The Financial Statements and Analyzing transactionsFinancial StatementsBalance SheetIncome StatementStatement of Stockholders’ Equity *Statement of Cash FlowsHow are the four financial statements interrelated?Transactions analysisHow do transactions affect the accounting equation?Transactions analysis: an exampleTransaction 1Transaction 2Transaction 3Transaction 4Transaction 5Transaction 6Transaction 7Transaction 8Transaction 9Transaction 10Transaction 11Transaction 12Transaction 13RecapNext stepsThe Financial Statements and Analyzing transactionsFinancial StatementsAccounting 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’ EquityStatement of Cash FlowsBalance SheetThe 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 + EquitiesIncome StatementThe 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 customersExpenses – decreases to a company’s resources from generating revenueGains – 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 Airlinesreports revenue from ticket sales to customers, reports a gain if it sells an un-needed aircraft for more than book value to another airlineLosses – similar to expenses but caused by an event that is not a typical, recurring operating activitityFormat of the income statement:Revenues + Gains – (Expenses + Losses) = Net incomeStatement 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 REStatement of Cash FlowsThe 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 incurredInvesting cash flows – reports on cash received or paid from selling or acquiring long-term assetsFinancing cash flows – reports on cash received from issuing long-term liabilities and capital stock, and cash paid to repay long-term liabilities and dividendsHow 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 analysisFinancial 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’ EquityHow 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 exampleTom 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 1Tom took $1,000 from his personal savings account to use in his business. He opened a new