CHAPTER

BASIC FINANCIAL
STATEMENTS
TWO
 2.1
2.1 Introduction
Introduction to
to Financial
Financial Statements
Statements
Companies prepare interim financial statements
and annual financial statements.

2012

X
 (Introduction
(Introduction to
to Financial,
Financial, Cont’d)
Cont’d)

Balance Sheet Three primary

Income Statement
financial
statements.
Statement of Cash Flows
We will use a corporation
to describe these
statements.
 (Introduction
(Introduction to
to Financial,
Financial, Cont’d)
Cont’d)

Balance Sheet
Describes
where the
Income Statement enterprise
stands at a
Statement of Cash Flows
specific date.
 (Introduction
(Introduction to
to Financial,
Financial, Cont’d)
Cont’d)

Balance Sheet

Income Statement
Depicts the
revenue and
Statement of Cash Flows expenses for a
designated
period of time.
 (Introduction
(Introduction to
to Financial,
Financial, Cont’d)
Cont’d)

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

Either in the past, present, or future.

 (Introduction
(Introduction to
to Financial,
Financial, Cont’d)
Cont’d)

Balance Sheet

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

Balance Sheet

Income Statement

Statement of Cash Flows

Depicts the
ways cash has
changed during
a designated
period of time.
2.2
2.2 The
The Concept
Concept of
of the
the Business
Business Entity
Entity

A business
entity is
Lucy Travel separate from
Agency the personal
affairs of its
owner.
 2.3
2.3AAStarting
Starting Point:
Point: Statement
Statement of
of
Financial
Financial Position
Position

Lucy Travel Agency

Balance Sheet
December 31, 2012
Assets Liabilities & Owners' Equity
Cash Br. 22,500 Liabilities:
Notes receivable 10,000 Notes payable Br. 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities Br. 80,000
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total Br. 300,000 Total Br. 300,000
 (A
(AStarting
Starting point,
point, Cont’d)
Cont’d)
Lucy Travel Agency
Balance Sheet
Dec. 31, 2012
Assets Liabilities & Owners' Equity
Cash Assets are
Br. 22,000 Liabilities:
Notes receivable 10,000 economic resources
Notes payable Br. 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:
Br. 39,000

Office equipment 15,000 are expected to

Capital stock 150,000
Retained earnings 70,000
Total
provide positive
Br. 300,000 Total Br. 300,000
future cash flows.
 Assets
Assets

Cost Principle

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

Objectivity
Principle
 Liabilities
Liabilities
Lucy Travel Agency
Balance Sheet
Dec. 31, 2012
Assets Liabilities & Owners' Equity
Liabilities are
Cash Br. 22,500 Liabilities:
debts that
Notes receivable
Accounts receivable
10,000
60,500
Notes payable
Accounts payable
Br. 41,000
36,000
represent negative
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities Br. 80,000
future cash flows
Building 90,000 Owners' Equity:
for the enterprise.
Office equipment 15,000 Capital stock
Retained earnings
150,000
70,000
Total Br.300,000 Total Br300,000
 Owners’
Owners’Equity
Equity
Lucy Travel Agency
Balance Sheet
Dec. 31, 2012
Assets Liabilities & Owners' Equity
Owners’ equity
Cash Br.22,500 Liabilities:
Notes receivable 10,000 Notes payable Br. 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
Br. 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 Br300,000 Total Br300,000
 Owners’
Owners’Equity
Equity

Changes in Owners’
Equity

•Owners’ •Payments
Investments to Owners
•Revenues •Expenses
 2.4
2.4 The
TheAccounting
Accounting Equation
Equation
Vagabond Travel Agency
Balance Sheet
December 31, 2002
Assets Liabilities & Owners' Equity
Cash Br. 22,500 Liabilities:
Notes receivable 10,000 Notes payable Br. 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities Br.80,000
Building 90,000 Owners' Equity
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total Br300,000 Total Br300,000
 Let’s analyze
some
transactions for
AG Lawn Care
Service.
 On May 1, 2013, Abel Gidey & his family invested
Br. 8,000 in AG Lawn Care Service and received
800 shares of stock.
AG Lawn Care Service
Balance Sheet
1-May-13
Assets Owners' Equity
Cash Br. 8000 Capital Stock Br. 8000

Total Br. 8000 Total Br. 8000

 On May 2, AG Lawn Care purchased a
riding lawn mower for Br. 2,500 cash.
AG Lawn Care Service
Balance Sheet
May 2, 2013
Assets Owners' Equity
Cash Br. 5,500 Capital Stock Br. 8000
Tools & Equipment 2,500

