FUNDAMENTALS OF

ACCOUNTANCY, BUSINESS AND

MANAGEMENT 2
For Senior High School

Antique National School

Prepared by:

KRISTIN M. CEPEDA
Module in Fundamentals of ABM 2
1st Semester

Lesson 1: Statement of Financial

Position
At the end of the lesson, the students will be able to:
1. understand the purpose of the Statement of Financial Position (SFP);
2. enumerate the basic elements of the Statement of Financial Position;
3. describe the nature of the accounts reported on the Statement of Financial Position;
4. prepare Statement of Financial Position using report format and account format; and
5. prepare a classified Statement of Financial Position.

STATEMENT OF FINANCIAL POSITION – Also known as the balance sheet. This statement
includes the amounts of the company’s total assets, liabilities, and owner’s equity which in
totality
provides the condition of the company on a specific date. (Haddock, Price, & Farina, 2012)

The statement of financial position reflects the claim of the creditors and the owners on
the assets of the business. The claim of the creditors is technically called liabilities, while the
claim of the owners is referred as equity. This relationship is clearly depicted in the basic
accounting equation: asset is equal to liabilities plus capital.

Assets are resources controlled by the entity as a result of past events and from which
future economic benefits are expected to flow the entity. Assets are the resources owned by a
business. Thus, they are the things of value used in carrying out such activities as production,
consumption, and exchange. The common characteristic possessed by all assets is the capacity
to provide future services or benefits to the entities that use them.

Liabilities are resent obligations of the entity arising from past events, the settlement of
which are expected to result in an outflow from the entity of resources embodying economic
benefits. Liabilities are existing debts and obligations. These are claims of the creditors against
assets.

Equity is the residual interest in the assets of the entity after deducting all its liabilities.
It is the ownership claim on total assets. It is equal to total assets minus total liabilities. It is
usually referred as residual equity since the claims of creditors’ take precedence over ownership
claims.

PERMANENT ACCOUNTS – As the name suggests, these accounts are permanent in a

sense that their balances remain intact from one accounting period to another. (Haddock, Price,
& Farina, 2012) Examples of permanent account include Cash, Accounts Receivable, Accounts
Payable, Loans Payable and Capital among others. Basically, assets, liabilities and equity
accounts are permanent accounts. They are called permanent accounts because the accounts
are retained permanently in the SFP until their balances become zero. This is in contrast with
temporary accounts which are found in the Statement of Comprehensive Income (SCI).
Temporary accounts unlike permanent accounts will have zero balances at the end of the
accounting period.

CONTRA ASSETS – Contra assets are those accounts that are presented under the assets
portion of the SFP but are reductions to the company’s assets. These include Allowance for
Doubtful Accounts and Accumulated Depreciation. Allowance for Doubtful Accounts is a contra
asset to Accounts Receivable. This represents the estimated amount that the company may not
be able to collect from delinquent customers. Accumulated Depreciation is a contra asset to the
company’s Property, Plant and Equipment. This account represents the total amount of
depreciation booked against the fixed assets of the company.

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Report Form – A form of the SFP that shows asset accounts first and then liabilities and
owner’s equity accounts after. (Haddock, Price, & Farina, 2012) The balance sheet
shown earlier is in report form.

Account Form – A form of the SFP that shows assets on the left side and liabilities and
owner’s equity on the right side just like the debit and credit balances of an account.
(Haddock, Price, & Farina, 2012)

Current Assets – Assets that can be realized (collected, sold, used up) one year after
year-end date. Examples include Cash, Accounts Receivable, Merchandise Inventory,
Prepaid Expense, etc.

Current Liabilities – Liabilities that fall due (paid, recognized as revenue) within one
year after yearend date. Examples include Notes Payable, Accounts Payable, Accrued
Expenses (example: Utilities Payable), Unearned Income, etc.

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Current Assets are arranged based on which asset can be realized first (liquidity).
Current assets and current liabilities are also called short term assets and shot term
liabilities.

Noncurrent Assets – Assets that cannot be realized (collected, sold, used up) one year
after yearend date. Examples include Property, Plant and Equipment (equipment,
furniture, building, land), Long Term investments, Intangible Assets etc.

Noncurrent Liabilities – Liabilities that do not fall due (paid, recognized as revenue)
within one year after year-end date. Examples include Loans Payable, Mortgage
Payable, etc.

Noncurrent assets and noncurrent liabilities are also called long term assets and long
term liabilities.

The main difference of the Statements of the two types of business lies on the
inventory account. A service company has supplies inventory classified under the
current assets of the company. While a merchandising company also has supplies
inventory classified under the current assets of the company, the business has another
inventory account under its current assets which is the Merchandise Inventory, Ending.

THE ASSETS

An entity shall present current and noncurrent assets as separate classifications

on the face of its balance sheet.

Current Assets
Current assets are cash and other resources that are reasonably expected to be
realized in cash or sold or consumed in the business within one year of the balance
sheet date or the company’s operating cycle, whichever is longer. For example,
accounts receivable is included in current assets because they will be realized in cash
through collection within one year. In contrast, a prepayment such as supplies is a
current asset because it is expected of its expected use or consumption in the business
within one year.
The operating cycle of a company is the average time that is required to go from
cash to cash in producing revenues. It is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents. When the organization’s
normal operating cycle is not clearly identifiable, its duration is assumed to be twelve
months.
In service enterprise, it is customary to recognize four types of current assets:
(1) cash, (2) marketable securities such as government bonds held as a temporary
(short-term) investment, (3) receivables (notes receivable, accounts receivable and
interest receivable), and (4) prepaid expenses (insurance and supplies). These items
are listed in the order of liquidity, that is, in the order which they are expected to
be converted into cash.

