Vagabond separate from
Travel the personal
Agency
affairs of its
owner.
 A Starting Point: Statement of Financial
Position
Vagabond Travel Agency
Statement of Financial Position
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
 Assets
Vagabond Travel Agency
Statement of Financial Position
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.
Assets

Cost Principle

These accounting
Stable-Dollar principles support Going-Concern
Assumption cost as the basis Assumption
for asset valuation.

Objectivity
Principle
Cost Principle

• The cost principle is one of the basic underlying guidelines in

accounting. It is also known as the historical cost principle.
• The cost principle requires that assets be recorded at the cash
amount (or the equivalent) at the time that an asset is acquired.
Further, the amount recorded will not be increased for inflation or
improvements in market value. 

• Example of Cost Principle

• The cost principle means that a long-term asset purchased for the
cash amount of $50,000 will be recorded at $50,000. If the same
asset was purchased for a down payment of $20,000 and a formal
promise to pay $30,000 within a reasonable period of time and with
a reasonable interest rate, the asset will also be recorded at $50,000.
Stable- dollar assumption

• The stable dollar assumption, then, is the underlying accounting

principle that the definition of the dollar will remain constant across
fiscal periods. The inflation rate is assumed to be zero.

• In this way, one can make meaningful comparisons of accounts from

entries posted at different points of time.
Objectivity principle

• The objectivity principle states that you should use only factual,
verifiable data in the books, never a subjective measurement of
values. Even if the subjective data seems better than the verifiable
data, the verifiable data should always be used.
Going concern assumption

• An accounting guideline which allows the readers of financial

statements to assume that the company will continue on long
enough to carry out its objectives and commitments.
• In other words, the accountants believe that the company will not
liquidate in the near future. This assumption also provides some
justification for accountants to follow the cost principle.
 ASSETS
Owned By Business
Provide Future Benefits
Help Earn Revenue In Future

Must Be “Owned”
Not Rented
 ASSETS

Cash
Supplies
Merchandise
Land
Furniture
ACCOUNTS RECEIVABLE
Money owed our business
• By customers
• From sales made on credit
• Customers have received goods or services and promised to pay
later
“On account” or “on credit”
 Liabilities
Vagabond Travel Agency
Statement of Financial Position
December 31, 2002
Assets Liabilities & Owners' Equity
Liabilities are
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
financial
Accounts receivable 60,500 Accounts payable 36,000
obligations that
Supplies
Land
2,000
100,000
Salaries payable
Total liabilities
3,000
$ 80,000
represent negative
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
future cash flows Retained earnings 70,000
for the enterprise.
Total $ 300,000 Total $ 300,000
 LIABILITIES
Obligation to do something in future

Usually Paid In Cash

Can Be Paid With
Goods Or Services
LIABILITIES

• Accounts Payable

• Notes Payable

• Wages Payable

• Taxes Payable
ACCOUNTS PAYABLE

Promise to pay supplier

• No contract signed
• No interest charged
• Small amount
• Short time
“On account” or “on credit”
RECEIVABLE AND PAYABLES

Accounts receivable
• Right to receive cash
• For services rendered or goods delivered
Accounts payable
• Obligation to pay cash
• For services or goods received

Watch out!
NOTES PAYABLE

Promise to pay supplier or

lender
• Written contract signed
• Interest charged
• Large amount
• Long time
Examples
• Car loan
• Home loan
 Owners’ Equity
Vagabond Travel Agency
Statement of Financial Position
December 31, 2002
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
owner’s claims 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
Owners’ Equity

Changes in Owners’
Equity

•Owners’ •Payments
Investments to Owners
•Business •Business
Earnings Losses
 The Accounting Equation

Assets
Assets ==Vagabond
Liabilities ++ Agency
Travel
Liabilities Owners’
Owners’ Equity
Equity
Statement of Financial Position
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
Assets = Liabilities + Equity

• This basic accounting equation “balances” the company’s balance

sheet, showing that a company’s total assets are equal to the sum of
its liabilities and shareholders’ equity.
• This formula, also known as the balance sheet equation, shows that
what a company owns (assets) is purchased by either what it owes
(liabilities) or by what its owners invest (equity).

• If a hospital wants to purchase an equipment part, they will need to

purchase machine X that costs $1000. It borrows $400 from the bank
and spends another $600 in order to purchase the machine. Its
assets are now worth $1000, which is the sum of its liabilities ($400)
and equity ($600).
 Let’s analyze
some
transactions for
JJ’s Lawn Care
Service.
 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

 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

 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

 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

 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

 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

 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

 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
 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
affected the accounting equation.
 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

May 31 $21,850 = $21,850

 Let’s prepare the Income Statement and
Assets = Liabilities + Owners' Equity
Statement
Accts. Toolsof
& Cash Flows Notes forAccts.
JJ’s Lawn
Capital Care
Retained
Cash Service for
+ Rec. + Equip. the month
+ Truck ending
= Payable + Pay.May 31,
+ Stock 2003.
+ Earnings
May 1 $ 8,000 $ 8,000
Balances $ 8,000 $ 8,000
May 2 (2,500) $ 2,500
Balances $ 5,500 These
$ 2,500These transactions
transactions $ 8,000
May 8
Balances
(2,000)
$ 3,500 $ 2,500
impact
$ 15,000
impact
$ 15,000
the
$ 13,000
the
$ 13,000 $ 8,000
300Statement of Cash
May 11
Balances $ 3,500 $ 2,800
Statement
$ 15,000
of
$ 13,000
Cash
$ 300
$ 300 $ 8,000
May 18 $ 150 (150) Flows.
Flows.
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 These
$ 15,000 transactions
These transactions
$ 13,000 $ 150 $ 8,000 $ 750
May 31 (50) (50)
Balances $ 4,125 $ 75 $ 2,650 impact
impact
$ 15,000 the
$the Income
13,000Income
$ 150 $ 8,000 $ 700
Statement.
Statement.
 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.
 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
 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
 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
 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
 Relationships Among Financial Statements

Beginning End of
of period Time period

Balance Balance
Sheet Sheet

Income Statement
Statement of Cash Flows
Balance Sheet vs. Income Statement: The
Key Differences

• Timing: The balance sheet shows what a company owns (assets) and

owes (liabilities) at a specific moment in time, while the income
statement shows total revenues and expenses for a period of time. 
• Performance: The balance sheet doesn’t show performance—that’s
what the income statement is for.
• Reporting: The balance sheet reports assets, liabilities, and equity,
while the income statement reports revenue and expenses.
• Usage: The company uses the balance sheet to determine if the
company has enough assets to meet financial obligations. The
income statement is used to evaluate performance and to see if
there are any financial issues that need correcting.
• Creditworthiness: Lenders use the balance sheet to see if they should
extend any more credit, but they use the income statement to
decide on whether or not the business is making enough profit to
pay its liabilities. 
 Forms of Business Organizations

Sole
Sole Partnership
Partnership Corporation
Corporation
Proprietorship
Proprietorship
 Reporting Ownership Equity in the Balance
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
The Use of Financial Statements by
Outsiders

Two
Two concerns:
concerns:
Creditors Liquidity
Liquidity
Profitability
Profitability

Investors
 The Need for Adequate 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.
Sunnyvale Clinic: Income Statements Years
Ended December 31, 2004 and 2003 (in
thousands)