Total Br. 8000 Total Br. 8000

 On May 8, AG purchased a Br. 15,000 truck.
AG’s paid Br. 2,000 down in cash and issued a note
payable for the remaining Br. 13,000.
AG Lawn Care Service
Balance Sheet
May 8, 2013
Assets Liabilities and Owners' Equity
Cash Br. 3,500 Liabilities:
Tools & Equipment 2,500 Notes Payable Br. 13,000
Truck 15,000 Owners' Equity:
Capital Stock 8,000

Total Br. 21,000 Total Br. 21,000

 On May 11, AG purchased some repair
parts for Br. 300 on account.
AG Lawn Care Service
Balance Sheet
May 11, 2013
Assets Liabilities and Owners' Equity
Cash Br. 3,500 Liabilities:
Tools & Equipment 2,800 Notes Payable Br. 13,000
Truck 15,000 Accounts Payable 300
Total Liabilities Br. 13,300
Owners' Equity:
Capital Stock 8,000

Total Br. 21,300 Total Br. 21,300

 Abel realized he had purchased more repair parts than needed.
On May 18, AG was able to sell half of the repair parts to ABC Lawns for
Br. 150, a price equal to AG’s cost. AG will receive the cash within 30
days.
AG Lawn Care Service
Balance Sheet
May 18, 2013
Assets Liabilities and Owners' Equity
Cash Br. 3,500 Liabilities:
Accounts Receivable 150 Notes Payable Br. 13,000
Tools & Equipment 2,650 Accounts Payable 300
Truck 15,000 Total Liabilities Br. 13,300
Owners' Equity:
Capital Stock 8,000

Total Br. 21,300 Total Br. 21,300

 On May 25, ABC Lawns pays AG Br. 75 as a
partial settlement of its accounts receivable.
AG lawn Care Service
Balance Sheet
May 25, 2013
Assets Liabilities and Owners' Equ
Cash Br. 3,750 Liabilities:
Accounts Receivable 75 Notes Payable Br. 13,
Tools & Equipment 2,650 Accounts Payable
Truck 15,000 Total Liabilities Br. 13,
Owners' Equity:
Capital Stock 8,

Total Br. 21,300 Total Br. 21,

 On May 28, AG pays Br. 150 of its accounts
payable.
AG Lawn Care Service
Balance Sheet
May 28, 2013
Assets Liabilities and Owners' Equity
Cash Br. 3,425 Liabilities:
Accounts Receivable 75 Notes Payable Br. 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities Br. 13,150
Owners' Equity:
Capital Stock 8,000

Total Br. 17,725 Total Br. 17,725

 On May 29, AG recorded lawn care services
provided during May of Br. 750. All clients paid
in cash.
AG Lawn Care Service
Balance Sheet
May 29, 2013
Assets Liabilities and Owners' Equity
Cash Br. 4,175 Liabilities:
Accounts Receivable 75 Notes Payable Br. 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities Br. 13,150
Owners' Equity:
Capital Stock 8,000
Retained Earnings 750
Total Br. 21,900 Total Br. 21,900
 On May 31, AG purchased gasoline for the
lawn mower and the truck for Br. 50 cash.
AG Lawn Care Service
Balance Sheet
May 31, 2013
Assets Liabilities and Owners' Equity
Cash Br. 4,125 Liabilities:
Accounts Receivable 75 Notes Payable Br. 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities Br. 13,150
Owners' Equity:
Capital Stock 8,000
Retained Earnings 700
Total Br. 21,850 Total Br. 21,850
Now, let’s review how AG’s transactions
affected the accounting equation.
 Assets = Liabilities + Owne
Accts. Tools & Notes Accts. Capital
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock
May 1 Br. 8000 Br. 8000
Balances Br. 8000 Br. 8000
May 2 (2,500) Br.2,500
BalancesBr. 5,500 Br.2,500 Br. 8000
May 8 (2,000) Br.15,000 Br. 13,000
Balances Br.3,500 Br.2,500 Br. 15,000 Br. 13,000 Br. 8000
May 11 300 Br. 300
BalancesBr. 3,500 Br. 2,800 Br.15,000 Br. 13,000 Br. 300 Br. 8000
May 18 Br. 150 (150)
BalancesBr. 3,500 Br. 150 Br. 2,650 Br. 15,000 Br. 13,000 Br. 300 Br. 8000
May 25 75 (75)
BalancesBr. 3,575 Br. 75 Br. 2,650 Br. 15,000 Br. 13,000 Br. 300 Br. 8000
May 28 (150) (150)
BalancesBr. 3,425 Br. 75 Br. 2,650 Br. 15,000 Br. 13,000 Br. 150 Br. 8000
May 29 750
BalancesBr. 4,175 Br. 75 Br. 2,650 Br.15,000 Br. 13,000 Br. 150 Br. 8000
May 31 (50)
BalancesBr. 4,125 Br. 75 Br. 2,650 Br. 15,000 Br. 13,000 Br. 150 Br. 8000
 Let’s prepare the Income Statement and
Statement Assets of Cash Flows
= for AG+ Lawn
Liabilities Owners'Care
Equity

