Slide 2-1

2
McGraw-Hill/Irwin

Financial Statements and Business transactions

The McGraw-Hill Companies, Inc., 2002

Slide 2-2

Previewing Financial Statements

Income Statement

Exh. 2.1

Beginning Balance Sheet

Statement of Cash Flows

Ending Balance Sheet

Statement of Changes in Owners Equity

Point in time
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Period of time

Point in time
The McGraw-Hill Companies, Inc., 2002

Slide 2-3

Income Statement
FastForward Income Statement For Month Ended December 31, 2001 Revenues: Consulting revenue Rental revenue Total revenues Expenses: Rent expense Salaries expense Total expenses Net income $ 5,800 300

Exh. 2.2

Inflows of assets in exchange for products and services provided to customers.

Outflows or the using up of assets that result from providing products and services to customers.
McGraw-Hill/Irwin

$ 6,100 1,000 700 1,700 $ 4,400

The McGraw-Hill Companies, Inc., 2002

Slide 2-4

Statement of Changes in Owners Equity

For corporations, instead of Withdrawals by Owner we use the term Dividends. Dividends represent distributions to the stockholders.
FastForward Statement of Changes in Owner's Equity For Month Ended December 31, 2001 C. Taylor, Capital 12/1/01 Add: Investment by owner Net income Total Less: Withdrawal by owner C. Taylor, Capital 12/31/01 $ $ 30,000 4,400 -

Exh. 2.3

34,400 $ 34,400 (600) $ 33,800

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-5

Balance Sheet
Assets are properties or economic resources owned by a business. They are expected to provide future benefits to the business.
FastForward Balance Sheet December 31, 2001 Assets Liabilities
4,400 9,600 26,000 Accounts payable Total liabilities C. Taylor, Capital Total liabilities and owners' equity $ $ 6,200 6,200

Exh. 2.4

Liabilities are obligations of the business. They are claims against the assets of the business.

Cash Supplies Equipment

Owners' Equity
$ 33,800 $ 40,000

Total assets

40,000

Equity is the owners claim on the assets of the business. It is the residual interest in the assets after deducting liabilities.
The McGraw-Hill Companies, Inc., 2002

McGraw-Hill/Irwin

Slide 2-6

Balance Sheet
Assets

Exh. 2.4

Liabilities

Equity
Remember from Chapter 1 that we learned that total assets must equal the sum of total liabilities and total equity.

FastForward Balance Sheet December 31, 2001 Assets

Cash Supplies Equipment $ 4,400 9,600 26,000

Liabilities
Accounts payable Total liabilities C. Taylor, Capital Total liabilities and owners' equity $ $ 6,200 6,200

Owners' Equity
$ 33,800 $ 40,000

Total assets

40,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-7

Balance Sheet

Owners Investment

Owners Equity

Owners Withdrawal

Revenues
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Expenses
The McGraw-Hill Companies, Inc., 2002

Slide 2-8

Exh. 2.6

FastForward Statement of Cash Flows For Month Ended December 31, 2001
Cash flows from operating activities: Cash received from clients Cash paid for supplies Cash paid for rent Cash paid to employee Net cash provided by operating acitivities Cash flows from investing activities: Purchase of equipment Net cash used by investing activities Cash flows from financing activities: Investment by owner Withdrawal by owner Net cash provided by financing activities Net increase in cash Cash balance, December 1, 2001 Cash balance, December 31, 2001 $ 6,100 (3,400) (1,000) (700) $ 1,000 $ (26,000) (26,000) $ 30,000 (600) 29,400 $ 4,400 $ 4,400

Describes the sources and uses of cash for a reporting period.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-9

Financial Statements, Auditing and Users

FASB GAAP
Financial Statements

Exh. 2.9

Preparers
Audit Report

Decision makers

Auditors

ASB
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GAAS

The McGraw-Hill Companies, Inc., 2002

Slide 2-10

International Accounting Principles

Despite our growing global economy, countries continue to maintain their unique set of acceptable accounting practices.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-11

Fundamental Principles of Accounting

Business Entity Principle Objectivity Principle Cost Principle Going-Concern Principle Monetary Unit Principle
A business is accounted for separately from its owner or owners. Financial statement information is supported by independent, unbiased evidence.

