Lecture 2

The Basic Financial Statements & Recording

Process

Dr Asma Abdul Rehman

 Learning outcomes
• Will be able to understand the basic
terminology used in accounts
• Learn about the basic financial statements
• Describe how accounts, debits, and credits are
used to record business transactions.
 Introduction to Financial Statements

Companies prepare interim

financial statements and annual
financial statements.

2000

X
 Financial statements
• Income statements
• Balance sheet
• Statement of cash flow
• Owners equity statement
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 cash negative cash
flow. 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.
 Income statement
• Income statement presents the revenue, expenses and
resulting net income or net loss for a specific period of
time.
• Also known as statement of operations, earnings
statement, or profit and loss statement.
• Income statement lists revenues first followed by
expenses. Finally income statement shows the net income
or net loss.
• Net income results when the revenues exceed expenses.
• A net loss occurs when expenses exceed revenues.
• Note that Income statement does not include investment
and withdrawal transactions between the owner &
business in measuring net income.
INCOME STATEMENT:EXAMPLE
 Owner’s Equity Statement
• An owner’s equity statement summarizes or report the
changes in owner’s equity for a specific period of time.
• The time period is same as covered by the income
statement.
• Data comes from the owner’s equity column and income
statement.
• The first row of the statement shows the beginning owner’s
equity amount; then come the owner’s investment, net
income (or Loss) and the owner’s drawings.
• This statement indicates why owner’s equity has increased
or decreased during the period.
 Net income is needed to determine the
Financial Statements ending balance in owner’s equity.

SOFTBYTE
Income Statement
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements and
their interrelationships

SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

LO 5
 SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

Illustration 1-9
The ending
balance in SOFTBYTE
owner’s equity Balance Sheet
is needed in September 30, 2017
preparing the
balance sheet.

Illustration 1-9
Financial statements
and their
interrelationships
The Concept of the Business Entity

A business
entity is
Vagabond Travel separate from
Agency
the personal
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.
 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
 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 to
Investments Owners/Drawing
• Business • Business
Earnings Losses
Balance Sheet

 Reports the assets, liabilities, and owner's equity at a

specific date.
 Lists assets at the top, followed by liabilities and owner’s
equity.
 Total assets must equal total liabilities and owner's
equity.
 Is a snapshot of the company’s financial condition at a
specific moment in time (usually the month-end or year-
end).

LO 5
Statement of Cash Flows

 Information on the cash receipts and payments for a

specific period of time.
 Answers the following:
► Where did cash come from?
► What was cash used for?
► What was the change in the
cash balance?

LO 5
DO IT! Financial Statement Items

Presented below is selected information related to Falcon Company at

December 31, 2017. Falcon reports financial information monthly.
Equipment $10,000 Utilities Expense $ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000

(a) Determine the total assets of at December 31, 2017.

(b) Determine the net income reported for December 2017.

LO 5
DO IT! Financial Statement Items

Presented below is selected information related to Falcon Company at

December 31, 2017. Falcon reports financial information monthly.
Equipment $10,000 Utilities Expense $ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000

(a) Determine the total assets of at December 31, 2017.

The total assets are $27,000, comprised of

• Cash $8,000,
• Accounts Receivable $9,000, and
• Equipment $10,000.

LO 5
DO IT! Financial Statement Items

Presented below is selected information related to Falcon Company at

December 31, 2017. Falcon reports financial information monthly.
Equipment $10,000 Utilities Expense $ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000

(b) Determine the net income reported for December 2017.

LO 5
 Forms of Business Organizations

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

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

Owners' equity
Capital stock $ 7,000
Corporation
Retained earnings 1,000
Total stockholders' equity $ 8,000
 The Need for Adequate Disclosure

Balance Sheet Notes to the

Income Statement
financial
statements often
Statement of Cash Flows
provide facts
necessary for the
proper
interpretation of
the statements.
The Recording Process
 The account

 Itis an individual accounting Record of increases and decreases in

a specific asset, liability, owners’ equity, revenue, or expense item.
 Debit = “Left”
 Credit = “Right”
Account Name
Debit / Dr. Credit / Cr.