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Composition of Current Assets

1. Cash and Cash Equivalents

Cash compromises cash on hand and demand deposit.
a. Money. This includes undeposited cash collection in form of bills and coins.
Money may be on hand (cash on hand) or in bank (cash in bank).
b. Money Substitutes. These are in form of customer’s checks, bank drafts,
money orders, manager’s checks, cashier checks or traveler’s checks.
Money substitutes are included as part of cash and cash equivalent
account if they are acceptable for immediate credit.
c. Current working funds. These are funds set aside to meet current needs
like petty cash fund, interest fund, dividend fund, and payroll fund. These
are included if they are maintained for the current operation of the
business.
Cash equivalents are short term liquid investments that are readily convertible
to known amounts of cash and subject to an insignificant risk of changes in value. An
investment qualifies as a cash equivalent only when it has a short-term maturity of
three months or less from the date of acquisition. Examples: three-month time deposit,
three-month money market placement, three-month BSP treasury bill, and five-year
treasury bill acquired three months before the maturity date.

2. Trade and Other Receivables

Receivables are broadly classified as trade receivable and nontrade

receivable.
a. Trade receivable arises from the ordinary course of business transactions
and are shown as current assets if collectible within one year or within the
normal operating cycle of the business. The common examples of trade
receivables are accounts receivable and notes receivable.
b. Nontrade receivable, on the other hand, are claims that arise not from the
ordinary course of the business operations. Nontrade receivables will
include advances to officers, employees, directors or shareholders;
advances to affiliates; claims against common carriers for damages; and
advance to suppliers for merchandise.

3. Inventories
Inventories are assets on the face of the business that are held for sale in the
ordinary course of business, in the process of production for such sale, or in
form of materials or supplies to be consumed in the production process or in
the rendering of services.

Cost of inventories shall comprise:

a. Cost of purchase
i. Purchase price
ii. Add Import duties and other taxes, transport and handling, and
other costs directly attributable to the acquisition of finished goods,
materials and services.
iii. Less trade discounts, rebates, and other similar items
The cost of goods purchased is computed as follows:

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b. Cost of conversion
i. Direct materials
ii. Direct labor
iii. Manufacturing overhead
c. Other cost incurred in bringing the inventories to their present location
and condition

Merchandising or trading business entities generally label their inventories as

merchandising inventory. Manufacturing concerns label their inventories
as finished goods, goods in process, and raw materials inventory.

4. Prepaid Expenses
Prepaid expense is a one-line item classification that includes all prepayments
made that are expected to be consumed within one year from the date of the
statement of financial position. Examples of prepaid expenses are prepaid
rent, prepaid advertising, prepaid insurance, and unused office and store
supplies.

Noncurrent Assets

Assets that do not meet any of the criteria required for current assets are
classified as noncurrent assets. The term “noncurrent” is use to include tangible,
intangible and financial assets of a long-term nature. It does not prohibit the use of
alternative descriptions as long as the meaning is clear.

Composition of Noncurrent Assets

The noncurrent assets section of the statement of financial position shall include
property, plant and equipment; long-term investment; intangibles; and other
noncurrent assets.
1. Property, Plant and Equipment (PPE)
PPE are tangible items that are held for use in the production or supply of goods
or services for rentals to others, or for administrative purposes; and are
expected to be used during more than one period. PPE are tangible resources of
relatively permanent nature that are used in business and not intended for sale.
This category includes land, buildings, machinery and equipment, delivery
equipment and furniture and fixtures. Assets subject to depreciation should be
reported at cost less accumulated depreciation.

Measurement of PPE at Recognition. The cost of an item of PPE comprises of:

a. Its purchase price, including import duties and nonrefundable purchase taxes,
after deducting trade discounts and rebates;
b. Any cost directly attributable to bringing the asset to the location and
conditions necessary for it to be capable of operating in the manner intended
by management; and
c. The initial estimate of the cost of dismantling and removing the item and
restoring the site on which it is located.
Examples of directly attributable costs;
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 Cost of employee benefits arising directly from the construction or

acquisition of the item of PPE
 Cost of site preparation
 Initial delivery and handling costs
 Installation and assembly costs
 Cost of testing whether the asset is functioning properly
A class of property, plant and equipment is a grouping of assets of similar nature
and use in an entity’s operation. The following are examples of separate classes:
a. Land
b. Land and buildings
c. Machinery
d. Ships
e. Aircraft
f. Motor vehicles
g. Furniture and fixtures
h. Office equipment

2. Long-term Investments
Long-term investments are assets held by an entity intended to accumulate
wealth or resources by means of capital distribution in form of royalties, interest,
dividends, rentals, capital appreciation, or other benefits obtained through
trading relationships with the intention of holding the investments for more than
one year.

Like current assets, long-term investments are resources that can be realized in
cash. However, the conversion into cash is not expected within one year or the
operating cycle, whichever is longer. In addition, long-term investments are not
intended for use or consumption within the business. This category, often just
called “investments,” normally includes stocks and bonds of other corporations.

Examples:
a. Sinking fund
b. Plant expansion fund
c. Investment in bonds
d. Investment in stocks
e. Cash surrender value of life insurance
f. Investment in subsidiary
g. Investment property
h. Investment in joint control entity

3. Intangibles
Intangible asset is defined as an identifiable nonmonetary asset without physical
substance. Intangible assets are noncurrent resources that do not have physical
substance. Intangible assets are recorded at cost, and this cost is expensed over
the useful life of the intangible asset. Intangible assets include patents,
copyrights, and trademarks or trade names that give the holder exclusive right

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of use for specified period of time. Their value to a company is generally derived
from the rights or privileges granted by governmental authority.

