© the mcgraw-hill companies, inc., 2008 mcgraw-hill/irwin 2-1 basic financial statements chapter 2
TRANSCRIPT
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
2-1
BASIC FINANCIAL STATEMENTS
Chapter
2
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2-2
Learning ObjectiveLearning Objective
LO1
To explain the nature and general purpose of
financial statements.
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Income Statement
Balance Sheet
Statement of Cash Flows
Introduction to Financial StatementsIntroduction to Financial Statements
Three primary financial
statements.
We will use a corporation to describe these
statements.
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Introduction to Financial StatementsIntroduction to Financial Statements
Describes where the enterprise stands at a
specific date.
Income Statement
Balance Sheet
Statement of Cash Flows
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Introduction to Financial StatementsIntroduction to Financial Statements
Depicts the revenue and
expenses for a designated
period of time.
Income Statement
Balance Sheet
Statement of Cash Flows
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Introduction to Financial StatementsIntroduction to Financial Statements
Revenues result in positive
cash flow.
Expenses result in negative
cash flow.
Either in the past, present, or future.
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Introduction to Financial StatementsIntroduction to Financial Statements
Net income (or net loss) is simply the difference between
revenues and expenses.
Income Statement
Balance Sheet
Statement of Cash Flows
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Introduction to Financial StatementsIntroduction to Financial Statements
Depicts the ways cash has changed during
a designated period of time.
Income Statement
Balance Sheet
Statement of Cash Flows
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Vagabond Travel AgencyBalance Sheet
December 31, 2007Assets Liabilities & Owners' Equity
Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000 Total 300,000$ Total 300,000$
A Starting Point: Statement of Financial Position
A Starting Point: Statement of Financial Position
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Learning ObjectiveLearning Objective
LO2
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.
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The Concept of the Business EntityThe Concept of the Business Entity
Vagabond Travel
Agency
A business entity is
separate from the personal affairs of its
owner.
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Vagabond Travel AgencyBalance Sheet
December 31, 2007Assets Liabilities & Owners' Equity
Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000 Total 300,000$ Total 300,000$
AssetsAssets
Assets are economic resources
that are owned by the business and are expected to benefit future operations.
Assets are economic resources
that are owned by the business and are expected to benefit future operations.
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AssetsAssets
Cost PrincipleCost PrincipleCost PrincipleCost Principle
Going-ConcernGoing-ConcernAssumptionAssumption
Going-ConcernGoing-ConcernAssumptionAssumption
Objectivity Objectivity PrinciplePrinciple
Objectivity Objectivity PrinciplePrinciple
Stable-DollarStable-DollarAssumptionAssumption
Stable-DollarStable-DollarAssumptionAssumption
These accounting principles support cost as the basis
for asset valuation.
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Vagabond Travel AgencyBalance Sheet
December 31, 2007Assets Liabilities & Owners' Equity
Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000 Total 300,000$ Total 300,000$
LiabilitiesLiabilities
Liabilities are debts that
represent negative future cash flows
for the enterprise.
Liabilities are debts that
represent negative future cash flows
for the enterprise.
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Vagabond Travel AgencyBalance Sheet
December 31, 2007Assets Liabilities & Owners' Equity
Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000 Total 300,000$ Total 300,000$
Owners’ EquityOwners’ Equity
Owners’ equity represents the
owners’ claims on the assets of the
business.
Owners’ equity represents the
owners’ claims on the assets of the
business.
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Owners’ EquityOwners’ Equity
Changes in Owners’ Equity
•Owners’ Investments
•Business Earnings
•Payments to Owners
•Business Losses
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Learning ObjectiveLearning Objective
LO3
To demonstrate how certain business
transactions affect the elements of the
accounting equation: Assets = Liabilities +
Owners’ Equity.
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Vagabond Travel AgencyBalance Sheet
December 31, 2007Assets Liabilities & Owners' Equity
Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' EquityOffice equipment 15,000 Capital stock 150,000
Retained earnings 70,000 Total 300,000$ Total 300,000$
The Accounting EquationThe Accounting Equation
Assets = Liabilities + Owners’ Equity
$300,000 = $80,000 + $220,000
Assets = Liabilities + Owners’ Equity
$300,000 = $80,000 + $220,000
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Let’s analyze some
transactions for JJ’s Lawn Care
Service.
