CHAPTER 2

Format and Importance of Financial

Statements for Engineers

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 Learning Outcome

 Describe the use of balance sheets.

CHAPTER 2- OUTLINE
Meaning and Types of Financial Statement
Format of various Financial Statement
Important Terminologies used in Financial Statement.
Objectives to Prepare the financial Statement.
Comparative financial statements.
Financial Statement- Meaning
• A financial statement is a report that shows the financial
activities and performance of a business. It is used by
owners and investors to understand financial health and
earnings potential of a business.
Types of financial statements
The balance sheet,

Income statement,

A statement of changes in equity

Cash flow statement

Income Statement
Income statement
• Income statement is prepared find out the profit/loss earned by an
business organization during a particular period.

• Basically, profit/loss is the difference between total revenues and

total expenses during a particular period
Forms of the Income Statement

• Traditionally, income from operations is presented:

• In a single step form- all revenues and gains are first on the
statement.

• Multiple step form- divided into separate sections and various

subtotals are reported that reflect different levels of profitability.
Form of the Income Statement- Single Step

Revenue xxx
Costs and expenses:
Costs of sales xxx
Selling and administrative xxx
Interest expense xxx
Other income/expense, net xxx
Restructuring charge xxx
Total costs and expenses xxx
Income before income taxes xx
Income taxes xx
Net income xx
Form of the Income Statement- Multiple Steps
Revenue xxx
Costs of goods sold:
Beginning inventory xxx
Net purchases xxx
Cost of goods available for sale xxx
Less ending inventory xxx xxx
Gross profit on sales xxx
Operating expenses:
Selling expenses xxx
General expenses xxx xxx
Other income xxx

Continued…….
Other expenses and losses (xxx)
Income from operations before
income taxes xxx
Income taxes (xxx)
Net income xxx
 MEANING OF DIFFERENT TERMS IN INCOME STATEMENT

● Cost of goods sold is the major expense in merchandising companies and represents what the seller
has paid for the inventory that has been sold out. Will discuss how to calculate COGS in next slide.

● Gross margin or gross profit is the value of Net Sales less Cost of goods sold. It represents the
amount charged to customers over what has been paid for the items. This is also referred to as a
company’s mark-up.

● Operating expenses for a merchandising company are those expenses, other than cost of goods sold,
incurred in the normal business functions of a company. Usually, operating expenses represents selling
expenses and administrative expenses.

● Selling expenses are expenses that a company incurs in selling and marketing efforts. Examples include
salaries and commissions of salespersons, expenses for salespersons’ travel, delivery, advertising, rent
(or depreciation, if owned) and utilities on a sales building, sales supplies used, and depreciation on
delivery trucks used in sales.
 Multiple-Step Income Statement

Cost of Goods Sold Statement - For the Year Ended December 31

Amount (R.O.)
Merchandise Inventory, January 1 24,000
Purchases 167,000
Less: Purchase discount 3,000
Purchase returns and allowances 8,000 11,000
Net Purchases 156,000
Add: Transportation In 10,000
Net cost of purchases (156,000 + 10,000) 166,000
Cost of goods available for sale 190,000
Less: Merchandise Inventory, December 31 31,000
Cost of goods sold 159,000
 MEANING OF DIFFERENT TERMS IN INCOME STATEMENT

Administrative expenses are expenses a company incurs in the management of a business. Examples are
administrative salaries, rent and utilities on an admin building, insurance expense, administrative supplies used,
and depreciation on office equipment.

Income from Operations is Gross profit (or margin) less Operating expenses. It represents the amount of income
directly earned by business operations

Non-Operating revenues and expenses are revenues and expenses not related to the sale of products or services
regularly offered for sale by a business. This typically includes interest earned (interest revenue) and interest
owed (interest expense).