Examples:
a. Copyrights
b. Patent
c. Licenses and franchise
d. Brand names
e. Masthead and publishing titles
f. Computing software
g. Recipes, formulae, modes, designs and prototypes
h. Industrial property rights, service and operating rights

4. Other Noncurrent Assets

This is the line item that presents noncurrent assets not falling under the
classification of property, plant and equipment; long-term investment; or
intangibles. Examples of other noncurrent assets are abandoned property, long-
term refundable deposits, or long-term advances to employees or officers.

LIABILITIES

Liability is a present obligation of the entity arising from past events the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits.
Characteristics of Liabilities:
a. It is a present obligation of an entity, and not a future commitment.
b. It is legally enforceable as a consequence of a binding contract or statutory
requirements, or when asset is delivered.
c. It arises from business practice, customs, and a desire to maintain good
business relations or act in equitable manner.
d. The settlement of the obligation usually involves giving up of entity’s resources.

Current Liabilities

Listed first in the liabilities and owner’s equity section of the balance sheet are
current liabilities. Current liabilities are obligations that are reasonably expected to be
paid from existing current assets or through the creation of another current liabilities.
Current liabilities include debts related to the operating cycle such as accounts payable
and wages and salaries payable, and other short-term debts, such as bank loans
payable, interest payable, taxes payable and current maturities of long-term
obligations.

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The arrangement of items within the current liabilities section has evolved
through custom rather than from a prescribed rule. Notes payable is usually listed first,
followed by accounts payable. Other items are then listed in any order.
A liability shall be classified as current when it satisfies any of the following criteria:
a. It is expected to be settled in the entity’s normal operating
b. It is held primarily for the purpose of being traded.
c. It is due to be settled within twelve months after the balance sheet date.
d. The entity does not have an unconditional right to defer settlement of the
liability for at least 12 months after the balance sheet date.
Examples of current liabilities
a. Trade and other payables
b. Short term bank loan
c. Warranty payable
d. Income taxes payable
e. Current portion of noncurrent financial liabilities
f. Short-term loans
g. Dividends payable

Users of financial statements look closely at the relationship between current

assets and current liabilities. This relationship is important in evaluating a company’s
liquidity – its ability to pay obligations that are expected to become due within the
next year or operating cycle. When current assets exceed current liabilities at the
balance sheet date, the likelihood for paying the liabilities is favorable. When the
reverse is true, short term creditors may not be paid, and the company may ultimately
be forced into bankruptcy.

Noncurrent / Long-term Liabilities

Obligations expected to be paid after one year or an operating cycle, whichever

is longer, are classified as long-term liabilities. Liabilities in this categeory include
bonds payable, mortgages payable, long-term notes payable, lease liabilities, and
obligations under employee pension plans. Many companies report long-term debt
maturing after one year as a single amount in the balance sheet and show the details
of the debt in the notes that accompany the financial statements.

EQUITY

Equity is the residual interest in the assets of the entity after deducting all its
liabilities. For sole proprietorship, the equity section of the owner is commonly labeled
as Owner’s Capital or Owner’s Equity. In case the business is considered a partnership,
the equity of the partners is generally labeled as Partners’ Equity and there is a capital
account for each partner.
The equity section of a corporate entity is usually labelled as Stockholders’ or
Shareholders’ Equity. For a corporation, owner’s equity is divided into two accounts –
Capital Stock and Retained Earnings. Investment of assets in the business by the

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stockholders are recorded by debiting an asset account and crediting the Capital Stock
account. Income retained for use in the business is recorded in the Retained Earnings
account. These two accounts are combined and reported as stockholder’s equity on
the balance sheet.
Although equity is defined as a residual interest, it may be subclassified in the
statement of financial position of the corporate entity. For example, a separate
presentation may be made for funds contributed by shareholders, retained earnings,
reserves representing appropriation for retained earnings, and reserves representing
capital maintenance adjustments.
Classified Statement of Financial Position in report form:
PIONEER ADVERTISING AGENCY
Statement of Financial Position
October 31, 2019

ASSETS
Current Assets
Cash $15,200
Accounts Receivable 200
Advertising Supplies 1,000
Prepaid Insurance 550
Total current assets 16,950
Property, plant and equipment
Offi ce equipment $5,000
Less: Accumulated depreciation 40 4,960
Total assets $21,910

LIABILITIES AND OWNER'S EQUITY

Current liabilities
Notes payable $1,000
Accounts payable 2,500
Interest payable 50
Unearned revenue 800
Salaries payable 1,200
Total current liabilities $5,550
Long-term liabilities
Notes payable 4,000
Total liabilities $9,550
Owner's equity
C.R. Byrd, Capital 12,360
Total liabilities and owner's equity $21,910

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EXERCISES:

1. If assets are Php17,000 and owner's equity is Php10,000, liabilities are ______.

2. At the end of the first month of operations for Juana’s Delivery Service, the
business had the following accounts: Accounts Receivable, Php1,200; Prepaid
Insurance, Php500; Equipment, Php36,200 and Cash, Php40,650. On the same
date, Juana owed the following creditors: Nena’s Supply Company, Php12,000;
Maria’s Equipment, Php9,500.The current assets for the Juana’s Delivery Service
are _________.

3. At the end of the first month of operations for Juana’s Delivery Service, the
business had the following accounts: Accounts Receivable, Php1,200; Prepaid
Insurance, Php500; Equipment, Php36,200 and Cash, Php40,650. On the same
date, Juana owed the following creditors: Nena’s Supply Company, Php12,000 (due
in 6 months); Maria’s Equipment, Php9,500 (due after years). Current liabilities are
_________.

4. If during the year total assets increase by Php75,000 and total liabilities decrease
by Php16,000, by how much did owner's equity increase/decrease?

5. Prepare a Statement of Financial Position using the following accounts (one in

report form and one in account form):
Cash 5,000
Loans Payable 77,500
Accounts Receivable 2,600
Supplies 2,300
Equipment 17,000
Owner’s equity 40,000
Accounts Payable 22,400
Building 113,000

PROBLEM 1
Friendly Convenience Store is managed by Juana Dela Cruz.