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JJ's Lawn Care ServiceBalance Sheet
May 1, 2007Assets
Cash 8,000$ Capital Stock 8,000$
Total 8,000$ Total 8,000$
Owners' Equity
On May 1, Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received
800 shares of stock.
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JJ's Lawn Care ServiceBalance Sheet
May 2, 2007Assets
Cash 5,500$ Capital Stock 8,000$ Tools & Equipment 2,500
Total 8,000$ Total 8,000$
Owners' Equity
On May 2, JJ’s purchased a riding lawn mower for $2,500 cash.
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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 $13,000.
JJ's Lawn Care ServiceBalance Sheet
May 8, 2007Assets
Cash 3,500$ Liabilities: Tools & Equipment 2,500 Notes Payable 13,000$ Truck 15,000 Owners' Equity:
Capital Stock 8,000
Total 21,000$ Total 21,000$
Liabilities and Owners' Equity
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JJ's Lawn Care ServiceBalance SheetMay 11, 2007
AssetsCash 3,500$ Liabilities: Tools & Equipment 2,800 Notes Payable 13,000$ Truck 15,000 Accounts Payable 300
Total Liabilities 13,300$ Owners' Equity:Capital Stock 8,000
Total 21,300$ Total 21,300$
Liabilities and Owners' Equity
On May 11, JJ’s purchased some repair parts for $300 on account.
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JJ's Lawn Care ServiceBalance SheetMay 18, 2007
AssetsCash 3,500$ Liabilities: Accounts Receivable 150 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 300 Truck 15,000 Total Liabilities 13,300$
Owners' Equity:Capital Stock 8,000
Total 21,300$ Total 21,300$
Liabilities and Owners' Equity
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 $150, a price equal to JJ’s cost. JJ’s will receive the cash within 30 days.
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JJ's Lawn Care ServiceBalance SheetMay 25, 2007
AssetsCash 3,575$ Liabilities: Accounts Receivable 75 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 300 Truck 15,000 Total Liabilities 13,300$
Owners' Equity:Capital Stock 8,000
Total 21,300$ Total 21,300$
Liabilities and Owners' Equity
On May 25, ABC Lawns pays JJ’s $75 as a partial settlement of its accounts receivable.
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JJ's Lawn Care ServiceBalance SheetMay 28, 2007
AssetsCash 3,425$ Liabilities: Accounts Receivable 75 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 150 Truck 15,000 Total Liabilities 13,150
Owners' Equity:Capital Stock 8,000
Total 21,150$ Total 21,150$
Liabilities and Owners' Equity
On May 28, JJ’s pays $150 of its accounts payable.
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JJ's Lawn Care ServiceBalance SheetMay 29, 2007
AssetsCash 4,175$ Liabilities: Accounts Receivable 75 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 150 Truck 15,000 Total Liabilities 13,150
Owners' Equity:Capital Stock 8,000 Retained Earnings 750
Total 21,900$ Total 21,900$
Liabilities and Owners' Equity
On May 29, JJ’s recorded lawn care services provided during May of $750. All clients were
paid in cash.
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Learning ObjectiveLearning Objective
LO4
To explain how the statement of financial
position, often referred to as the balance sheet, is an expansion of the
basic accounting equation.
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JJ's Lawn Care ServiceBalance SheetMay 31, 2007
AssetsCash 4,125$ Liabilities: Accounts Receivable 75 Notes Payable 13,000$ Tools & Equipment 2,650 Accounts Payable 150 Truck 15,000 Total Liabilities 13,150
Owners' Equity:Capital Stock 8,000 Retained Earnings 700
Total 21,850$ Total 21,850$
Liabilities and Owners' Equity
Now, let’s review how JJ’s transactions affected the accounting equation.
On May 31, JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.