An account can
be illustrated in a
T-account form.
The Account

DEBIT AND CREDIT PROCEDURES

Double-entry system
 Each transaction must affect two or more accounts to
keep the basic accounting equation in balance.
 Recording done by debiting at least one account and
crediting at least one other account.
 DEBITS must equal CREDITS.

LO 1
 Debits and Credits

If the sum of Debit entries are greater than the sum of

Credit entries, the account will have a debit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000

Balance $15,000

LO 1
 Debits and Credits

If the sum of Credit entries are greater than the sum of

Debit entries, the account will have a credit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance $1,000

LO 1
 Dr./Cr. Procedure
• A debit is an accounting entry that either
increases an asset or expense account. Or
decreases a liability or equity account. It is
positioned on the left in an accounting entry.
• A credit is an accounting entry that increases
either a liability or equity account. Or
decreases an asset or expense account. It is
positioned on the right in an accounting entry.
 Debits/Credits Rules

Balance Sheet Income Statement

Asset = Liability + Equity Revenue - Expense

Debit

Credit

LO 1
Debits and Credits

Assets  Assets - Debits should exceed

Debit / Dr. Credit / Cr.
credits.
 Liabilities – Credits should
Normal Balance
exceed debits.
 Normal balance is on the
Chapter
3-23

increase side.
Liabilities
Debit / Dr. Credit / Cr.

Normal Balance

Chapter
3-24

LO 1
 Debits and Credits

Owner’s Equity  Owner’s investments and

Debit / Dr. Credit / Cr.
revenues increase owner’s equity
(credit).
Normal Balance  Owner’s drawings and expenses
Chapter
3-25 decrease owner’s equity (debit).

Owner’s Capital Owner’s Drawing

Helpful Hint Because
Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.
revenues increase
owner’s
equity, a revenue account
has the same debit/credit
Normal Balance Normal Balance rules as the Owner’s
Capital account.
Chapter
3-25
Chapter
3-23
Expenses
have the opposite effect.

LO 1
Debits and Credits

Revenue  The purpose of earning revenues

Debit / Dr. Credit / Cr.
is to benefit the owner(s).
 The effect of debits and credits on
Normal Balance
revenue accounts is the same as
Chapter
3-26 their effect on Owner’s Capital.
 Expenses have the opposite
Expense
Debit / Dr. Credit / Cr.
effect: expenses decrease owner’s
equity.

Normal Balance

Chapter
3-27

LO 1
 Debits/Credits Rules
Liabilities
Debit / Dr. Credit / Cr.
Normal Normal
Balance Balance
Debit Credit Normal Balance

Assets Chapter
3-24

Owner’s Equity
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Normal Balance
Normal Balance

Chapter
3-23

Expense Chapter
3-25
Revenue
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Normal Balance
Normal Balance

Chapter
3-27 Chapter
3-26

LO 1
Debits/Credits Rules

Question
Debits:

a. increase both assets and liabilities.

b. decrease both assets and liabilities.

c. increase assets and decrease liabilities.

d. decrease assets and increase liabilities.

LO 1
Debits/Credits Rules

Question
Accounts that normally have debit balances are:

a. assets, expenses, and revenues.

b. assets, expenses, and equity.

c. assets, liabilities, and owner’s drawing.

d. assets, owner’s drawing, and expenses.

LO 1
 Summary of Debit/Credit Rules

Relationship among the assets, liabilities and owner’s equity

of a business:
Illustration 2-11
Basic
Equation Assets = Liabilities + Owner’s Equity

Expanded
Equation
Debit/Credit
Effects

The equation must be in balance after every transaction. Total

Debits must equal total Credits.

LO 1
 Practice
• Page 107 PROBLEM 2.1B Preparing and Evaluating a Balance
Sheet
• Page 107 PROBLEM 2.2B Interpreting the Effects of Business
Transactions
• Page 108 PROBLEM 2.3B
• Page 109 PROBLEM 2.6B Preparing a Balance Sheet—A Second
Problem
Record debit and credit