A. Juana asked you to determine the balance of her cash account as of December
31, 2018. You determined the following:
1. She kept some cash in the store as change fund (sukli). The cash count revealed
3 pieces of 100 peso bill, 5 pieces of 50 peso bills, 5 pieces of 20 peso bills, 5
pieces of 10 peso coins, 10 pieces of 5 peso coins, 10 pieces of 1 peso coins, and
25 pieces of 25 centavo coins.
2. Two of the regular customers gave Juana the following checks in payment of
debts:
a. P1540 check dated December 31, 2018
b. P2,432 check dated January 3, 2019
3. There are two bank accounts in the name of the store with the following
balances:
a. Balance of the saving accounts on December 31, 2018 according to the
passbook is P26,780
b. A time deposit certificate for P100,000 for 90-days.

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Report to Juana Dela Cruz the balance of the cash and cash equivalents accounts of
Friendly Convenience Store.

B. Juana paid premium of P2,500 for one-year fire insurance in the name of the
store on October 1, 2018. How much should prepaid insurance be on December
31, 2018?
C. On January 1, 2017, Juana purchased an electronic cash register to be used in
the Friendly Convenience Store. The cash register was purchased at a cost of
P15,000. Juana depreciates the cash register over five years. Determine the
following:
a. Equipment
b. Annual Depreciation
c. Accumulated Depreciation as of December 31, 2018
d. Net book value of Equipment as of December 31, 2018.

D. On November 15, 2018, Juana Dela Cruz purchased five sacks of rice at P1,800
per sack. The credit term is 2/10,n/30. Determine how much Juana should pay
given the following payment dates:
a. November 25, 2018
b. December 15, 2018
E. Read the excerpt of the Promissory Note below
Answer the following questions:

Promissory Note
November 1, 2018

1. Promise to Pay. For value received, Friendly Convenience Store, represented by

Juana Dela Cruz, the manager (Borrower) promises to pay United Bank (Lender)
P25,000 (Twenty Five Thousand pesos) and interest at the yearly rate of 6% on
the unpaid balance as specified below.
2. Installment. Borrower will pay five payments of P5,000 each at monthly interval
on the 30th day of the month. First payment is due on November 30, 2018.
3. Application of Payments. Payments will be applied first to interest and then to
principal.
4. Prepayment. Borrower may prepay all or any part of the principal without
penalty.
5. Loan Acceleration. If Borrower is more than five days late in making any
payment, Lender may declare that the entire balance of unpaid principal is due
immediately, together with the interest that has accrued.

1. Who will record the Notes Payable?

2. Who will record the Notes Receivable?
3. Compute for the payment due on November 30, 2018 and December 30,
2018.
4. Determine the balance of Notes Payable as of December 31, 2018.
F. Juana hired Elene Reyes as storekeeper with salary of P400 per day. Elena is
paid every Saturday for work rendered during the week. Sunday is her off-day.
December 32, 2018 falls on a Thursday. Determine the balance of Salaries
Payable to be reported on the Store’s SFP as of December 31, 2018.

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G. Pedro Benites, a neighbor of Juana, operates a coffee vending machine business.

On October 1, 2018, he entered in a contract with Juana to rent a small space
on the counter-top of the Store where he can put his coffee vending machine.
The rent is P500 per month. Pedro paid six months in advance rent on October
1, 2018. How much should be reflected as Unearned Rent Income on the Store’s
SFP as of December 31, 2018?
H. In order to construct a store, Juana borrowed P50,000 from Universal Bank and
P25,000 from United Bank. Terms of the loans are as follows:
Universal Bank: The bank requires Juana to pay interest of 7% payable monthly.
The principal is payable on October 1, 2020.
United Bank: The bank requires Juana to pay five monthly installment of P5,000
plus interest on the unpaid balance. The loan was taken on November 1, 2018
and first monthly installment id due on November 30, 2018.
Which of the two loans should be reported as Long-Term Liability on the Store’s
calendar year 2018 SFP?

PROBLEM 2

You were hired by Mr. Juan Dela Cruz to prepare his sari-sari store’s Statement of
Financial Position. In order to prepare the statement, you identified the following assets
and liabilities of Mr. Dela Cruz:
1. His sari-sari store has cash deposited in a bank account amounting to
P50,000
2. His sari-sari store had a lot of uncollected sales from customers
amounting to P75,000
3. The total amount of merchandise left inside the store is P30,000
4. He already paid one year’s rent in advance amounting to P12,000
5. The value of all the company’s furniture amounted to P100,000
6. He bought merchandise from his supplier amounting to P25,000 and the
supplier agreed that payment can be made 2 months after year-end
7. SSS, Philhealth and Pag-ibig Payables for his one employee totaled P5,000
8. The sari-sari store had outstanding liabilities to utility companies
amounting to P3,000
9. He had a loan from the bank amounting to P50,000 to be paid in 3 years
Prepare a Statement of Financial Position for the company (one in report form and one
in account form)
PROBLEM 3
On February 1, 2014, Mira Delamar opened a store that sells school supplies. Her main
customers are the students and teacher of Happy Student School that is situated in
from of her store. Mira wanted to know the financial position of Mira’s Store. Mira knew
you were studying accounting so she asked for your help.

The following information were made available to you:

1. To start her business, Mira opened a checking account in the name of Mira’s
Store. The statement of the account from bank shows that the checking account
has a balance of P31,535 as of December 31, 2014.

