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4.27: Structures of Key Financial Statements

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    Learning Outcome

    • Explain how key financial statements are structured

    As you have seen, there are four basic financial statements: the Income Statement, the Statement of Owners’ Equity, the Balance Sheet, and the Statement of Cash Flows.

    Income Statement

    The income statement shows revenues less expenses, also known as net income. In accounting, the word “net” means the combined total of both negative and positive amounts. For financial statement purposes, accountants don’t identify account balances by debit and credit—that’s part of the internal process of accounting and bookkeeping that has to do with the double-entry system you studied earlier.

    Here is the adjusted trial balance we created for our sample company:

    Adjusted Trial Balance as of Jan 31, 20XX
        Debit Credit
    1101 Checking 16,050  
    1210 Merchandise Inventory 360  
    1320 Prepaid Rent 800  
    1620 Furniture and Equipment 2,750  
    2101 Accounts Payable   600
    2201 Wages Payable   500
    2550 Notes Payable   15,000
    3310 Capital Contributions   5,000
    4510 Merchandise Sales   400
    5200 Cost of Goods Sold 240  
    5300 Wage Expense 500  
    5510 Rent Expense 200  
    5520 Insurance Expense 600  
      Total debits must equal total credits 21,500 21,500

    The income statement always begins with revenue and then continues with a list of expenses for a period of time, either a month, a quarter, or most commonly, a year. Large companies summarize expenses into major categories, such as Cost of Goods Sold, and a broad category called Selling, General and Administrative (SG&A). For our sample company, however, we have just a very few accounts, so we can list them out, subtotal the expenses, and subtract that amount from revenue to show net income or net loss.

    Your Company
    Income Statement
    For the month ended January 31, 20XX
    Merchandise Sales $400
    Cost of Goods Sold $240
    Wage Expense 500
    Rent Expense 200
    Insurance Expense 600
    Total Expenses 1,540
    Net Income/(Loss) $ (1,140)

    The bottom line on the income statement is either an increase in owners’ equity, if it is net income, or a reduction in owners’ equity if it is a loss (expenses exceed revenues). It is like a moving picture of the company, showing amounts earned during the regular course of business (revenues) and the matching costs (expenses).

    In our example from the previous section, expenses far exceeded revenues, which is common in the first few months of a new business, so the company is showing a net loss.

    Statement of Owners’ Equity

    The statement of owners’ equity, or owner’s equity if the company is a sole proprietorship, shows beginning owner capital, additions and subtractions to capital, including net income from the Income Statement. This gives the total owners’ capital at the end of the same specific time period as the Income Statement. This amount will be the beginning capital for the next Statement of Owners’ Equity. Both of the Income Statement and the Statement of Owners’ Equity, as well as the Statement of Cash Flows, show activities over a period of time, such as a year.

    Your Company
    Statement of Owner’s Equity
    For the month ended January 31, 20XX
    Beginning Capital $–
    Owner Contributions 5,000
    Net Income/(Loss) (1,140)
    Owner Withdrawals
    Ending Capital
    Ending Capital $3,860

    Notice that the Statement of Owner’s Equity reflects the expanded accounting equation:

    Equity = Owner Contributions – Owner Withdrawals + Revenues – Expenses.

    Balance Sheet

    The balance sheet, unlike the previous two statements, shows a snapshot of the business at a moment in time. Notice that the Income Statement and the Statement of Owners’ Equity both identify the period of time covered, but the Balance Sheet indicates a specific date that is always the last day of the time period covered by the prior two statements. The balance sheet is based on the accounting equation and show total assets, total liabilities, and owners’ equity, and shows as well how they balance.

    Your Company
    Balance Sheet
    As of January 31, 20XX
          Current Assets
                      Cash and Cash Equivalents $16,050
                      Merchandise Inventory 360
                      Prepaid Expenses 800
                             Total Current Assets 17,210
                      Property, Plant, and Equipment 2,750
    Total Assets $ 19,960
    Current Liabilities
                 Accounts Payable $600
                 Wages Payable 500
                    Total Current Liabilities 1,100
    Long-term debt 15,000
                Total Liabilities $16,100
    Owner’s Equity 3,860
    Total Liabilities and Owner’s Equity 19,960

    Notice that total assets of $19,960 is equal to total liabilities and equity of $19,960, and that the owner’s equity of $3,860 carried forward from the bottom line of the Statement of Owner’s Equity. Finally, the statement of cash flows reconciles beginning cash and cash equivalents from the balance sheet (ending cash from the prior set of financial statements) to ending cash from the current balance sheet, effectively reconciling accrual basis accounting to cash basis.

    Your Company
    Statement of Cash Flows
    For the month ended January 31, 20XX
    Cash provided by operating activities
                      Cash receipts from customers $400
                      Cash payments to vendors (1,600)
                                Cash provided by/(used by)operations (1,200)
    Cash provided by investing activities
                    Purchases of fixed assets (2,750)
                                Cash provided by/(used by) investing (2,750)
    Cash provided by financing
               Long-term borrowing 15,000
               Owner contributions 5,000
                    Cash provided by/(used by) financing 20,000
    Change in cash 16,050
    Beginning cash balance
    Ending cash balance $16,050

    In our sample company, both beginning equity and beginning cash were zero. This statement tells us that operations used $1,200 in cash, as opposed to accrual basis net income from the income statement in the amount of $1,140, and that investing in fixed assets used $2,750 in cash. It also tells us that cash was provided by a combination of borrowing and owner investment in the company.

    Other Financial Statements

    A Statement of Comprehensive Income is often included along with the Income Statement if the company has certain investments that are adjusted to fair market value. Some smaller companies not subject to the full disclosure of GAAP only prepare the three most basic financial statements, and exclude the Statement of Cash Flows and the Statement of Comprehensive Income, providing instead just the Income Statement, the Statement of Owners’ Equity, and the Balance Sheet.

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    • Structures of Key Financial Statements. Authored by: Freedom Learning Group. Provided by: Lumen Learning. License: CC BY: Attribution

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