BASIC FINANCIAL

STATEMENTS

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective
 To explain the nature and general purpose financial statements.
 To explain certain accounting principles that are important for an
understanding of financial statements.
 To demonstrate how certain business transactions affect the elements
of the accounting equation:
Assets = Liabilities + Owners’ Equity.
 To explain how the statement of financial position, often referred to as
the balance sheet, is an expansion of the basic accounting equation.
 To explain the important relationships among the statement of financial
position, income statement, and statement of cash flows, and how
these statements relate to each other.
 To explain common forms of business ownership and demonstrate
how they differ in terms of their presentation in the statement of
financial position.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Introduction
Introduction to
to Financial
Financial Statements
Statements
 Financial statements are a structured representation of the
financial position (Balance Sheet), financial performance
(Income Statement) of an entity and the inflow and outflow of
cash (cash flow statement).

 The objective of financial statements is to provide information

about the financial position, financial performance and cash
flows of an entity that is useful to a wide range of users in
making economic decisions.

 Financial statements is also help to assess the probability that an

enterprise will be able to make future cash.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Three
Three primary
primary financial
financial statements
statements are
are
Describes where the
Balance Sheet enterprise stands at a
Depicts the specific date.
revenue and Income Statement
expenses for
a designated Statement of Cash Flows Depicts the ways
period of cash has changed
time. during a
designated period
of time.

 These financial statements are windows to a company's

performance and health.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 The Balance Sheet
Sheet ~~ What
What is
is it?
it?
 The balance sheet represents a record of a company's assets,
liabilities and equity at a particular point in time. Balance sheet is
named by the fact that a business’s financial structure balances in the
following manner:
 Assets = Liabilities + Shareholders' Equity

 Assets represent the resources that the business owns or controls at

a given point in time. This includes items such as cash, inventory,
machinery, buildings etc.
 The other side of the equation represents the total value of the
financing the company has used to acquire those assets. Liabilities
represent debt, while equity represents the total value of money that
the owners have contributed to the business – including retained
earnings, which is the profit made in previous years.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 The Balance Sheet
ASSETS LIABILITIES EQUITY
Cash Accts Payable Pref Stock
Inventory Wages Payable Common Stk
Land/Bldgs = Taxes Payable
+ Retained
Equipment Notes Payable Earnings

Accts Rcvbl Short term

Securities Long Term

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 The
The Balance
Balance Sheet
Sheet ~~ Why
Why do
do we
we care?
care?
 The balance sheet provides investors with a snapshot of a
company's health as of the date provided on the financial
statement.
 If a company assets are large relative to liabilities, it's in
good shape. Conversely, if a company with a large amount
of liabilities relative to assets has risk to creditors.
 The higher the debt ratio, the greater risk will be
associated with the firm's operation. In addition, high debt
to assets ratio may indicate low borrowing capacity of a
firm, which in turn will lower the firm's financial flexibility.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 The
The Income
Income Statement
Statement ~~ What
What is
is it?
it?
 The income statement measures a company's performance
over a specific time frame and presents information about the
revenues, expenses and profit that was generated as a result of
the business' operations for that period.
 Components of the Income Statement include:
 Revenue (how much the company earned)
 Expenses (how much the company has spent)
 Net Income before and after Tax (the profits of the company)

 This statement contains the information that most of the time

mentioned in the press or in financial reports - figures such as
total revenue, net income, or earnings per share.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 The
The Income
Income Statement
Statement ~~ Why
Why do
do we
we
care?
care?
 The income statement answers the question,
"How well is the company's business performing?"
Basically, "Is it making money?"
 Firms with low expenses and high profits relative
to revenues are typically more desirable for
investment because it brings more money directly
to a shareholder.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 The
The Statement
Statement of
of Cash Flows ~
Cash Flows ~ What
What is
is it?
it?
 The statement of cash flows represents a record of a business'
cash inflows and outflows over a period of time. It is the most
sensitive of the statements and focuses on the following cash-
related activities:
 Operating Cash Flow: Cash generated from day-to-day business
operations.
 Cash from Investing: Cash used for investing in assets, as well as
the proceeds from the sale of other businesses, equipment or
long-term assets
 Cash from financing: Cash paid or received from the issuing and
borrowing of funds

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 The
The Statement
Statement of
of Cash
Cash Flows
Flows ~~ Why
Why do
do we
we
care?
care?