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2. Mira told you that she keeps P1,000, in small bills and coins, in her store which
she uses as a change fund.
3. As of December 31, 2014, cash on hand from sales and collections for the day
amounted to P12,000. This does not include Mira’s change fund.
4. Mira showed you a delivery receipt for P575. The receipt dated December 29,
2014 showed that manila papers and color markers were delivered to a Ms.
Rebecca Di who is a grade school teacher in Happy Students School. Ms. Di
noted on the delivery receipt that she will pay Mira on January 15, 2015.
5. Mira’s Store is located on the ground floor of a commercial building. The
commercial unit costs her P5,00 per month for rent. As of December 31, 2014,
Mira’s store has a remaining one month advance rent with the landlord.
6. Mira purchased shelves and cabinets amounting to P30,000 to be used as display
racks and storage for her store. The shelves and cabinets are expected to be
used in the store for 5 years. Mira started using the shelves and cabinets on
December 1, 2014.
7. After closing the store on December 31, 2014, Mira counted the unsold
merchandise inside the store. Mira does not have any other store space except
for the store premises. Based on Mira’s count, the remaining unsold merchandise
costs P15,345.
8. Mira showed you a folder she kept her unpaid receipts and bills. You noted the
following:
a. A sales invoice dated December 25, 2014 from Long Lasting Ballpoint
Pens Incorporated amounting to P2,645. The invoice term is 30 days.
b. A sales invoice from Papier Paper Company dated December 15, 2014 for
P5,465. The payment terms on the invoice is 40 days.
c. A Meralco bill for electricity consumption from December 1-31 for P3,400.
The bill is payable on January 15, 2015.
d. December PLDT bill for P600. The bill is payable on January 17, 2015.
e. Mira hired Emily to help her inside the store. Emily’s salary is P500/day.
Emily’s wage were paid on December 30, 2014, for work rendered until
December 29. Her pay for December 30 and 31 will be included in her
January wages.
9. Mira showed you an official receipt for P1,395. She told you that this is a down
payment from Ms. Benny Ling, a grade 5 teacher in Happy Students School. Ms.
Ling ordered green, red and blue poster pain for her students. The total price of
the order was P2790. According to their agreement, Mira will deliver the paints
on January 3, 2015.
10. On December 31, 2014, Mira borrowed P23,000 from her bank. She took
advantage of the bank’s special terms for small entrepreneurs. She signed a
promissory note for her loan. The principal is payable on December 30, 2016.
The interest is payable monthly beginning January 31, 2015.
11. Mira started her business depositing P30,000 to open the checking
account. On October 15, 2014, the business is in need of additional cash so Mira
deposited P5,000 to the checking account. Mira also withdraw P15,000 from the
business over the year.

Requirements:

1. Prepare a classified Statement of Financial Position for Mira’s Store as of

December 31, 2014.

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PROBLEM 4

The adjusted trial balance for Bel-Air’s Bowling Alley at December 31, 2019, contains the
following accounts.

Debits Credits
Building 6,313,800.00 T. Henkel, Capital 5,610,000.00
Accounts Receivable 740,520.00 Accumulated Depreciation - Building 2,325,600.00
Prepaid Insurance 238,680.00 Accounts Payable 687,480.00
Cash 1,062,840.00 Mortgage Payable 4,773,600.00
Equipment 3,182,400.00 Accumulated Depreciation - Equipment 954,720.00
Land 3,121,200.00 Interest Payable 132,600.00
Insurance Expense 39,780.00 Bowling Revenues 723,180.00
Depreciation Expense 375,360.00 15,207,180.00
Interest Expense 132,600.00
15,207,180.00

Instructions:

1. Prepare a classified statement of financial position; assume that ₱693,600 of the

mortgage payable will be paid in 2020.

PROBLEM 5

The following items were taken from the financial statements of J. Pineda Company.
(All amounts are in thousands.)

Instructions: Prepare a classified balance sheet in good form as of December 31, 2017.

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PROBLEM 6
Izzy Merchandising provided the following accounts appearing on its ledger as of December 31,
2018:

Cash in bank 1,800,000

Accounts receivable - trade 2,100,000
Inventories 800,000
Offi ce supplies 50,000
Notes receivable - trade 1,000,000
Accounts payable - trade 1,200,000
Long-term investment 1,500,000
Held for trading securities 900,000
Property, plant and equipment 5,000,000
Accrued expenses 350,000
Bonds payable 4,000,000
Petty cash fund 30,000
Allowance for doubtful accounts 250,000
Accumulated depreciation 1,500,000
Patent 300,000
Prepaid advertising 70,000
Izzy, Capital 7,300,000
Izzy, Drawing 850,000
Advances to employees 200,000

Prepare the classified statement of financial position as of December 31, 2018.

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Performance Name Grade Level 12 Score

Task
No. 1 Section Learning Area Fundamentals of ABM 2
1st Semester
2020-2021 Date Topic Statement of Financial
Position

PROBLEM 7

The following account balances were provided by Nicanor Company as of December 31, 2018:

Notes receivable - trade 2,500,000 Land 2,500,000

Notes payable - trade 1,500,000 Withholding tax payable 150,000
Income tax payable 250,000 SSS payable 300,000
Patent 150,000 Accumulated depreciation - building 1,500,000
Cash on hand awaiting deposit 500,000 Accumulated depreciation - machinery 1,000,000
Accounts receivable - trade 2,200,000 Refundable deposit of customers - long term 100,000
Finished goods 900,000 Prepaid insurance 180,000
Claims receivable 200,000 Investmet in bonds 500,000
Franchise 200,000 Bonds payable 6,000,000
Goods in process 400,000 Building 6,000,000
Goodwill 500,000 Machinery 3,000,000
Factory supplies 100,000 Advances to offi cers collectible in 2021 1,800,000
Offi ce supplies 40,000 Nicanor, Drawing 700,000
Cash in bank 1,400,000 Accrued interest on notes receivable 120,000
Sinking fund 250,000 Deferred tax liablity 100,000
Raw materials 300,000 Accounts payable 2,500,000
Nicanor, Capital 13,260,000 Trading securities 400,000
Time deposit, due in 60 days 1,000,000 Cash surrender value 120,000
Investment in subsidiary 1,200,000 Warranty payable 300,000
Allowance for doubtful accounts 200,000

Lesson 2: Statement of Comprehensive

Income
At the end of the lesson, the students will be able to:
1. understand the purpose of the Statement of Comprehensive Income;
2. identify the elements of the SCI and describe each of these items for a service business and a
merchandising business;
3. describe the nature of accounts reported on the Statement of Comprehensive Income;
4. prepare an SCI for a service business using the single-step approach; and
5. prepare an SCI for a merchandising business using the multistep approach.

