Analyzing Business Transactions Chapter 2 Analyzing Business Transactions Section 2: The Accounting Equation and Financial Statements Section Objectives Objective 5 of chapter 2, illustrates how to prepare a statement of owner’s equity and a balance sheet. Analyze the effects of business transactions on a firm’s assets, liabilities, and owner’s equity and record these effects in accounting equation form. Prepare an income statement. Prepare a statement of owner’s equity and a balance sheet. McGraw-Hill © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

Prepare the. . . The Statement of Owner’s Equity and the Balance Sheet Objective 5 Prepare the. . . The Statement of Owner’s Equity and the Balance Sheet The last objective in the chapter is the discussion of the statement of owner’s equity and a quick review of the balance sheet financial statement.

What is a statement of owner’s equity? QUESTION: What is a statement of owner’s equity? ANSWER: A statement of owner’s equity is a formal report of changes that occurred in the owner’s financial interest during a reporting period. The statement of owner’s equity is the second financial statement prepared for a business. It is created after the income statement but before the balance sheet. It reports the changes that occurred in the owner’s financial interest during the reporting period. It would include information about investments and withdrawals as well as the net income or net loss of the business during the period.

37 JT’s Consulting Services Statement of Owner’s Equity The statement of owner’s equity has a three-line heading. Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 $27,500.00 4,000.00 $90,000.00 23,500.00 $113,500.00 Note that the statement of owner’s equity has a three-line heading: who, what, and when. 37

JT’s Consulting Services Statement of Owner’s Equity The statement of owner’s equity shows the capital at the beginning of the period. Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 $27,500.00 4,000.00 $90,000.00 23,500.00 $113,500.00 The first line of the statement shows the balance in the owner’s capital account at the beginning of the period which is covered. In this example, Jason Taylor, Capital had a beginning balance of $90,000 on December 1. 37

37 JT’s Consulting Services Statement of Owner’s Equity Net income or net loss for the period is included. Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 27,500.00 4,000.00 $90,000.00 23,500.00 $113,500.00 The next line is net income which caused owner’s equity to go up. If there had been a net loss reported on the income statement, then the net loss would have caused a decrease in owner’s equity. 37

37 JT’s Consulting Services Statement of Owner’s Equity The withdrawals and additional investments for the period are shown. Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 27,500.00 4,000.00 $90,000.00 23,500.00 $113,500.00 Withdrawals by the owner are a decrease to owner’s equity. 37

37 JT’s Consulting Services Statement of Owner’s Equity The increase or decrease in capital for the period is reported. Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 27,500.00 4,000.00 $90,000.00 23,500.00 $113,500.00 The total of changes in equity is reported on the line “Increase in Capital” or (“Decrease in Capital”). 37

37 JT’s Consulting Services Statement of Owner’s Equity The result is the capital balance at the end of the period. Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 27,500.00 4,000.00 $90,000.00 23,500.00 $113,500.00 The last line of the statement of owner’s equity is the capital balance at the end of the period. 37

Additional Investments Note that Jason Taylor did not make any additional investments in December. Additional investments such as cash or equipment would appear in a new line in the statement of owner’s equity. An investment made in a form other than cash is recorded at its fair market value. If Jason had made any additional investments during December, this would appear as a separate line in the statement.

JT’s Consulting Services The balance sheet has a three-line heading. JT’s Consulting Services Balance Sheet December 31, 2007 Assets Cash 83,500.00 Accounts Receivable 5,000.00 Supplies 3,000.00 Prepaid Rent 7,000.00 Equipment 22,000.00 Total Assets 120,500.00 Liabilities Accounts Payable 7,000.00 Owner’s Equity Jason Taylor, Capital 113,500.00 Total Liabilities and Owner’s Equity 120,500.00 In preparing a balance sheet, remember the three line heading: who, what and when. The ending capital balance from the statement of owner’s equity is also used to prepare the balance sheet. Dollar signs are omitted when financial statements are prepared on paper with ruled columns. Statements that are prepared on plain paper, not ruled forms, show dollar signs with the first amount in each column and with each total. Balance sheets prepared using the account form show total assets on the same horizontal line as the total liabilities and owner’s equity. A single line shows that the amounts above it are being added or subtracted. A double line indicates final amounts for the column or section of a report.

Notice any difference in the date line?? JT’s Consulting Services Income Statement Month Ended December 31, 2007 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 JT’s Consulting Services Balance Sheet December 31, 2007 The when (date) line on the balance sheet is only good for one day but the other two financial statement date lines show a period of time. Put another way, the income statement and the statement of owner’s equity are like a movie covering a period of time but the balance sheet is only a snap shot of one day. Notice any difference in the date line??

The Importance of Financial Statements

The Importance of Financial Statements Business managers and owners use the balance sheet and the income statement to control current operations and plan for the future. Creditors, prospective investors, governmental agencies, and others are interested in the profits of the business and in the asset and equity structure. Preparing financial statements is one of the accountant’s most important jobs. Each day millions of business decisions are made based on the information in financial statements.

Financial statements are prepared in a specific order: 1st Income Statement 2nd Statement of Owner’s equity 3rd Balance Sheet Financial statements are always prepared in a certain order.

JT’s Consulting Services Income Statement Month Ended December 31, 2007 Revenue Fees Income $35,000.00 Expenses Salaries Expense 7,000.00 Utilities Expense 500.00 Total Expenses 7,500.00 Net Income $27,500.00 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 27,500.00 4,000.00 $90,000.00 23,500.00 $113,500.00 Net income from the income statement is used to prepare the statement of owner’s equity. 37

JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 22,400.00 3,000.00 80,000.00 19,400.00 113,500.00 JT’s Consulting Services Balance Sheet December 31, 2007 Assets Cash $83,500.00 Accounts Receivable 5,000.00 Supplies 3,000.00 Prepaid Rent 7,000.00 Equipment 22,000.00 Total Assets $ 120,500.00 Liabilities Accounts Payable $7,000.00 Owner’s Equity Jason Taylor, Capital 113,500.00 Total Liabilities and Owner’s Equity $ 120,500.00 The ending capital balance from the statement of owner’s equity is used to prepare the balance sheet.

Complete the following sentences: fundamental accounting equation SECTION R E V I W Complete the following sentences: fundamental accounting equation The _____________________________ is the relationship between assets and liabilities plus owner’s equity. ________ is the inflow of money or other assets that results from the sales of goods or services or from the use of money or property. Revenue Let’s see if you can complete the following section review questions. . . An increase in expense leads to a ________ in owner’s equity. decrease

Complete the following sentences: statement of owner’s equity V I W SECTION Complete the following sentences: The financial statement that is dated as of a single date is the _____________. balance sheet The ________________ shows the results of business operations for a specific period of time such as a month, a quarter, or a year. income statement statement of owner’s equity The ________________________ reports the changes that occurred in the owner’s financial interest during the reporting period.

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