The Financial Statements and Analyzing transactions Financial Statements Accounting is a process of collection analyzing and recording information and then communicating that information to decision makers For decision makers outside the day to day operating activities of the business information is reported using financial statements Large publicly traded companies provide quarterly and annual financial reports to the U S Securities and Exchange Commission The financial reports include the Balance Sheet aka Statement of Financial Position Income Statement aka Statement of Operations Statement of Stockholders Equity Statement of Cash Flows Balance Sheet The balance sheet reports on a company s financial position as of a specific date for example December 31 2014 Elements of the balance sheet are Assets resources that are expected to provide a future economic benefit things the company owns or controls Assets include Cash Accounts receivable Inventories Equipment Buildings Investments and Intangible Assets such as Patents and Goodwill Liabilities obligations that will be satisfied in the future debts of the firm Many liabilities have the word payable in their name such as Accounts payable Notes payable Taxes payable Equity the owners claims to the assets the residual claim to the assets that is the claim after the liabilities have been satisfied Equity can be contributed to the business by the owners or can be earned by the business The format of the balance sheet Assets Liabilities Equities Income Statement The income statement reports the results of operations for a period of time such as a month or a year Elements of the income statement are Revenues increases to a company s resources for providing goods and services what the company earns from customers Expenses decreases to a company s resources from generating revenue Gains similar to revenue in that it in an increase in resources but caused by an event that is not a typical recurring operating activity or by an owner s investment for example American Airlines reports revenue from ticket sales to customers reports a gain if it sells an un needed aircraft for more than book value to another airline Losses similar to expenses but caused by an event that is not a typical recurring operating activitity Format of the income statement Revenues Gains Expenses Losses Net income Statement of Stockholders Equity The Statement of Stockholders Equity or shareholders equity or owners equity reports on the changes in equity accounts over a period of time Elements of the Statement of equity there are two major components of equity contributed capital and earned capital Contributed capital consists of stock and related accounts Contributed capital represents amounts that owners invested into the business Earned capital or Retained earnings Retained earnings represents the profits the company has retained that is earnings that have not been distributed to owners in the form of dividends Format of the Statement of Stockholders Equity Beginning balance SE Investments by the owners Net income Dividends Ending balance SE NOTE We can also prepare a Statement of RE which shows changes only in the earned capital part of equity The format of the Statement of RE is Beginning balance RE NI Dividends Ending balance RE Statement of Cash Flows The Statement of Cash Flows shows the changes in Cash over a period of time The changes in cash are reported in three categories Operating cash flows reports on cash received from customers from the sale of goods or services and cash paid for expenses incurred Investing cash flows reports on cash received or paid from selling or acquiring long term assets Financing cash flows reports on cash received from issuing long term liabilities and capital stock and cash paid to repay long term liabilities and dividends How are the four financial statements interrelated The net income or loss reported on the Income Statement is also shown as an increase or decrease in retained earnings on the Statement of Retained Earnings The ending balance in retained earnings shown on the Statement of Retained Earnings is shown on the Balance Sheet as a part of stockholders equity The balance of cash reported on the Balance Sheet is also reported as the end of period cash on the Statement of Cash Flows Transactions analysis Financial statements are prepared on a regular basis at least once per year Where does the information used to prepare financial statements come from Throughout the reporting period accountants collect and record information about transactions then organize this information into financial statements Transactions are business events that affect a business entity and are recorded in the financial statements The basis for recording all transactions is the accounting equation or balance sheet equation Assets Liabilities Stockholders Equity How do transactions affect the accounting equation All business transactions can be stated in terms of their effect on elements of the accounting equation 1 Each transaction increases or decreases elements of the accounting equation 2 Every transaction must maintain the equality of the accounting equation that is the equation must always be in balance 3 In order to maintain the equality of the accounting equation each transaction must affect at least two accounts Transactions analysis an example Tom is a student at a major university To earn money for school Tom decided to start a business painting houses Tom used some of his savings to acquire necessary equipment and then got to work The following slides show Tom s business transactions and how each affects the accounting equation Transaction 1 Tom took 1 000 from his personal savings account to use in his business He opened a new account at the bank in the name of his business Tom s Painting Services Inc TPS and deposited the cash He then received stock in his new company The 1 000 deposited represents an investment by the owner or contributed capital From the point of view of Tom s business cash has increased and the amount of stock issued has increased The effect of the transaction on the accounting equation is Assets Cash Common stock 1 000 Liabilities 1 000 Assets and equity both increase Stockholders Equity Transaction 2 Tom s Painting Services borrowed 1 500 from the bank by signing a Note Payable The business will have to repay this loan in six months By borrowing the company now has more cash Since the source of the