A statement of comprehensive income (new title for income statement) is a

structured financial statement that shows the financial performance of a business
entity for a given period. A period covered by an income statement may be monthly,
quarterly, semi-annually or annually. This statement contains the following
information:
1. Revenue generated by operating the business;
2. Costs spent to generate the revenue; and
3. Income, which is the excess of revenue over costs.

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STATEMENT OF COMPREHENSIVE INCOME – Also known as the income statement. It

contains the results of the company’s operations for a specific period of time which is
called net income if it is a net positive result while a net loss if it is a net negative
result. This can be prepared for a month, a quarter or a year. (Haddock, Price, &
Farina, 2012)

Differences Between Statement of Financial Position and Statement of

Comprehensive Income
Statement of Financial Statement of
Position Comprehensive Income
As to accounting Assets, liabilities and Income and expenses
elements presented equity
As to the nature of the Presents the financial Presents the result of
statement position operation
As to the financial data Liquidity, solvency, Profitability of the business
needed for decision financial structure and entity
making capacity for adaptation
As to the date of the As of a given date (one For a given period
financial statement day)
As to the nature of the Real accounts Nominal accounts
account in the
statement

TEMPORARY ACCOUNTS – Also known as nominal accounts are the accounts found
under the SCI. They are called such because at the end of the accounting period,
balances under these accounts are transferred to the capital account, thus having only
temporary amounts and resulting to zero beginning balances at the beginning of the
following year.(Haddock, Price, & Farina, 2012)Examples of temporary accounts
include revenues, sales, utilities expense, supplies expense, salaries expense,
depreciation expense, interest expense among others.

Income refers to increases in economic benefits during the accounting period in

the form of inflows or enhancement of assets or decreases of liabilities that result in
increases in equity other than those relating to contributions from equity participants.

Expenses are decreases in economic benefits during the accounting period in

the form of outflows or depletion of assets or incurrences of liabilities that result in
decrease in equity other than those relating to distribution of equity participants.

Accrual Concept of Accounting

Accrual is one of the fundamental concepts of financial accounting. Specifically,

this is the concept that dictates when an item must be reported on the SCI. Accrual
states that revenue must be reported on the accounting period that it was earned.
Similarly, expenses must be reported during the same reporting period they were
incurred.
Generally, revenue is earned upon delivery of goods and services, not when
payment is received from the customer. More specifically, sale of goods are reported
on the SCI on the period of delivery. On the other hand, revenues from services are
counted on the period when services are rendered. Neither order from a customer nor

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signed contract of service count as sales. More importantly, cash collections are not
revenue.
By following the concept of accrual, expense is recognized when an item is used
to generate revenue. Expenses are recognized in the income statement based on
matching costs with revenues, systematic and rational allocation, and immediate
recognition.
Matching Principle - Expenses are matched and recognized in the same period
that the revenue it generated was recognized.
Rational Allocation – Requires the cost of long-term expenditure to be
rationally allocated over the period of usage on the expected pattern of usage. An
example of expenses estimated using rational allocation is the depreciation of
equipment.
Immediate Recognition - In cases when accountants cannot determine how
long the expenditure will benefit the business or if there is any benefit at all, then
conservatism dictates that the cost of the expenditure should be charged to expense
immediately. Why? Because we cannot rationally estimate the “life” of the benefit.
Hence, the cost is charged to expense immediately, generally in the year it was spent.
This method is used for costs of advertising.
To summarize, revenue is recognized on the period of delivery. Expense, on the
other hand, is recorded in the same period of the revenue it was able to generate. The
allocation maybe direct one to one correspondence or indirect estimate based on
rational allocation. However, should there be no rational way to allocate, the costs is
expensed immediately.

Elements of the Statement of Comprehensive Income

I. Revenue
a. Service Income. The Service Income account is generally used to
describe revenue derived from rendering of services. A more specific
account name may be used to identify the services rendered such as
Rental Income, Professional Fee and Tuition Fee Revenue.

Example 1. Tuition fee revenue

Little Lab pre-school collected tuition fee of ₱1,250,000 and
₱1,455,000 for the school year 2011-2012 and 2012-2013,
respectively. The school closed in April and May. Determine the
tuition fee revenue to be reported on SCI for the calendar year
2012.

Answer:

School Year 2011-2012 ₱1,250,000

Number of months from January – March 2012 3
Number of months in one school year 10
Tuition fee revenue for calendar year 2012 ₱375,000

School Year 2012-2013 ₱1,455,000

Number of months from June-December 2012 7
Number of months in one school year 10
Tuition fee revenue for calendar year 2012 ₱1,018,500

Total Tuition fee revenue for the year 2012 ₱1,393,500

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b. Sales. The Sales Revenue account is generally used to describe revenue

derived from selling of goods. A more specific account name may be used
to identify the foods such as Office Supplies Sales, Book Sales, Food
Sales, etc.

Revenue from sales of goods is recognized when goods have been

delivered. However, customers are allowed to return goods that do not
meet their quality standards. When goods are returned, it is not deducted
from Sales. Rather, normal accounting practice is to report it under the
account name Sales Return and Allowances – a Contra Sales account.
Also, accounting practice does not deduct discount from sales revenue.
Rather, use another contra sales account called Sales Discount.