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Assets = Liabilities +
Cash +Accts. Rec. +
Tools & Equip. + Truck =
Notes Payable +
Accts. Pay. +
Capital Stock +
Retained Earnings
May 1 8,000$ 8,000$ Balances 8,000$ 8,000$
May 2 (2,500) 2,500$ Balances 5,500$ 2,500$ 8,000$
May 8 (2,000) 15,000$ 13,000$ Balances 3,500$ 2,500$ 15,000$ 13,000$ 8,000$
May 11 300 300$ Balances 3,500$ 2,800$ 15,000$ 13,000$ 300$ 8,000$
May 18 150$ (150) Balances 3,500$ 150$ 2,650$ 15,000$ 13,000$ 300$ 8,000$
May 25 75 (75) Balances 3,575$ 75$ 2,650$ 15,000$ 13,000$ 300$ 8,000$
May 28 (150) (150) Balances 3,425$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$
May 29 750 750 Balances 4,175$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 750$
May 31 (50) (50) Balances 4,125$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 700$
Owners' Equity
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Assets = Liabilities +
Cash +Accts. Rec. +
Tools & Equip. + Truck =
Notes Payable +
Accts. Pay. +
Capital Stock +
Retained Earnings
May 1 8,000$ 8,000$ Balances 8,000$ 8,000$
May 2 (2,500) 2,500$ Balances 5,500$ 2,500$ 8,000$
May 8 (2,000) 15,000$ 13,000$ Balances 3,500$ 2,500$ 15,000$ 13,000$ 8,000$
May 11 300 300$ Balances 3,500$ 2,800$ 15,000$ 13,000$ 300$ 8,000$
May 18 150$ (150) Balances 3,500$ 150$ 2,650$ 15,000$ 13,000$ 300$ 8,000$
May 25 75 (75) Balances 3,575$ 75$ 2,650$ 15,000$ 13,000$ 300$ 8,000$
May 28 (150) (150) Balances 3,425$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$
May 29 750 750 Balances 4,175$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 750$
May 31 (50) (50) Balances 4,125$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 700$
Owners' Equity
These transactions impact the
Statement of Cash Flows.
These transactions impact the
Statement of Cash Flows.
These transactions impact the Income
Statement.
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.
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Learning ObjectiveLearning Objective
LO5
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.
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JJ's Lawn Care ServiceIncome Statement
For the Month Ended May 31, 2007
Sales Revenue 750$ Operating Expense: Gasoline Expense 50 Net Income 700$
Investments by and payments to the owners are not included on the Income Statement.
Investments by and payments to the owners are not included on the Income Statement.
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Learning ObjectiveLearning Objective
LO6
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.
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JJ's Lawn Care ServiceStatement of Cash Flows
For the Month Ended May 31, 2007Cash flows from operating activities: Cash received from revenue transactions 750$ Cash paid for expenses (50) Net cash provided by operating activities 700$ Cash flows from investing activities: Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125$
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JJ's Lawn Care ServiceStatement of Cash Flows
For the Month Ended May 31, 2007Cash flows from operating activities: Cash received from revenue transactions 750$ Cash paid for expenses (50) Net cash provided by operating activities 700$ Cash flows from investing activities: Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125$
Operating activities include the cash effects of revenue and expense
transactions.
Operating activities include the cash effects of revenue and expense
transactions.
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JJ's Lawn Care ServiceStatement of Cash Flows
For the Month Ended May 31, 2007Cash flows from operating activities: Cash received from revenue transactions 750$ Cash paid for expenses (50) Net cash provided by operating activities 700$ Cash flows from investing activities: Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125$
Investing activities include the cash effects of purchasing and selling
assets.
Investing activities include the cash effects of purchasing and selling
assets.
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JJ's Lawn Care ServiceStatement of Cash Flows
For the Month Ended May 31, 2007Cash flows from operating activities: Cash received from revenue transactions 750$ Cash paid for expenses (50) Net cash provided by operating activities 700$ Cash flows from investing activities: Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125$
Financing activities include the cash effects of transactions with the owners
and creditors.
Financing activities include the cash effects of transactions with the owners
and creditors.
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Assets = Liabilities +
Cash +Accts. Rec. +
Tools & Equip. + Truck =
Notes Payable +
Accts. Pay. +
Capital Stock +
Retained Earnings
May 1 8,000$ 8,000$ Balances 8,000$ 8,000$
May 2 (2,500) 2,500$ Balances 5,500$ 2,500$ 8,000$
May 8 (2,000) 15,000$ 13,000$ Balances 3,500$ 2,500$ 15,000$ 13,000$ 8,000$
May 11 300 300$ Balances 3,500$ 2,800$ 15,000$ 13,000$ 300$ 8,000$
May 18 150$ (150) Balances 3,500$ 150$ 2,650$ 15,000$ 13,000$ 300$ 8,000$
May 25 75 (75) Balances 3,575$ 75$ 2,650$ 15,000$ 13,000$ 300$ 8,000$
May 28 (150) (150) Balances 3,425$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$
May 29 750 750 Balances 4,175$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 750$
May 31 (50) (50) Balances 4,125$ 75$ 2,650$ 15,000$ 13,000$ 150$ 8,000$ 700$
Owners' Equity
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.