Net Income is the income earned after other revenues are added to, and other expenses are subtracted from Income
from Operations.
Multiple-Step Income Statement
SAMPLE ILLUSTRATION 2
The following are the selected accounts from Hanlon’s adjusted trial balance:
Adjusted Trial Balance
Account Titles Debit Credit
Sales 275,000
Sales discounts 2,000

Sales returns and allowances 1,000

Interest revenue 150

Cost of goods sold 159,000

Commissions expense 10,000

Adverti sing expense 7,000

Sales Salaries expense 20,000

Rent expense – sales 12,000

Rent expense – offi ce 12,000

Offi ce Salaries expense 40,000

Uti liti es expense 5,000

Interest expense 50
Multiple-Step Income Statement
Multi-step Income Statement - For the Year Ended December 31
Amount (R.O.)
SALES 275,000
Less: Sales Discounts 2,000 3,000
Sales Returns and allowances 1,000
Net Sales (275,000 – 3,000) 272,000
Less: Cost of goods sold 159,000
GROSS PROFIT 113,000
Less: Operating Expenses
Selling Expenses:
Commission expense 10,000
Advertising expense 7,000
Sales Salaries expense 20,000
Rent expense – Sales 12,000 49,000
Administrative Expenses:
Rent expense – Office 12,000
Office salaries expense 40,000
Utilities expense 5,000 57,000 106,000

INCOME FROM OPERATIONS 7,000

Add: Non-Operating revenues
Interest revenue 150
7,150
Less: Non-Operating Expenses
Interest expense 50
NET INCOME 7,100
Exercise 1
From the Following Trial Balance of Mac Corporation for the year ended 31 st December 2021. Prepare
Single step and Multi Step Income Statement.
Account Debit (RO) Credit (RO)

Sales 300,000

Sales Discounts 2,000

Sales Returns and Allowances 4,500

Interest Revenue 5,650

Cost of Goods Sold 180,000

Interest Expenses 8,400

Advertising Expenses 6,250

Sales Salaries Expenses 40,000

Depreciation Expenses – Office Equipment 4,700

Office Supplies Expenses 1,200

Insurance Expenses 6,900

Exercise 2:
Prepare single step and Multi Step Income Statement from the following Accounts.
Account Amount (OMR) Account Amount (OMR)

Sales 790,866 Sales Discount 62,750

Merchandise Inventory 465,000 Interest Expenses 5,444

Accounts Receivable 115,509 Sales Returns and Allowance 100,043

Office supplies expenses 2,312 Interest Revenue 12,321

Rent Revenue 42,900 Cost of Goods Sold 295,840

Sales Salaries expenses 65,300 Rent Expenses 12,678

Account Payable 158,234 Depreciation Expenses:

Office Equipment 4,210

Common Stock 80,963 Insurance Expenses 2,000

Marketing expenses 25,450 Advertising Expenses 14,650

Format of the Balance Sheet/Statement of
Financial Position
The Balance Sheet/Statement of
Financial Position
 Presents a listing of an organization’s assets and liabilities
at a certain time point.

 The difference between assets and liabilities is called equity.

 Represented by the basic accounting equation:

Assets = Liabilities + Owners’ Equity

 MEANING OF DIFFERENT TERMS IN BALANCE SHEET

1. Accounts Payable (AP)

Accounts Payable include all the amounts that a business owes to its suppliers/vendors. This account is recorded as a
liability on the Balance Sheet as it is a debt owed by the company.

2. Accounts Receivable (AR)

Accounts Receivable include all the revenues (sales) that a company has earned but has not yet received payment yet.
This account is recorded as an asset in the Balance Sheet. This asset will be converted to cash in the short-term.

3. Accrued Expense

A business expense that was incurred but hasn’t been paid is described by the term ‘Accrued Expense’.

4. Asset (A)

Anything the company owns that has a monetary value.

 MEANING OF DIFFERENT TERMS IN BALANCE SHEET

5. Balance Sheet (BS)

A financial statement that reports on all of a company’s assets, liabilities, and equity. As suggested by its name, a
balance sheet abides by the equation <Assets = Liabilities + Equity>.

6. Book Value (BV)

As an asset is depreciated, it loses value. The Book Value of an asset is equal to the Cost of an Asset less any
Accumulated Depreciation.