Only Net Sales is reported on the face of SCI. Net Sales refer to Gross
Sales less Sales Return and Allowances and Sales Discount.

Example 2. Friendly Convenience Store: Sales Revenue

Juana Dela Cruz, owner of friendly Convenience Store, sold 3

boxes of ballpoint pens to Mrs. Susan Gonzales on account at a
price of P150 per box or P15 per pen. Juana gave Mrs. Gonzales
two weeks to pay the account. Moreover, Juana told Mrs.
Gonzales that she will deduct 2% discount if she pays within a
week.

Mrs. Gonzales return one week later. She returned five pens and
took advantage of the discount.

Determine the amount of Sales, Sales Return, Sales Discount

and Net Sales from the transaction with Mrs. Gonzales.

Answer:

Sales 150 x 3 ₱ 450.00

Sales Return 15 x 5 (75.00)
Amount to be paid by Mrs. Gonzales before discount 375.00
Sales discount (375 x 2%) 2% (7.50)
Amount paid by Mrs. Gonzales ₱367.50

Alternatively:

Sales ₱ 450.00
Less: Sales returns and allowances (75.00)
Less: Sales discount (7.50)
Net sales ₱367.50

II. Expenses
a. Cost of Goods Sold (Cost of Sales). This is an account used by
companies that sells goods instead of services. For trading operations,
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Cost of Sales collects the cost of merchandise sold. This includes the
purchase price inventory, brokerage, and shipment cost to bring the
goods to the premises of the company. This shipment cost is called
Freight-In.

Cost of sales is part of inventory accounting. Accountants have two ways

of keeping records of inventory – perpetual and periodic inventory system.
Perpetual means that the Inventory and Cost of Goods Sold accounts are
“perpetually” updated. The inventory account is increased when goods for
sale are acquired and decreased when goods are sold. The Cost of Goods
Sold account is updated every time a sale is made.

The other method is called periodic inventory system. The Inventory

account is only periodically updated. “periodically” means that the
inventory account is updated only at end of the year or end of the month.
Cost of merchandise acquired is collected using the Purchases account.
Returns of defective goods are reported under Purchase Returns and
Allowances. Discounts taken are reported under Purchase Discounts. “Net
Purchases” is equivalent to Purchases plus Freight-In less Purchase
Returns and Purchase Discount.

Cost of Sales under periodic inventory system is computed as follows:

Beginning Inventory
Add: Net Purchases (Purchases + Freight In- Purchase Returns –
Purchase Discount)
Cost of Goods Available for Sale
Less: ending Inventory
Cost of Goods Sold

Example 3. Friendly Convenience Store: Cost of Goods Sold

Juana Dela Cruz, owner of friendly convenience store, asked for
your help to determine the cost of sales of her store. This is the
first year of operations for Juana’s store. She provided the
following data to you.

Purchases (Based on supplier’s receipts) P55,344

Freight-In (based on receipts of taxi fares she 430
incurred when she shops for merchandise at
Divisoria
Purchase returns 760

Based on the inventory count taken at the last day of the year, the ending
inventory is valued at P2,320. How much is cost of sales?

Answer:

Beginning inventory ₱0
Purchases ₱ 55,344
Add: Freight-in 430
Less: Purchase Returns (760)
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Net purchases 55,014

Cost of Goods Available for Sale 55,014
Less: Ending inventory (2,320)
Cost of goods sold ₱52,694

b. Operating Expenses. Operating expenses refer to all other expenses

related to the operation of the business, other than cost of sales. These
include salaries of employees, supplies, utilities, gasoline expense,
representation, bad debts expense, depreciation and amortization.

Bad debt expense is an operating expense related to accounts receivable.

It is an estimated expense. Accounts Receivable is the right to collect
payment from customers. However, some accounts become uncollectible.
The accounting rule is (1) to periodically analyze the collectability of
Accounts Receivable and; (2) to immediately charge to expense the
amount deemed uncollectible. We will refer to this account as bad debts
expense. We can estimate bad debts expense using percentage of sales.
This method requires the determination of the historical relationship
between bad debts and sales (or credit sales).

Example 4. Friendly Convenience Store: Bad Debts Expense

Current year sales of the store amounted to p128,865. Of this,
only p70,000 is cash sales. Based on the company’s experience,
bad debts is 3% of total sales of 6.5% of credit sales. Determine
the bad debts expense if the owner decided to use the following:
1. percentage of total sales method
2. percentage of credit sales method

Answer
3% of total sales 6.5% of credit sales
Total sales ₱128,865
Total credit sales ₱ 58,865
Historical experience 3% 6.5%
Bad debts expense ₱3,866 ₱3,826

III. Other Expenses and Other Income

Losses and other expenses as well as gains and other income are reported after
the operating section of the SCI. Line items included under this section are
interest income from investment of excess cash, interest expense from
borrowing and gain or loss from sales of equipment (proceeds from sales less
net book value of PPE on date of sale).

Presentation of Statement of Comprehensive Income

Philippine Accounting Standard (PAS) 1 mentions two methods of presenting the

statement of comprehensive income:
1. Nature of expense method – expenses are aggregated according to their
nature.
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2. Function of expense / cost of sales method – expenses are classified

according to their function as part of cost of sales, distribution or administrative
activities. This method can provide more relevant information to users.

There are two format for SCI, namely, the single-step and the multi-step. The
single-step is closely related to the nature of expense format. On the other hand, the
multi-step approach is associated with the function of expense.

