CHAPTER 8 – FINANCIAL STATEMENT PRESENTATION, CLOSING THE BOOKS AND FINANCIAL ANALYSIS

PREPARING THE FINANCIAL STATEMENTS

CARLA AUTO REPAIR SHOP

ADJUSTED TRIAL BALANCE
December 31, 2018

Debit Credit
Cash on Hand ₱ 25,000
Cash in Bank 45,000
Accounts Receivable 49,000
Allowance for Doubtful Accounts ₱ 4,900
Notes Receivable 30,000
Interest Receivable 450
Prepaid Insurance 5,000
Prepaid Supplies 200
Machinery & Equipment 150,000
Accumulated Depreciation-Machinery & Equipment 7,500
Furniture & Fixtures 25,000
Accumulated Depreciation-Furniture & Fixtures 2,250
Accounts Payable 26,000
Notes Payable 50,000
Interest Payable 750
Taxes Payable 1,500
Carla, Capital 132,850
Carla, Drawings 5,000
Repair Income 275,000
Referral Income 15,000
Interest Income 450
Depreciation Expense-Machinery & Equipment 7,500
Depreciation Expense-Furniture & Fixtures 2,250
Doubtful Accounts 4,900
Insurance Expense 10,000
Salaries Expense 45,000
Supplies Expense 400
Rent Expense 55,000
Taxes & Licenses Expense 8,750
Utilities Expense 46,750
Interest Expense 1,000
Totals 516,200 516,200

INCOME STATEMENT – usually presented first to enable one to determine the profit which is needed to be able to prepare the capital
statement. The ending capital is then presented in the statement of financial position.

Nature of Income
1. Regular or operating income
2. Other income

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Forms of Presentation for Costs and Expenses
1. Based on nature – normally used for a simple business such as that of a service provider. Two sections may be formed, one
for revenues and the other for expenses. This form which is called the single step form makes a single step of deducting the
total expenses from the total revenues to arrive at the profit or loss.

CARLA AUTO REPAIR SHOP

INCOME STATEMENT
For the year ended December 31, 2018

Revenue:
Repair Income ₱ 275,000
Other Operating Income (note 1) 15,450

Expenses:
Rent Expense ₱ 55,000
Utilities Expense 46,750
Salaries Expense 45,000
Depreciation Expense (note 2) 9,750
Other Expenses (note 3) 24,050 - 180,550
Interest Expense - 1,000
Profit for the year ₱ 108,900

Note 1: Other Income

Referral Income ₱ 15,000
Interest Income 450
Total ₱ 15,450

Note 2: Depreciation Expense

Depreciation - Machinery & Equipment ₱ 7,500
Depreciation - Furniture & Fixtures 2,250
Total ₱ 9,750

Note 3: Other Expenses

Insurance Expense ₱ 10,000
Taxes & Licenses Expense 8,750
Doubtful Accounts 4,900
Supplies Expense 400
Total ₱ 24,050

2. Based on function – presents the expenses according to its function or use: cost of sales, distribution cost, administrative
cost and financial cost, to name a few.

Observe the following rules in preparing the income statement:

1. Note that the statement consists of four parts: heading, revenues earned, expenses incurred and net income or profit.
2. The third line in the heading must always be for a time period.
3. Margin on the left side – the extreme margin is used to describe the major sections and the inner margin is used to describe
the accounts contained in the minor section.
4. Money columns on the right side – the extreme margin is for the major amounts and the inner money column is for the amounts
of the described accounts.

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 5. Peso signs in the final money column (extreme right) are placed on the first and last amounts.
6. A single rule is placed under the last figure to be added or subtracted and a double line or rule is placed under the final figure.
7. Income from the principal line of operation called operating revenue is always presented first followed by other income. Expenses
may be presented from the highest amount to the lowest amount (descending order) in which case other expenses may be
presented first in the expense section of the income statement. Or these may be arranged alphabetically. Interest expense being
a financial cost is always presented last. The rule is also the same in the arrangement of the expenses in the supporting notes.

STATEMENT OF CHANGES IN EQUITY - changes in the owner’s capital or owner’s equity are summarized in this statement also
known as the capital statement. It explains what happened to the capital or claim of the owner.

CARLA AUTO REPAIR SHOP

STATEMENT OF CHANGES IN OWNER'S EQUITY
As of December 31, 2018

Carla, Capital, January 1 ₱ 100,000

Additional Investment 32,850
Add: Profit 108,900
Total ₱ 241,750
Less: Withdrawals 5,000
Carla, Capital, December 31 ₱ 236,750

STATEMENT OF FINANCIAL POSITION – this statement lists in detail the assets and liabilities of the business and shows the residual
interest of the owner as of a specific date.

