Introduction to Accounting and Business LO 5 – Preparing Financial Statements

LO 5 Financial Statements After transactions have been recorded and summarized, reports are prepared for users. The accounting reports providing this information are called financial statements. Once all the transactions have been recorded, the accountant’s responsibility is to prepare reports that users can use to analyze the company’s financial information.

LO 5 Financial Statements

LO 5 Income Statement The income statement reports the revenues and expenses for a period of time, based on the matching concept. The matching concept is applied by “matching” the expenses incurred during a period with the revenue that those expenses generated. The excess of the revenue over the expenses is called net income, net profit, or earnings. If expenses exceed revenue, the excess is a net loss. The Income Statement summarizes the revenue and expenses for a specific period of time, such as a month or a year. Since the Income Statement is prepared for a period of time, the concept of matching expenses and revenues is critical. In order to determine if a company experiences a profit or a loss, the company computes the total expenses for a period and matches those expenses against the total revenues reported for the same period. The purpose of the Income Statement is to report to the user whether the company’s operations are successful or not. This is measured on the Income Statement by the computation of the Net Income or Net Loss. Net Income or Net Loss is computed by comparing revenues and expenses for a period of time. An excess of revenues over expenses results in net income; the excess of expenses over revenues results in a net loss.

Retained Earnings Statement LO 5 Retained Earnings Statement The retained earnings statement reports the changes in the retained earnings for a period of time. It is prepared after the income statement because the net income or net loss for the period must be reported in this statement. The Retained Earnings Statement summarizes the changes in the retained earnings that have occurred during a specific period of time, such as a month or a year.

LO 5 Income Statement The Income Statement reports on the revenues earned by the business during November. Each expense incurred by NetSolutions during November is reported on a separate line of the income statement in a section labeled Expenses. For readability, the left column is used to list each of the expenses. The expense column is added, and its total, $4,450, is labeled Total Expense. The total expenses are then listed in the right column. Notice that the first amounts listed in each column have a dollar sign, but the amounts that follow do not have a dollar sign. The total of expenses, $4,450, is subtracted from the Fees Earned of $7,500, and the difference is labeled Net Income. When the revenues earned by a business are greater than the total expenses of the business, the business reports a net income. If the total expenses are greater than the total revenues, the company reports a net loss. Net income is carried to the retained earnings statement (continued)

Retained Earnings Statement LO 5 Retained Earnings Statement From the income statement The first item reported in this statement is the Beginning Retained Earnings. Since this is NetSolutions’ first month of operation, on November 1 the beginning retained earnings balance is zero. Notice the use of the dollar sign for the first amount reported in each column. The net income that was determined on the Income Statement is listed next. The dividends of $2,000 is listed on the next free line. The left column is then added, and the total of $1,050 is listed in the right column. It is labeled Increase in Retained Earnings. The increase in retained earnings of $1,050 is then added to the beginning capital balance of zero dollars to determine the new retained earnings balance of $1,050. The final amount of this statement, $1,050, is given a dollar sign and is double underlined. To the balance sheet

LO 5 Balance Sheet A balance sheet is a list of the assets, liabilities, and stockholders’ equity as of a specific date. The Balance Sheet lists the assets, liabilities, and stockholders’ equity as of a specific date, usually at the close of the last day of a month or a year.

LO 5 Account Form The account form of a balance sheet lists the assets on the left and the liabilities and stockholders’ equity on the right. It resembles the basic format of the accounting equation. The form of the balance sheet shown in Exhibit 6 in the text is called the Account Form. This is because it resembles the format of the accounting equation with Assets appearing on the left side of a balance sheet and Liabilities and Stockholders’ Equity appearing on the right side of the balance sheet.

LO 5 Balance Sheet As of the end of November, NetSolutions has three assets. All three assets are reported in the Assets section of the balance sheet. The order that they are reported is important. Cash is listed first because it is the most liquid of assets. The nearer an asset is to being converted into cash, the higher up it will be listed in the assets section of the balance sheet. Like all financial statement columns, the first amount in a column is given a dollar sign. Accounts Payable of $400 is the only liability. Liabilities are listed on the right side of the balance sheet. The $400 of accounts payable is given a dollar sign because it is the first amount in the right column. This form of the balance sheet is called the account form. It mirrors the accounting equation with the assets on the left and the liabilities and stockholders’ equity on the right. Next, the ending retained earnings balance, from the statement of retained earnings, is listed below the liabilities. The Assets column on the left is added together and labeled total assets. The right column is added, and the total is labeled total liabilities and stockholders’ equity. Both of these totals are double underlined, and dollar signs are added. The total assets, $26,450, equals the total of liabilities and stockholders’ equity of $26,450. The balance sheet proves the equality of the accounting equation. This amount is compared to the net cash flow on the statement of cash flows. From the retained earnings statement

Statement of Cash Flows A statement of cash flows is a summary of the cash receipts and cash payments for a specific period of time. It consists of three sections: (1) operating activities (2) investing activities (3) financing activities A Statement of Cash Flows is a summary of cash receipts and payment for a specific period of time. The Statement of Cash Flows is made up of three sections.

Statement of Cash Flows The ending cash balance shown on the statement of cash flows is also reported on the balance sheet as of the end of the period. This amount should match Cash on the balance sheet.

Cash Flows from Operating Activities The cash flows from operating activities section reports a summary of cash receipts and cash payments from operations. The first section is called cash flows from operating activities. This represents a summary of cash receipts and payment from operations. Collections of cash from sales of goods or services, cash payments to purchase inventory, and cash payments for expenses incurred to generate revenue are all examples of operating activities.

Cash Flows from Investing Activities The cash flows from investing activities section reports the cash transactions for the acquisition and sale of relatively permanent assets. The second section is called cash flows from investing activities. This section reports cash payments for the acquisition of relatively permanent assets. It also reports the cash receipts from the sales of those assets.

Cash Flows from Financing Activities The cash flows from financing activities section reports the cash transactions related to cash investments by the owner, borrowings, and withdrawals by the owner. The third section is called cash flows from financing activities. This section summarizes cash received and disbursed through owner’s equity transactions and through long-term borrowing activities.