These balances will appear on the
Balance Sheet.
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Cash 4,125$ Notes payable 13,000$ Accounts receivable 75 Accounts payable 150 Tools & equipment 2,650 Truck 15,000 Capital stock 8,000
Retained earnings 700 Total assets 21,850$ Total liabilities & equity 21,850$
Assets Liabilities
Owners' Equity
JJ's Lawn Care ServiceBalance SheetMay 31, 2007
Assets = Liabilities + Owners’ Equity
$21,850 = $13,150 + $8,700
Assets = Liabilities + Owners’ Equity
$21,850 = $13,150 + $8,700
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Learning ObjectiveLearning Objective
LO7
To explain the important relationships among the
statement of financial position, income statement,
and statement of cash flows, and how these
statements relate to each other.
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Relationships Among Financial Statements
Relationships Among Financial Statements
Date at beginning of period
Date at end of period
Balance Sheet
Balance Sheet
Time
Income Statement
Statement of Cash Flows
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Financial Statement ArticulationFinancial Statement Articulation
JJ's Lawn Care ServiceStatement of Cash Flows
For the Month Ended May 31, 2007Cash flows from operating activities: Cash received from revenue transactions 750$ Cash paid for expenses (50) Net cash provided by operating activities 700$ Cash flows from investing activities: Purchase of lawn mower (2,500)$ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125$ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125$
Cash 4,125$ Notes payable 13,000$ Accounts receivable 75 Accounts payable 150 Tools & equipment 2,650 Truck 15,000 Capital stock 8,000
Retained earnings 700 Total assets 21,850$ Total liabilities & equity 21,850$
Assets Liabilities
Owners' Equity
JJ's Lawn Care ServiceBalance SheetMay 31, 2007
JJ's Lawn Care ServiceIncome Statement
Sales Revenue 750$ Operating Expense: Gasoline Expense 50 Net Income 700$
For the Month Ended May 31, 2007
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Statement of Cash Flows
Balance Sheet
Income Statement
Other Information:•Industry•Competitors•National economy
Financial Reporting and Financial Statements
Financial Reporting and Financial Statements
Financial statements are just one source of
financial accounting information.
Financial statements are just one source of
financial accounting information.
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Learning ObjectiveLearning Objective
LO8
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.
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Forms of Business OrganizationForms of Business Organization
Sole Proprietorships
Sole Proprietorships PartnershipsPartnerships CorporationsCorporations
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Reporting Ownership Equity in the Statement of Financial Position
Reporting Ownership Equity in the Statement of Financial Position
Owner's equity:
Jill Jones, capital 8,000$ Sole
Proprietorships
Sole Proprietorships
Partners' equity Jill Jones, capital 4,000$ Bill Jones, capital 4,000 Total partners' equity 8,000$
PartnershipsPartnerships
Owners' equity Capital stock 7,000$ Retained earnings 1,000 Total stockholders' equity 8,000$
CorporationsCorporations
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The Use of Financial Statements by External Parties
The Use of Financial Statements by External Parties
Creditors
Investors
Two concerns:
Liquidity
Profitability
Two concerns:
Liquidity
Profitability
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The Need for Adequate DisclosureThe Need for Adequate Disclosure
Notes to the financial
statements often provide facts
necessary for the proper
interpretation of the statements.
Notes to the financial
statements often provide facts
necessary for the proper
interpretation of the statements.
Income Statement
Balance Sheet
Statement of Cash Flows
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Learning ObjectiveLearning Objective
LO9
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.
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Management’s Interest in Financial Statements
Management’s Interest in Financial Statements
Creditors are more likely to extend credit if financial statements show a strong statement of financial position—that is, relatively little debt and large
amounts of liquid assets.
Window dressing occurs when management takes measures to make the company appear as strong
as possible in it financial statements.
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End of Chapter 2End of Chapter 2