 The statement of cash flows is very important to investors because it

shows how much actual cash a company has generated. The income
statement includes non-cash revenues or expenses, which the
statement of cash flows excludes.
 In addition it shows the ability of firms to generate cash. Many
companies have shown “profits” on the income statement but struggled
later because of insufficient cash flows.
 It shows correct figures of firms, because cash flow statement is very
difficult for a business to manipulate its cash situation. Earnings can be
manipulated, but it's tough to “fake” cash in the bank. For this reason
some investors use the cash flow statement as a more conservative
measure of a company's performance.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Bringing It All Together
 The three financial statements we have discussed are all
related.
 The changes of assets and liabilities that is indicated on
the balance sheet are also reflected in the revenues and
expenses which are stated on the income statement,
which shows the company’s gains or losses.
 Cash flows provide more information about cash assets
listed on a balance sheet and are related, but not
equivalent, to net income shown on the income
statement. Therefore, no one financial statement tells
the complete story of firms.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 A
A Starting
Starting Point:
Point: Statement
Statement of
of
Financial
Financial Position
Position
Vagabond Travel Agency
Balance Sheet
December 31, 2007
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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 certain
certain accounting
accounting principles
principles that
that are
are important
important for
for an
an understanding
understanding
of
of financial
financial statements
statements and
and how
how professional
professional judgment
judgment byby
accountants may affect the application of those principles.
accountants may affect the application of those principles.


The
The Concept
Concept of
of the
the Business
Business Entity
Entity

A business
Vagabond entity is
Travel
Agency
separate from
the personal
affairs of its
owner.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Assets
Assets
Vagabond Travel Agency
Balance Sheet
December 31, 2007
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
benefit future
$ 300,000 Total $ 300,000
operations.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Assets
Assets

Cost Principle

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

Objectivity
Principle

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 Liabilities
Liabilities
Vagabond Travel Agency
Balance Sheet
December 31, 2007
Assets Liabilities & Owners' Equity
Liabilities are
Cash $ 22,500 Liabilities:
debts that
Notes receivable
Accounts receivable
10,000
60,500
Notes payable
Accounts payable
$ 41,000
36,000
represent negative
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 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 $ 300,000 Total $ 300,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Owners’
Owners’ Equity
Equity
Vagabond Travel Agency
Balance Sheet
December 31, 2007
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
owners’ claims on
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
the assets of the
Building 90,000 Owners' Equity:
business.
Office equipment 15,000 Capital stock
Retained earnings
150,000
70,000
Total $ 300,000 Total $ 300,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Owners’
Owners’ Equity
Equity

Changes in Owners’
Equity

• Owners’ • Payments
Investment to Owners
s • Business
• Business Losses
Earnings

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 
Demonstrate
Demonstrate how
how certain
certain business
business transactions
transactions affect
affect the
the
elements
elements of
of the
the accounting
accounting equation:
equation:
Assets
Assets == Liabilities
Liabilities ++ Owners’
Owners’ Equity.
Equity.
Vagabond Travel Agency
Balance Sheet
December 31, 2007
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
Assets == Liabilities
Liabilities ++ Owners’
Owners’Equity Equity
$300,000
$300,000 == $80,000
$80,000 ++ © The$220,000
$220,000
McGraw-Hill/Irwin McGraw-Hill Companies, Inc., 2008
 Let’s analyze some transactions for JJ’s Lawn Care Service.