Two Forms of Statement of Financial Position

1. Account Form – follows the accounting equation where assets are listed on the left hand column of the report with the liabilities
and owner’s equity listed on the right hand column.
2. Report Form – shows in one straight column the assets followed by the liabilities and owner’s equity.

CARLA AUTO REPAIR SHOP

STATEMENT OF FINANCIAL POSITION
As of December 31, 2018

ASSETS
Current Assets:
Cash (Note 1) ₱ 70,000
Trade and Other Receivable (Note 2) 74,550
Prepaid Expenses (Note 3) 5,200
Total ₱ 149,750
Non-Current Assets:
Property & Equipment (Note 4) 165,250
Total Assets ₱ 315,000

LIABILITIES AND OWNER'S EQUITY

Current Liabilities:
Trade and Other Payables (Note 5) ₱ 78,250
Owner's Equity:
Carla, Capital 236,750
Total Liabilities & Owner's Equity ₱ 315,000

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 Note 1: Cash on Hand ₱ 25,000
Cash in Bank 45,000
Total ₱ 70,000

Note 2: Accounts Receivable ₱ 49,000

Less: Allowance for Doubtful Accounts 4,900 ₱ 44,100
Notes Receivable 30,000
Interest Receivable 450
Total 74,550

Note 3: Prepaid Insurance ₱ 5,000

Prepaid Supplies 200
Total ₱ 5,200

Note 4: Machinery & Equipment ₱ 150,000

Less: Accumulated Depreciation 7,500 ₱ 142,500

Furniture & Fixtures ₱ 25,000

Less: Accumulated Depreciation 2,250 22,750
Total ₱ 165,250

Note 5: Accounts Payable ₱ 26,000

Notes Payable 50,000
Interest Payable 750
Taxes Payable 1,500
Total ₱ 78,250

Observe the following rules in presenting the statement of financial position:

1. The heading consists of three lines:
a. Name of the Business
b. Title of the Report
c. Date
2. Margin on the left side for the major classifications: The extreme left margin is used for describing the major classifications like
current assets or current liabilities and the inner margin is used for describing the accounts herein like cash, accounts receivable
and supplies.
3. Money columns on the right side: The placement of the amounts usually follows the margin on the left side, extreme right
money column for the major amounts following the major classifications and inner money column for the amounts of the
described accounts.
4. In the final money column, the peso sign is placed on the first and last amounts per accounting value; while in the inner money
column, the peso sign is placed on the first amount of every column of figures.
5. A single line or rule is placed under the last figure to be added or subtracted and a double line or rule is placed under the final
figure.

ADEQUATE DISCLOSURES – this principle requires the inclusion of significant information that will help enhance the firm’s financial
statements.

Aside from the notes supporting the line items presented in the financial statements, other notes are given below for the Carla problem:

Notes to Financial Statements:

1. Financial statements are presented in accordance with generally accepted accounting principles.
2. Revenues and expenses are recognized based on the realization principle and the matching principle.
3. Machinery and equipment are presented at book value based on cost less accumulated depreciation.
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 4. Depreciation is computed using straight line method.
5. Accounts receivables are presented at net realizable value based on cost less allowance for doubtful accounts.
6. Doubtful accounts are estimated using an aging of accounts receivables.
7. Merchandise is valued based on net realizable value which is lower than cost.

Other information that should be disclosed include major liabilities and their due dates, contingent assets and liabilities, subsequent
events that may affect the resources that were presented in the statement of financial position. PAS 1 states that an entity should disclose
any information that a reasonably informed person would consider necessary for the proper interpretation of the financial statements.

STATEMENT OF CASH FLOWS

Some questions cannot be answered just by reading the income statement or the statement of financial position such as:
a. How was cash obtained by the business?
b. How was cash spent?
c. What caused the increase or decrease in cash?
d. Why was the cash only P50,000 when the net income was P100,000?

Relevance of the Statement of Cash Flows

a. It will enlighten you on how cash is being managed.
b. Cash flows are vital to the financial health of the business.
c. Some businesses fail because of its inability to maintain a proper balance between receipts and disbursements.