7. Equity (E)

Equity denotes the value left over after liabilities have been removed. Recall the equation: Assets = Liabilities +
Equity. If you take the Assets and subtract the Liabilities, the balance left is known as Equity. It represents the portion of the
company that is owned by the investors/owners.
MEANING OF DIFFERENT TERMS IN BALANCE SHEET

8. Inventory

Inventory is a term used to classify the asset of a company which has been purchased to resell to
its customers but has remain unsold during the year. As these assets are usually sold to customers, the inventory
account will have a lower balance.

9. Liability (L)

All debts that a company has to pay are referred to as Liabilities. Common liabilities include
Accounts Payable, Payroll, Loans etc.
Objectives of Financial Statements

1. True & Fair view of financial position

2. True & fair view of financial performance
3. To provide information about resources
4. To provide Information about the earning potential
5. To form basis for decisions of the stakeholders
6. To report on the effectiveness and efficiency of the management
Comparative financial statements

 Comparative financial statements present the same company’s financial

statements for one or two successive periods in side-by-side columns.
 The calculation of amounts changes or percentage changes in the statement items
or totals is horizontal analysis.
 This analysis detects changes in a company’s performance and highlights trends.
 Comparative statement analysis is an analysis of financial statement at different
period of time.
 This statement helps to understand the comparative position of financial and
operational performance at different period of time.
 Comparative financial statements again classified into two major parts such as
comparative balance sheet analysis and comparative profit and loss account
analysis.

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Comparative financial statements
Balance Sheet Analysis

 Comparative balance sheet analysis concentrates only the balance

sheet of the concern at different period of time.
 Under this analysis the balance sheets are compared with previous
year’s figures or one-year balance sheet figures are compared with
other years.
 Comparative balance sheet analysis may be horizontal or vertical
basis.
 This type of analysis helps to understand the real financial position
of the concern as well as how the assets, liabilities and capitals are
placed during a particular period.

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The earliest period is usually used as the base
period and the items on the statements for all
later periods are compared with items on the
statements of the base period.
The changes are generally shown both in dollars
and percentage.

Dollar and percentage changes are computed by

using the following formulas:

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Comparative financial statement
Income statement Analysis

• Another comparative financial statement analysis is comparative profit and loss

account analysis.
• Under this analysis, only profit and loss account is taken to compare with
previous year’s figure or compare within the statement.
• This analysis helps to understand the operational performance of the business
concern in a given period.
• It may be analyzed on horizontal basis or vertical basis.

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In the analysis, 2007 is the base year and 2008 is the
comparison year. All items income statement for the
year 2008 have been compared with the items of
balance sheet and income statement for the year
2007.

The actual changes in items are compared with

the expected changes.
For example, if management expects a 30%
increase in sales revenue but actual increase is
only 10%, it needs to be investigated.

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• Giving the following information of Omani Company financial statements, you are required to prepare the horizontal and then interpret your results regards the financial and
operation performance of the company.
• Balance Sheet
• Assets (OMR) 2019 2018 Liabilities and Equity (OMR)
• Cash and cash equivalent 91000 80100 Accounts payable 135000 132000
• Short-term investment 28600 27800 Accruals 13500 12000
• Account receivable 162500 168900 Notes payable 2100 23400
• Inventories 33600 22400 Total current liabilities 169500 167400
• Total current assets 315700 299200 Long-term debt 72600 60000
• Land and Buildings 103200 101800 Total liabilities 242100 227400
• Machinery and Equipment 62400 58900 Common stock 151100 161500
• Total gross fixed assets 165600 160700 Retained Earnings 65000 55900
• Less: Depreciation (23100) (15100) Total common equity 216100 217400
• Net fixed assets 142500 145600
• Total assets 458200 444800 Total liabilities & equity 458200 444800

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 • Income Statement
• 2019 2018
• Sales 1680000 1600000
• Cost of goods sold 910400 890700
• Gross profit 769600 709300
• Less: Operating expenses
• Salaries expense 389000 356000
• Depreciation expense 79000 72000
• Advertising expense 55000 49000
• Utilities expense 24000 19000
• EBIT 222600 213300
• Interest expense 25000 20000
• EBT 197600 193300
• Tax 79000 77300
• Net Income 118600 116000
•

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 Summary

Financial statements report the past performance of a business entity.