On May 1, 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, 2007
Assets Owners' Equity
Cash $ 8,000 Capital Stock $ 8,000

Total $ 8,000 Total $ 8,000

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 On May 2, JJ’s purchased a riding lawn
mower for $2,500 cash.
JJ's Lawn Care Service
Balance Sheet
May 2, 2007
Assets Owners' Equity
Cash $ 5,500 Capital Stock $ 8,000
Tools & Equipment 2,500

Total $ 8,000 Total $ 8,000

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 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, 2007
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

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 On May 11, JJ’s purchased some repair
parts for $300 on account.

JJ's Lawn Care Service

Balance Sheet
May 11, 2007
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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 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, 2007
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

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 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, 2007
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

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 On May 28, JJ’s pays $150 of its accounts
payable.
JJ's Lawn Care Service
Balance Sheet
May 28, 2007
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

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 On May 29, JJ’s recorded lawn care services
(revenue) provided during May of $750. All clients
were paid in cash.
JJ's Lawn Care Service
Balance Sheet
May 29, 2007
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

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 On May 31, JJ’s purchased gasoline (expense) for the lawn mower
and the truck for $50 cash.

JJ's Lawn Care Service

Balance Sheet
May 31, 2007
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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 To explain how the statement of financial position, often referred to as the
balance sheet, is an expansion of the basic 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

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 Let’s prepare the Income Statement and Statement of Cash Flows
for JJ’s Lawn Care Service for the month ending May 31, 2007.

Assets = Liabilities + Owners' Equity

Accts. Tools & Notes Accts. Capital Retained
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + Earnings
May 1
Balances
$
$
8,000
8,000
These
These transactions
transactions $
$
8,000
8,000
May 2 (2,500) $ 2,500 impact
impact the
the
Balances $ 5,500 $ 2,500 $ 8,000
May 8 (2,000) Statement
Statement
$ 15,000 $ of
of Cash
Cash
13,000
Balances $ 3,500 $ 2,500 $ 15,000 $ 13,000 $ 8,000
May 11 300 Flows.
Flows. $ 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 These
These transactions
transactions 750
Balances
May 31
$ 4,175
(50)
$ 75 $ 2,650
impact
$ 15,000
the
$
Income
13,000
impact the Income
$ 150 $ 8,000 $ 750
(50)
Balances $ 4,125 $ 75 $ 2,650 $
Statement.
15,000 $ 13,000
Statement.
$ 150 $ 8,000 $ 700

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 To explain how the income statement reports an enterprise’s financial
performance for a period of time in terms of the relationship of
revenues and expenses.

JJ's Lawn Care Service

Income Statement
For the Month Ended May 31, 2007

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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 To explain how the statement of cash flows presents the change in cash
for a period of time in terms of the company’s operating, investing, and
financing activities.

JJ's Lawn Care Service

Statement of Cash Flows
For the Month Ended May 31, 2007
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, 2007 -
Cash balance, May 31, 2007 $ 4,125
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 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2007
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
of lawn activities
Operating
Purchase activities include
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, 2007 -
Cash balance, May 31, 2007 $ 4,125
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2007
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, 2007 -
Cash balance, May 31, 2007 assets.
assets. $ 4,125
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2007
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, 2007 -
Cash balance, May 31, 2007 $ 4,125
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Now, let’s prepare the Balance Sheet for JJ’s
Lawn
Assets Care Service
= for May 31,
Liabilities + 2007.
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 These
These
$ 2,650 balances
$ 15,000 $ 13,000 will
balances will
$ 300 $ 8,000
May 25 75 (75)
Balances $ 3,575 $ 75 $ 2,650 appear
appear
$ 15,000 on
on
$ the
the $ 300
13,000 $ 8,000
May 28
Balances
(150)
$ 3,425 $ 75
Balance
$ 2,650 Balance
$ 15,000
Sheet.
$Sheet.
13,000
(150)
$ 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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 JJ's Lawn Care Service
Balance Sheet
May 31, 2007
Assets Liabilities
Cash $ 4,125 Notes payable $ 13,000
Accounts receivable 75 Accounts payable 150
Tools & equipment 2,650 Owners' Equity
Truck 15,000 Capital stock 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850

Assets
Assets == Liabilities
Liabilities ++ Owners’
Owners’ Equity
Equity

$21,850
$21,850 == $13,150
$13,150 ++ $8,700
$8,700
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 To explain the important relationships among the statement of financial
position, income statement, and statement of cash flows, and how
these statements relate to each other.