Classification of Cash Flows

1. Operating activities
2. Investing activities
3. Financing activities

A summary of cash flows is given below:

ACTIVITIES INFLOWS OUTFLOWS

OPERATING Revenue collections Payment for expenses

INVESTING Sale of securities, plant, property and equipment Acquisition of securities, plant, property
and equipment

FINANCING Loans extended by creditors or contributions of Cash paid to creditors or withdrawn by

investors investors

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DIRECT METHOD OF DETERMINING CASH FLOW
The cash flow statement for the year ended December 31, 2018 appears below. Additional information are needed such as: cash on
January 1, 2018 was P100,000 with an additional investment of P32,850 in cash during the year. Accounts payable came from the
purchase of machinery.

CARLA AUTO REPAIR SHOP

STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2018

Cash flows from operating activities:

Collections from customers Schedule 1 ₱ 196,000
Collections for referrals made 15,000
Payment for rent - 55,000
Payment for utilities - 46,750
Payment for salaries - 45,000
Payment for insurance Schedule 2 - 15,000
Payment for taxes Schedule 3 - 7,250
Payment for supplies Schedule 4 - 600
Payment for interest expense Schedule 5 - 250
Net cash inflows from operating activities ₱ 41,150
Cash flows from investing activities:
Purchase of machinery and equipment Schedule 6 -₱ 124,000
Acquisition of furniture - 25,000
Net cash outflows from investing activities - 149,000
Cash flows from financing activities:
Investment by the owner ₱ 32,850
Cash withdrawals - 5,000
Loan from Republic Finance 50,000
Net cash inflows from financing activities 77,850
Decrease in cash -₱ 30,000
Cash, January 1 100,000
Cash, December 31 ₱ 70,000

Schedule 1: Repair Income 275,000 Schedule 4: Supplies Expense 400

Accounts Receivable, Dec. 31 - 49,000 Prepaid Supplies 200
Notes Receivable, Dec. 31 - 30,000 Supplies paid 600
Collections from customers 196,000

Schedule 2: Insurance Expense 10,000 Schedule 5: Interest Expense 1,000

Prepaid Insurance, Dec. 31 5,000 Interest Payable - 750
Insurance paid 15,000 Interest paid 250

Schedule 3: Taxes and Licenses Expense 8,750 Schedule 6: Machinery and Equipment 150,000
Taxes Payable - 1,500 Accounts Payable - 26,000
Taxes and Licenses paid 7,250 Payment for machinery 124,000

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The following rules are to be observed:
1. Determine the increases or decreases in the statement of financial position accounts related to revenue and expense accounts.
Since this is the first year of operation, the procedure is quite simple. All items appearing in the statement of are deemed to be
increases. Receivables at the end of the year represent increases in uncollected accounts hence it should be deducted from
income to arrive at the cash actually collected. The same rule applies for payables. Ending balances represent increases in
unpaid accounts and should be deducted from expenses reported in the income statement to arrive at expenses actually paid.
2. For investing activities, go over the property and equipment accounts: increase in property represents acquisition of property
and paid in cash if there is no increase in payable for this; decrease in property represents sale or disposal of property but you
have to add the gain on disposal (or less loss on disposal) to arrive at the total proceeds representing cash inflow.
3. For financing activities, go over the loans and owner’s activities (investments and withdrawals). Increase in loan and investment
represent cash inflows from financing. Decrease in loan and owner’s drawing represent payment or cash outflow from financing
activities. To prove that you got the correct cash flows, the cash balance in this statement should reconcile with what was
reported in the statement of financial position.

CLOSING ENTRIES
After all the adjustments have been journalized and posted and the financial statements prepared, the income and expense accounts
and owner’s drawing account have to be closed. Closing the books means bringing the temporary or nominal accounts to
zero balance by transferring them to the capital account or owner’s equity. After the closing entries, the books are “cleared” of these
accounts so that in the next reporting period, the books are ready for a new set of temporary or nominal accounts. On the other hand,
we carry forward the balances of the assets, liabilities and owner’s equity to the next accounting period since these are real or
permanent accounts and we don’t close these accounts unless the assets are disposed, the liabilities are paid and the capital is
returned to the owner.

The following are the steps in making the closing entries:

1. The revenue accounts such as Repair Income and Interest Income which normally are credit balances should be closed on the
debit side and credited to the Income Summary account.
2. The expense accounts such as Salaries Expense and Taxes Expense which normally are debit balances should be closed on the
credit side and debited to the Income Summary account.
3. Determine the balance of the Income Summary account which is a net income or a net loss. If a credit balance, representing a
net income, close by debiting the Income Summary account and credit to increase the Owner’s Capital account. If a debit
balance, representing a net loss, close by crediting the Income Summary account and debit to decrease the Owner’s Capital
Account.
4. The drawing account which normally is a debit balance is credited to close and debited to the capital account to bring a reduction.