Financial statements are based on actual costs incurred in business transactions.

A business continues operating instead of being closed or sold. Express transactions and events in monetary units.
The McGraw-Hill Companies, Inc., 2002

McGraw-Hill/Irwin

Slide 2-12

Transactions and the Accounting Equation

The accounting equation must remain in balance after each transaction.

Assets

Liabilities

Equity

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-13

Transaction Analysis
Owners of Scott Company contributed $20,000 cash to start the business. The accounts involved are: (1) Cash (asset) (2) Owners Equity (equity)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-14

Transaction Analysis
Owners of Scott Company contributed $20,000 cash to start the business. Owners'
Assets Cash Supplies Equipment (1) $ 20,000 = Liabilities + Equity Accounts Notes Owners' Payable Payable Capital $ 20,000

$ 20,000 $

$ 20,000

$ 20,000
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$ 20,000
The McGraw-Hill Companies, Inc., 2002

Slide 2-15

Transaction Analysis
Purchased supplies paying $1,000 cash. The accounts involved are: (1) Cash (asset) (2) Supplies (asset)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-16

Transaction Analysis
Purchased supplies paying $1,000 cash.
Owners' Assets = Liabilities + Equity Accounts Notes Owner's' Cash Supplies Equipment Payable Payable Capital (1) $ 20,000 $ 20,000 (2) (1,000) $ 1,000

$ 19,000 $ 1,000 $ $ 20,000

$ 20,000

$ 20,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-17

Transaction Analysis
Purchased equipment for $15,000 cash. The accounts involved are: (1) Cash (asset) (2) Equipment (asset)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-18

Transaction Analysis
Purchased equipment for $15,000 cash.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 $ 4,000 $ 1,000 $ 20,000 $ 15,000 = = Liabilities Accounts Notes Payable Payable Owners' + Equity Owners' Capital $ 20,000

$ 20,000

$ 20,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-19

Transaction Analysis
Purchased Supplies of $200 and Equipment of $1,000 on account. The accounts involved are: (1) Supplies (asset) (2) Equipment (asset) (3) Accounts Payable (liability)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-20

Transaction Analysis
Purchased Supplies of $200 and Equipment of $1,000 on account.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 $ 4,000 $ 1,200 $ 16,000 $ 21,200 = = Liabilities Accounts Notes Payable Payable Owners' + Equity Owners' Capital $ 20,000

$ $

1,200 1,200

$ 20,000

$ 21,200

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-21

Transaction Analysis
The balances so far appear below. Note that the Balance Sheet Equation is still in balance.
Assets = Liabilities Accounts Notes Payable Payable $ 1,200 Owners' + Equity Owners' Capital $ 20,000

Cash Supplies Equipment Bal. $ 4,000 $ 1,200 $ 16,000

$ 4,000 $ 1,200 $ $ 21,200

16,000 =

$ 1,200 $

$ 20,000

$ 21,200

Now lets look at transactions involving revenues and expenses.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-22

Transaction Analysis
Rendered consulting services receiving $3,000 cash.

The accounts involved are: (1) Cash (asset) (2) Revenues (equity)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-23

Transaction Analysis
Rendered consulting services receiving $3,000 cash.
Assets Cash Supplies Equipment $ 4,000 $ 1,200 $ 16,000 3,000 = Liabilities Accounts Notes Payable Payable $ 1,200 + Owner's Equity Owner's Capital $ 20,000 3,000

Bal. (5)

$ 7,000

$ 1,200 $ 24,200

16,000 =

$ 1,200

$ 23,000

$ 24,200
The McGraw-Hill Companies, Inc., 2002

McGraw-Hill/Irwin

Slide 2-24

Transaction Analysis
Paid salaries to employees, $800 cash. The accounts involved are: (1) Cash (asset) (2) Salaries expense (equity)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-25