Income is measured using income statement

The format of an income statement can be single step or multiple steps.

Revenue , cost of sales , operating expenses, other expenses and other income are the
components of an income statement.

Balance sheet is prepared to ascertain the financial position of a business entity.

The specific elements of the balance sheet are assets, liabilities, and owners’ equity.

In balance sheet assets and liabilities are classified into current and non-current categories.
Exercise 3:
From the following information of Emmas Limited on 31 st
December 2019 You are required to
prepare Multi Step Income Statement and Balance Sheet .
Account Amount (OMR) Account Amount (OMR)
Opening Stock 5,000 Capital 89,500

Bills Receivable 22,500 Commission (Cr.) 2,000

Purchases 195,000 Return Outwards 2,500

Wages 14,000 Trade Expenses 1,000

Insurance 5,500 Office Fixtures 5,000

Sundry Debtors 150,000 Cash in hand 2,500

Carriage Inwards 4,000 Cash at Bank 23,750

Commission (Dr.) 4,000 Rent and Rates 5,500

Interest on Capital 3,500 Carriage Outwards 7,250

Stationery 2,250 Sales 250,000

Return Inwards 6,500 Bills Payable 15,000

Creditors 98,250 Closing Stock 12,500

 Exercise 4:
From the following information of Raman & Co., on 31 st December 2019 You are required to prepare
Multi Step Income Statement and Balance Sheet.
Account Amount (OMR) Account Amount (OMR)
Sales 65,000 Discount Allowed 100

Sales Return 500 Discount Received 500

Stock at the Beginning 8,000 Salaries 3,000

Purchases 29,000 Interest Paid 400

Purchase Returns 300 Furniture 3,000

Direct Wages 5,000 Buildings 20,000

Direct Expenses 5,000 Plant and Machinery 20,000

Carriage Inwards 4,000 Cash in Hand 1,000

Capital at the beginning 30,000 Bills Payable 6,000

Drawings 5,000 Reserves for Doubtful Debts 500

Sundry Debtors 10,000 Bad Debts 300

Sundry Creditors 12,000 Closing Stock at the end 8,000

References
• This chapter has been prepared by using following books:
https://ebookcentral.proquest.com/lib/momp/detail.action?docID=437704&query=Accounting
• Ramagopal, C.. Accounting for Managers, New Age International Ltd, 2009. ProQuest EBook Central,
https://ebookcentral.proquest.com/lib/hctom/detail.action?docID=437704.
• Larson KD, Wild JJ, Chiappetta B (2002), ”Fundamental of Accounting Principles” sixteenth edition, McGraw-
Hill Irwin Publisher
• Weygandt JJ, Kimmel PD, Kieso DE (2015), “Financial Accounting” IFRS edition, WILEY Publisher

• Sangster A, Wood F, (2015), “Business Accounting” Thirteen Edition, Pearson Publisher

• Hogget J., Edwards L., Medlin J., Chalmers K., Hellman A., Beattie C., Maxfield J., (2015) “ Financial
Accounting”, 9th Edition, Wiley Publisher
• Needles Jr BE, Powers M (2001), “ Financial Accounting” Seventh Edition, Houghton Muffin Company

• Jerry J. Weygandt, Donald E. Kieso, and Paul D. Kimmel, “Accounting Principles”, 8th Edition, Wiley
International Edition.
• Walter Harrison, Charles Horngren, Bill Thomas, Themin Suwardy, “Financial Accounting”, Pearson Global
Edition.
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VERSION HISTORY

Version No Date Approved Changes incorporated

New Outcome Sem. (II)

Version: 01 2022/2023