Using the Carla Auto Repair Shop, the closing entries in the general journal will appear thus:

Date Particulars F Debit Credit

Dec. 31 Closing Entries:
Repair Income 275,000
Referral Income 15,000
Interest Income 450
Income Summary 290,450
To close the credit accounts.

Income Summary 181,550

Salaries Expense 45,000
Supplies Expense 400
Taxes & Licenses 8,750
Rent Expenses 55,000
Utilities 46,750
Interest Expense 1,000
Bad Debts 4,900
Insurance Expense 10,000
Depreciation Expense - Machinery 7,500
Depreciation Expense - Furniture 2,250
To close the debit accounts.

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 Income Summary 108,900
Carla, Capital 108,900
To close profit to capital

Carla, Capital 5,000

Carla, Drawing 5,000
To close drawing to capital

PREPARING A POST CLOSING TRIAL BALANCE

The Post Closing Trial Balance is prepared after closing the books and contains only real accounts with balances. It has the same
accounts as those found in the statement of financial position.

CARLA AUTO REPAIR SHOP

POST CLOSING TRIAL BALANCE
December 31, 2018

Debit Credit
Cash on Hand ₱ 25,000
Cash in Bank 45,000
Accounts Receivable 49,000
Allowance for Bad Debts ₱ 4,900
Notes Receivable 30,000
Interest Receivable 450
Prepaid Insurance 5,000
Prepaid Supplies 200
Machinery & Equipment 150,000
Accumulated Depreciation-Machinery & Equipment 7,500
Furniture & Fixtures 25,000
Accumulated Depreciation-Furniture & Fixtures 2,250
Accounts Payable 26,000
Notes Payable 50,000
Interest Payable 750
Taxes Payable 1,500
Carla, Capital 236,750
Totals 329,650 329,650

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OPENING ENTRY
To bring forward the accounts with balances to the next accounting period, an opening entry should be prepared based on the post-
closing trial balance.

Date Particulars F Debit Credit

Jan. 1 Cash on Hand 25,000
Cash in Bank 45,000
Accounts Receivable 49,000
Notes Receivable 30,000
Interest Receivable 450
Prepaid Insurance 5,000
Prepaid Supplies 200
Machinery & Equipment 150,000
Furniture & Fixtures 25,000
Allowance for Bad Debts 4,900
Accumulated Depreciation-Machinery & Equipment 7,500
Accumulated Depreciation-Furniture & Fixtures 2,250
Accounts Payable 26,000
Notes Payable 50,000
Interest Payable 750
Taxes Payable 1,500
Carla, Capital 236,750
To open the books with the beginning balances.

REVERSING ENTRIES
These are the opposite of adjusting entries and are prepared on the first day of the succeeding reporting period. Prepaid Expenses under
the expense method and Deferred Income under the income method are the only items being reversed. No reversing entry is needed
for accruals. The reasons for making reversing entries are the following:
1. To close out the accounts created when the adjusting entries were prepared such as the prepaid expense (under the expense
method) and the unearned income (under the income method).
2. To recognize the expired/income portion applicable for the succeeding period.
3. To simplify the bookkeeping entries in the following accounting period.

If the expense method was used for the purchase of supplies, the following entries will be prepared for 2018 and 2019:

Date Particulars F Debit Credit

2018 Supplies Expense 600
Feb. 8 Cash on Hand 600
Purchased supplies for cash.

Dec. 31 Prepaid Supplies 200

Supplies Expense 200
Adjust for the unused portion.

2019
Jan. 1 Supplies Expense 200
Prepaid Supplies 200
Reverse prepaid supplies.

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Another Illustration: Commission income of P3,000 was received in advance on December 1, good for three months. On December
31, only one-month commission was earned. Under the income method, entries will be:

Date Particulars F Debit Credit

Dec. 1 Cash on Hand 3,000
Commission Income 3,000

31 Commission Income 2,000

Unearned Commission Income 2,000

Jan. 1 Unearned Commission Income 2,000

Commission Income 2,000
Reverse prepaid supplies.