Relationships
Relationships Among
Among Financial
Financial Statements
Statements

Date at Date at
beginning end of
of period Time period

Balance Balance
Sheet Sheet

Income Statement
Statement of Cash Flows

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Financial
Financial Statement
Statement Articulation
Articulation
JJ's Lawn Care Service
Statement of Cash Flows
JJ's Lawn Care Service
For the Month Ended May 31, 2007
Cash flows from operating activities: Income Statement
Cash received from revenue transactions $ 750 For the Month Ended May 31, 2007
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Sales Revenue $ 750
Purchase of lawn mower $ (2,500) Operating Expense:
Purchase of truck (2,000) Gasoline Expense 50
Collection for sale of repair parts 75
Net Income $ 700
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 JJ's Lawn Care Service
Cash balance, May 1, 2007 -
Balance Sheet
Cash balance, May 31, 2007 $ 4,125
May 31, 2007
Assets Liabilities
Cash $ 4,125 Notes payable $ 13,000
Accounts receivable 75 Accounts payable 150
Tools & equipment 2,650 Owners' Equity
Truck 15,000 Capital stock 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Forms
Forms of
of Business
Business Organization
Organization

Sole
Sole Partnerships
Partnerships Corporations
Corporations
Proprietorships
Proprietorships

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Forms of Business Organization

 Most business organizations are organized as a sole

proprietorship, a partnership or a corporation. GAAP can be
applied to the financial statements of all three forms of
organization.
 Sole proprietorship:- is unincorporated business owned by a
single person. It is separated from the other affairs of its owner.
It is common for small retailer stores, farms, service business
and professional practices, like in law, medicine and accounting.
 Partnership: is unincorporated business owned by two or more
persons agree to act as partners(co-owners). It is widely used
for small business.
 Corporation: is a type of business organization that is
recognized under the law as an entity separate from its owners.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Characteristics of Business organizations
Sole Partnership Corporation
proprietorship
Owner Proprietor—only Partners—two or Stockholders—
one owner more owners generally many owners

Life of organization Limited by the owner’s Limited by the owner’s Indefinite

choice, or death choice, or death

Legal viewpoint Owner and business entity are not Owners and business Separate entity from
regarded as separate entity are not regarded as owners
separate

Accounting viewpoint Business entity is separated from Business entity is Business entity is
other affairs of owner separated from other separated from other affairs
affairs of owners of owners

Separate taxable entity No No Yes

from owner

Ease of formation Very easy Partnership agreement is Articles of corporation

helpful generally requires

Management Owner May be divided among Board of directors

partners

Personal liability Proprietor is Partners are Stockholders are not

of the owner(s) for personally liable personally liable personally liable
the business’s debts
Transferability of Only by sale of entire business or Can sell all or a portion of Can easily transfer(sell) all
ownership creation of different entity partnership interest or a portion of stock

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reporting
Reporting Ownership
Ownership Equity
Equity in
in the
the
Statement
Statement of
of Financial
Financial Position
Position

Sole O
w
ne
r
'
seq
u
i
ty
:
Sole
Proprietorships
Proprietorships J
i
l
lJo
n
es
,
cap
i
t
al $8
,
00
0

P
ar
tner
s'e
qui
ty
J
il
lJones
,capi
tal$ 4
,
000
Partnerships
Partnerships Bi
llJ
ones
,capi
tal 4
,
000
T ot
alpa
rt
ners
'equi
ty $8
,0
00

Owners' equity
Capital stock $ 7,000
Corporations
Corporations Retained earnings 1,000
Total stockholders' equity $ 8,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008