Cash
Service
Accts.
for the
Tools &
month ending
Notes
May
Accts.
31,
Capital
2013.
Retained
+ 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
 AG Lawn Care Service
Income Statement
For the Month Ended May 31, 2013

Sales Revenue Br. 750

Operating Expense:
Gasoline Expense 50
Net Income Br. 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.
 AG Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2013
Cash flows from operating activities:
Cash received from revenue transactions Br. 750
Cash paid for expenses (50)
Net cash provided by operating activities Br. 700
Cash flows from investing activities:
Purchase of lawn mower Br. (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 Br. 4,125
Cash balance, May 1, 2013 -
Cash balance, May 31, 2013 Br. 4,125
 AG Lawn Care Service
Statement of Cash Flows
For the Month Ended may 31, 2013
Cash flows from operating activities:
Cash received from revenue transactions Br. 750
Cash paid for expenses (50)
Net cash provided by operating activities Br. 700
Cash flows from investing activities:
Operating
Operating activities
activities include
Purchase of lawn mower include the
the cash
cash Br. (2,500)
Purchase of truck (2,000)
effects
effects of
of revenue
revenue and
and expense
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 Br. 4,125
Cash balance, May 31, 2013 -
Cash balance, May 31, 2013 Br. 4,125
 AG Lawn Care Service
Statement of Cash Flows
For the Month Ended may 31, 2013
Cash flows from operating activities:
Cash received from revenue transactions Br. 750
Cash paid for expenses (50)
Net cash provided by operating activities Br. 700
Cash flows from investing activities:
Purchase of lawn mower Br. (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 activities
activities include
Investment by owners include the
the cash
cash 8,000
Increase in cash for month Br. 4,125
effects
effects of
of purchasing
purchasing and
Cash balance, May 1, 2013 and selling
selling -
assets.
assets.
Cash balance, May 31, 2013 Br. 4,125
 AG Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2013
Cash flows from operating activities:
Cash received from revenue transactions Br. 750
Cash paid for expenses (50)
Net cash provided by operating activities Br. 700
Cash flows from investing activities:
Purchase of lawn mower Br. (2,500)
Financing
Financing activities
activities include
Purchase of truck include the
the cash
cash (2,000)
effects
effects of
of transactions
transactions with
with the
the owners
Collection for sale of repair parts
owners 75
Payment for repair parts (150)
and
and creditors.
creditors.
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month Br. 4,125
Cash balance, May 1, 2013 -
Cash balance, May 31, 2013 Br. 4,125
 2.5
2.5 Relationships
RelationshipsAmong
Among Financial
Financial
Statements
Statements

Beginning End of
of period Time period

Balance Balance
Sheet Sheet

Income Statement
Statement of Cash Flows
 2.6
2.6 Forms
Forms of
of Business
Business Organizations
Organizations

Sole
Sole Partnership
Partnership Corporation
Corporation
Proprietorship
Proprietorship
 2.7
2.7 Reporting
Reporting Ownership
Ownership Equity
Equity in
in the
the
Balance
Balance Sheet
Sheet
Sole
Sole Owner’s Equity
Proprietorship
Proprietorship Abel Gidey, Capital Br. 8,000

Partner’s Equity
Partnership Abel Gidey, Capital Br. 4,000
Partnership Alemu A/Mecha, Capital 4,000
Total Partners’ Equity Br. 8,000

Owners' equity
Capital stock Br. 7,000
Corporation
Corporation Retained earnings 1,000
Total stockholders' equity Br. 8,000
 2.8
2.8 The
The Use
Use of
of Financial
Financial Statements
Statements by
by
Outsiders
Outsiders

Two
Two concerns:
concerns:
Creditors Solvency
Solvency
Profitability
Profitability

Investors
 2.9
2.9 The
The Need
Need for
forAdequate
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.
End
End of
of Chapter
Chapter 22