FINANCIAL ANALYSIS

HAPPY TOUR AND TRAVEL

Comparative Statement of Financial Position
December 31, 2018 & 2017

2018 2017
ASSETS
Current Assets:
Cash 155,750 138,500
Accounts Receivable 25,000 3,000
Supplies 4,500 700
Total Current Assets 185,250 142,200

Noncurrent Assets:
Cars 350,000 350,000
Less: Accumulated Depreciation - Cars 60,000 30,000
290,000 320,000
Equipment 45,000 30,000
Less: Accumulated Depreciation - Equipment 3,500 1,000
41,500 29,000
Furniture & Fixtures 25,000 25,000
Less: Accumulated Depreciation - Furniture & Fixtures 3,000 1,500
22,000 23,500
Total Noncurrent Assets 353,500 372,500
TOTAL ASSETS 538,750 514,700

LIABILITIES & OWNER'S EQUITY

Current Liabilities:
Accounts Payable 1,000 5,000
Loans Payable 25,000 50,000
Rent Payable 10,000
Utilities Payable 1,500 500
Total Current Liabilities 37,500 55,500

Owner's Equity
Gomez, Capital 501,250 459,200
TOTAL LIABILITIES & OWNER'S EQUITY 538,750 514,700
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 HAPPY TOUR AND TRAVEL
Comparative Income Statements
For the Years Ended December 31, 2018 and 2017

2018 2017
REVENUES EARNED
Service Fees Income 455,250 364,200
LESS: OPERATING EXPENSES
Rent Expense 120,000 108,000
Salary Expense 90,000 76,000
Gas & Oil Expense 46,520 35,500
Depreciation Expense 34,000 32,500
Utilities Expense 19,000 15,500
Repair Expense 11,500 10,000
Supplies Expense 4,330 7,500
Total 325,350 285,000
NET INCOME 129,900 79,200

Profitability – ability of the company to enhance owner’s equity through profit. The relevant information are the revenues earned, the
net income obtained, the assets used in the operation and the investment made by the owner.

Profit Margin = Net Income / Revenues

2018 2017
129,900/455,250 = .2853 or 28.53% 79,200/364,200 = .2175 or 21.75%

This shows the adequacy of the revenue to earn profit.

Rate of Return = Net Income / Average Total Assets

2018 2017
Average Total
Assets 538,750 + 514,700 = 526,725 514,700 + 385,000* = 449,850
2 2

129,900 / 526,725 = .2466 or 79,200 / 449,850 = .1761 or

Rate of Return 24.66% 17.61%

*Assume that P385,000 is the initial investment of Gomez at the start of the year.

The rate of return shows the income earned by the business based on assets invested. A high rate means the assets are being used
profitably by the business.

Rate of Return on Equity = Net Income / Average Owner’s Equity

2018 2017
Average Owner's Equity 501,250 + 459,200 = 480,225 459,200 + 385,000 = 422,100
2 2

129,900 / 480,225 = .2705 or 79,200 / 422,100 = .1876 or

Rate of Return 27.05% 18.76%

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Liquidity –ability of the business to pay for its short-term obligations. The relevant figures for liquidity are the current assets and current
liabilities.

Working Capital = Current Assets – Current Liabilities

2018 2017
P185,250-P37,500 = P147,750 P142,200-P55,500 = P86,700

Working capital was higher in 2018. A horizontal analysis of the assets will show that working capital is building up.

Current Ratio = Current Assets/Current Liabilities

2018 2017
185,250 / 37,500 = 4.95 : 1 142,200 / 55,500 = 2.56 : 1

This means that the business has P4.95 current assets to pay for a peso of current liability in 2018 against P2.56 current assets to pay
for a peso of current liability in 2017. The rule of thumb is a ratio of 2:1.

Quick or Acid Test Ratio = Quick Assets/Current Liabilities

2018 2017
180,750 / 37,500 = 4.82 : 1 142,200 / 55,500 = 2.55 : 1

Quick assets are usually composed of cash and accounts receivable. The rule of thumb is a 1:1 ratio.

Solvency – long term liquidity and is measured based on ability of the business to pay for long term obligations when they fall due.

Debt Ratio = Total Liabilities/Total Assets

2018 2017
37,500 / 538,750 = .0696 or 6.96% 55,000 / 514,700 = .1078 or 10.78%

The debt ratio shows the proportion of the assets provided by the creditors.

Equity Ratio = Total Owner’s Equity/Total Assets

2018 2017
501,250 / 538,750 = .9304 or 93.04% 459,200 / 514,700 = .8922 or 89.22%

The equity ratio shows the proportion of the assets invested by the owner.

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