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Chapter 2

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Introduction to Financial Introduction to Financial StatementsStatements

Three primary financial

statements.Income Statement

Balance Sheet

Statement of Cash Flows

We will use a corporation to describe these statements.

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Describes where the enterprise stands at a

specific date.

Income Statement

Balance Sheet

Statement of Cash Flows

Introduction to Financial Introduction to Financial StatementsStatements

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Depicts the revenue and

expenses for a designated

period of time.

Income Statement

Balance Sheet

Statement of Cash Flows

Introduction to Financial Introduction to Financial StatementsStatements

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Depicts the ways cash has changed during

a designated period of time.

Income Statement

Balance Sheet

Statement of Cash Flows

Introduction to Financial Introduction to Financial StatementsStatements

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Basic Financial Basic Financial StatementsStatements Three types 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.

2. 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)3. 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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Vagabond Travel AgencyBalance Sheet

December 31, 2009Assets 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$

A Starting Point: A Starting Point: Statement of Financial Statement of Financial PositionPosition

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The Concept of the The Concept of the Business EntityBusiness Entity

Vagabond Travel

Agency

A business entity is

separate from the personal affairs of its

owner.

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Vagabond Travel AgencyBalance Sheet

December 31, 2009Assets 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$

AssetsAssets

Assets are economic

resources that are owned by the

business and are expected to benefit future operations.

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AssetsAssets

Cost PrincipleCost Principle

Going-ConcernGoing-ConcernAssumptionAssumptionObjectivity Objectivity

PrinciplePrinciple

Stable-DollarStable-DollarAssumptionAssumption

These accounting principles support cost as the basis for asset valuation.

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Vagabond Travel AgencyBalance Sheet

December 31, 2009Assets 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$

LiabilitiesLiabilities

Liabilities are debts that represent

negative future cash flows for the

enterprise.

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Owners’ EquityOwners’ EquityVagabond Travel Agency

Balance SheetDecember 31, 2009

Assets Liabilities & Owners' EquityCash 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$

Owners’ equity represents the owners’ claims on the assets of the business.

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Vagabond Travel AgencyBalance Sheet

December 31, 2009Assets 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' EquityOffice equipment 15,000 Capital stock 150,000

Retained earnings 70,000 Total 300,000$ Total 300,000$

The Accounting EquationThe Accounting Equation Assets = Liabilities + Owners’ Equity

$300,000 = $80,000 + $220,000

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An Income StatementAn Income Statement SalesSales

Minus Cost of Goods SoldMinus Cost of Goods Sold = Gross Profit= Gross Profit Minus Operating ExpensesMinus Operating Expenses

Selling expensesSelling expensesGeneral and Administrative expensesGeneral and Administrative expensesDepreciation and Amortization ExpenseDepreciation and Amortization Expense

= Operating income (EBIT)= Operating income (EBIT) Minus Interest ExpenseMinus Interest Expense = Earnings before taxes (EBT)= Earnings before taxes (EBT) Minus Income taxesMinus Income taxes = Net income (EAT)= Net income (EAT)

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Sample Income StatementSample Income Statement

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The Cash Flow StatementThe Cash Flow StatementThe 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 StatementCash Flow Statement The format for a traditional cash flow statement is as

follows:Beginning Cash Balance

Plus: Cash Flow from Operating ActivitiesPlus: Cash Flow from Investing ActivitiesPlus: 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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Statement of Cash Flows

Balance Sheet

Income Statement

Other Information:•Industry•Competitors•National economy

Financial Reporting and Financial Reporting and Financial StatementsFinancial Statements

Financial statements are just one source of

financial accounting information.

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End of Chapter 2End of Chapter 2