Transaction Analysis
Paid salaries to employees, $800 cash.
Assets Cash Supplies Equipment $ 4,000 $ 1,200 $ 16,000 3,000 (800) $ 6,200 $ 1,200 $ 23,400 $ 16,000 = = Liabilities Accounts Notes Payable Payable $ 1,200 + Owner's Equity Owner's Capital $ 20,000 3,000 (800) $ 22,200

Bal. (5) (6)

$ 1,200

$ 23,400
The McGraw-Hill Companies, Inc., 2002

McGraw-Hill/Irwin

Slide 2-26

Transaction Analysis
Borrowed $4,000 from 1st American Bank. The accounts involved are: (1) Cash (asset) (2) Notes payable (liability)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-27

Transaction Analysis
Borrowed $4,000 from 1st American Bank.
Assets = Liabilities + Account s Notes Owner's payable Payable capital $ 1,200 $ 20,000 3,000 (800) $ 4,000 $ 1,200 $ 4,000 $ 22,200 $ 27,400
The McGraw-Hill Companies, Inc., 2002

Owner's Equity

Bal. (5) (6) (7)

Cash Supplies Equipment $ 4,000 $ 1,200 $ 16,000 3,000 (800) 4,000 $ 10,200 $ 1,200 $ 16,000 $ 27,400 =

McGraw-Hill/Irwin

Slide 2-28

Financial Statements
Lets prepare the Financial Statements reflecting the transactions we have recorded.

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The McGraw-Hill Companies, Inc., 2002

Slide 2-29

In come Statement
Scotts net The net income income is the of $2,200 difference increases between Scotts equity Revenues and by $2,200. Expenses.

Scott Company Income Statement For Month Ended December 31, 2001 Revenues: Consulting revenue Expenses: Salaries expense Net income

3,000 800 2,200

Scott Company Statement of Changes in Owners' Equity For Month Ended December 31, 2001 Owners' equity, 12/1/01 Plus: Investment by owners Net income Owners' equity, 12/31/01
McGraw-Hill/Irwin

20,000 2,200 22,200

The McGraw-Hill Companies, Inc., 2002

Slide 2-30

#Balance Sheet
Scott Company Statement of Changes in Owners' Equity For Month Ended December 31, 2001 Owners' equity, 12/1/01 Plus: Investment by owners Net income Owners' equity, 12/31/01 $ 20,000 2,200 22,200

The balance sheet reflects Scotts financial position at 12/31/01.

Scott Company Balance Sheet December 31, 2001 Assets $ Liabilities & Owners' Equity Accounts payable $ 1,200 Notes payable 4,000 Total liabilities $ 5,200 Owners' equity $ 22,200 Total liabilities and owners' equity $ 27,400
The McGraw-Hill Companies, Inc., 2002

Cash Supplies Equipment

10,200 1,200 16,000

Total assets
McGraw-Hill/Irwin

27,400

Slide 2-31

Statement of Cash Flows

Scott Company Statement of Cash Flows For Month Ended December 31, 2001 Cash flows from operating activities: Cash received from clients $ 3,000 Purchase of supplies (1,000) Cash paid to employees (800) Net cash provided by operating activities Cash flows from investing activities: Purchase of equipment $ (15,000) Net cash used in investing activities Cash flows from financing activities: Investment by owners $ 20,000 Borrowed at bank 4,000 Net cash provided by financing activities Net increase in cash Cash balance, December 1, 2001 Cash balance, December 31, 2001

1,200

$ (15,000)

24,000 $10,200 $ 10,200

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Slide 2-32

Using the Information Return on Equity

Return on = Equity Net Income Average Equity

For Corporations . . .

For Proprietorships and Partnerships . . .

Modified Return on = Equity Net Income - Value of Owners Efforts Average Equity

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The McGraw-Hill Companies, Inc., 2002

Slide 2-33

End of Chapter 2
We cant wait to start Chapter 3!

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The McGraw-Hill Companies, Inc., 2002