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BASIC FINANCIAL STATEMENTS

Chapter 2. BASIC FINANCIAL STATEMENTS. Learning Objective. To explain the nature and general purpose of financial statements. LO1. Three primary financial statements. Balance Sheet. Income Statement. Statement of Cash Flows. We will use a corporation to describe these statements.

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BASIC FINANCIAL STATEMENTS

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  1. Chapter2 BASIC FINANCIAL STATEMENTS

  2. Learning Objective To explain the nature and general purpose of financial statements. LO1

  3. Three primary financial statements. BalanceSheet Income Statement Statement of Cash Flows We will use a corporation to describe these statements. Introduction to Financial Statements

  4. Describes where the enterprise stands at a specific date. Balance Sheet Income Statement Statement of Cash Flows Introduction to Financial Statements

  5. Balance Sheet Depicts the revenue and expenses for a designated period of time. Income Statement Statement of Cash Flows Introduction to Financial Statements

  6. Introduction to Financial Statements Revenues result in positive cash flow. Expenses result in negative cash flow. Either in the past, present, or future.

  7. Balance Sheet Net income (or net loss) is simply the difference between revenues and expenses. Income Statement Statement of Cash Flows Introduction to Financial Statements

  8. Balance Sheet Income Statement Statement of Cash Flows Depicts the ways cash has changed during a designated period of time. Introduction to Financial Statements

  9. A Starting Point: Statement of Financial Position

  10. Learning Objective To explain certain accounting principles that are important for an understanding of financial statements and how professional judgment by accountants may affect the application of those principles. LO2

  11. The Concept of the Business Entity A business entity is separate from the personal affairs of its owner. Vagabond Travel Agency

  12. Assets Assets are economic resources that are owned by the business and are expected to benefit future operations.

  13. Assets Cost Principle These accounting principles support cost as the basis for asset valuation. Going-Concern Assumption Stable-Dollar Assumption Objectivity Principle

  14. Liabilities Liabilities are debts that represent negative future cash flows for the enterprise.

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

  16. Payments to Owners • Business Losses • Owners’ Investments • Business Earnings Owners’ Equity Changes in Owners’ Equity

  17. Learning Objective To demonstrate how certain business transactions affect the elements of the accounting equation: Assets = Liabilities + Owners’ Equity. LO3

  18. The Accounting Equation Assets = Liabilities + Owners’ Equity $300,000 = $80,000 + $220,000

  19. Let’s analyze some transactions for JJ’s Lawn Care Service.

  20. On May 1, Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.

  21. On May 2, JJ’s purchased a riding lawn mower for $2,500 cash.

  22. 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.

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

  24. 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.

  25. On May 25, ABC Lawns pays JJ’s $75 as a partial settlement of its accounts receivable.

  26. On May 28, JJ’s pays $150 of its accounts payable.

  27. On May 29, JJ’s recorded lawn care services provided during May of $750. All clients were paid in cash.

  28. Learning Objective To explain how the statement of financial position, often referred to as the balance sheet, is an expansion of the basic accounting equation. LO4

  29. On May 31, JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Now, let’s review how JJ’s transactions affected the accounting equation.

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

  31. Learning Objective 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. LO5

  32. Investments by and payments to the owners are not included on the Income Statement.

  33. Learning Objective 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. LO6

  34. Operating activities include the cash effects of revenue and expense transactions.

  35. Investing activities include the cash effects of purchasing and selling assets.

  36. Financing activities include the cash effects of transactions with the owners and creditors.

  37. Now, let’s prepare the Balance Sheet for JJ’s Lawn Care Service for May 31, 2007. These balances will appear on the Balance Sheet.

  38. Assets = Liabilities + Owners’ Equity $21,850 = $13,150 + $8,700

  39. Learning Objective 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. LO7

  40. Relationships Among Financial Statements Date at beginning of period Date at end of period Time Balance Sheet Balance Sheet Income Statement Statement of Cash Flows

  41. Financial Statement Articulation

  42. Statement of Cash Flows Balance Sheet Income Statement • Other Information: • Industry • Competitors • National economy Financial Reporting and Financial Statements Financial statements are just one source of financial accounting information.

  43. Learning Objective To explain common forms of business ownership—sole proprietorship, partnership, and corporation—and demonstrate how they differ in terms of their presentation in the statement of financial position. LO8

  44. Forms of Business Organization Sole Proprietorships Partnerships Corporations

  45. Sole Proprietorships Partnerships Corporations Reporting Ownership Equity in the Statement of Financial Position

  46. The Use of Financial Statements by External Parties Two concerns: Liquidity Profitability Creditors Investors

  47. Balance Sheet Income Statement Statement of Cash Flows The Need for Adequate Disclosure Notesto the financial statements often provide facts necessary for the proper interpretation of the statements.

  48. Learning Objective To discuss the importance of financial statements to a company and its investors and creditors and why management may take steps to improve the appearance of the company in its financial statements. LO9

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