Single-step – Called single-step because all revenues are listed down in one section
while all expenses are listed in another. Net income is computed using a “single-step”
which is Total Revenues minus Total Expenses. (Haddock, Price, & Farina, 2012)

Multi-step – Called multi-step because there are several steps needed in order to arrive
at the company’s net income. (Haddock, Price, & Farina, 2012)

Statement of Comprehensive Income of a Service Company and of a

Merchandising Company

The main difference of the Statements of the two types of business lies on how they
generate their revenue. A service company provides services in order to generate
revenue and the main cost associated with their service is the cost of labor which is
presented under the account Salaries Expense. On the other hand, a merchandising
company sells goods to customers and the main cost associated with the activity is the
cost of the merchandise which is presented under the line item Cost of Goods Sold. In
presenting these items on the Statement of Comprehensive Income, a service
company will separate all revenues and expenses (as seen in the single-step format)
while a merchandising company will present total sales and cost of goods sold on the
first part of the statement which will net to the company’s gross profit before
presenting the other expenses which are classified as either administrative expenses or
selling expenses (as seen in the multi-step format).

Parts of the Statement of Comprehensive Income

Single-Step SCI

Multi-Step SCI

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EXERCISES
1. During October, a sari-sari store had the following transactions involving revenue and
expenses. Did the firm earn a net income or incur a net loss for the period? What was the
amount?
a. Paid Php1,200 for rent
b. Provided services for Php2,750 in cash
c. Paid Php250 for telephone service
d. Provided services for Php1,900 on credit
e. Paid salaries of Php1,675 to employees
f. Paid Php350 for office cleaning service

2. Compute for the Cost of Goods Sold using the following:

a. Sales – 15,000
b. Purchases – 2,000
c. Purchase returns – 200
d. Purchase discounts – 200
e. Freight in – 100
f. Beginning inventory – 1,000
g. Ending inventory – 500

3. Prepare a single-step Statement of Comprehensive Income using the following:

a. Revenues – 20,000
b. Rent expense – 3,000
c. Salaries expense – 4,000
d. Utilities expense – 2,000

4. Nena had the following expense accounts for the year ended December 31, 2016:
a. Salaries of admin personnel
b. Salaries of janitors
c. Salaries of sales agents
d. Utilities of home office
e. Rent of office building
f. Depreciation of office equipment
g. Depreciation of delivery van

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Module in Fundamentals of ABM 2
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h. Advertising
i. Cost of merchandise sold during the year
Identify if the account is part of the general and administrative expenses or selling expenses

5. The Happy Toddles is a preparatory school for children three to five years old. Students are
enrolled for a school-year. Parents can pay the full tuition fee of P70,000 at the start of the
school year (June). There is also an option to pay two installments of P37000 each at the
start of the every semester (June 1 and November 1). Of the 150 students enrolled, 80 are
paid in full at the start of the year. The remaining students are on installment basis. One
school year runs from June 1 to March 31.

Determine the tuition fee revenue for the period December 31. This is the first year of
Happy Toddlers operations.

6. There are 10 teachers employed by The Happy Toddlers, 5 senior teachers with a salary of
P30,000 a month and 5 junior teachers at P18,000 a month. There are also 5
administrators with average monthly salary of P35,000. Annual depreciation for furniture
and fixtures amounted to P100,000. Utilities expense for the year totals to P200,000.

Prepare a single-step SCI (CY December 31) for Happy Toddlers. Use the revenue
information in the previous problem.

7. The adjusted trial balance of Lopez Company shows the following data pertaining to sales at
the end of its fiscal year October 31, 1999: Sales $800,000, Freight-out $12,000, Sales
Returns and Allowances $24,000 and Sales Discounts $15,000. Prepare the sales revenues
section of the SCI.

8. Angel Company provided the following information for the year 2018:
Purchases 5,250,000 Purchases 5,250,000
Freight-in 150,000 Frei ght-i n 150,000
Freight-out 100,000 Frei ght-out 100,000
Purchase discount 280,000 Purchase discount 280,000
Purchase returns and allowances 120,000 Purchase returns and al lowances 120,000
Sales 9,000,000 Sales 9,000,000
Sales returns and allowances 200,000 Sales returns and allowances 200,000
Sales discounts 100,000 Sales discounts 100,000
Merchandise inventory, January 1 2,000,000 Merchandi se inventory, January 1 2,000,000
Merchandise inventory, December 31 3,200,000 Merchandi se inventory, December 31 3,200,000

What is the goods available for sale?

9. An analysis of the records of Princess Merchandising revealed the following information

during the current year:
Disbursement for purchases 6,500,000
Coll ection on sales 9,000,000
Payment for freight-in 100,000
Payment for freight-out 80,000
Increase in merchandise inventory 300,000
Increase in trade accounts payable 600,000
Disbursement for purchases 6,500,000
Coll ection on sales 9,000,000
Payment for freight-in 100,000
Payment for freight-out 80,000
Increase in merchandise inventory 300,000
Increase in trade accounts payable 600,000

a. Find the total purchases made during the year.

b. Find the cost of sales during the year.

10. On February 1, 2014, Mira Delamar opened a store that sells school supplies. Mira wanted
to know the results of operating the store. Mira knew you were studying accounting so she
asked for your help. The following were taken from the accounting records of Mira’s Store:

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Module in Fundamentals of ABM 2
1st Semester
Sales 114,567
Sales returns and allowances 1,544
Sales discounts 1,675
Purchases 61,558
Purchase returns and allowances 504
Purchase discounts 1,076
Freight - in 765
Utilities expense 4,000
Salaries expense 14,000
Rent expense 10,000
Depreciation 500

Sales 114,567
Sales returns and allowances 1,544
Sales discounts 1,675
Purchases 61,558
Purchase returns and allowances 504
Purchase discounts 1,076
Freight - in 765
Utilities expense 4,000
Salaries expense 14,000
Rent expense 10,000
Depreciation 500

Additional information:
a. Physical inventory conducted at the end of the year revealed an ending inventory of
P15,345.
b. Depreciation is for shelves and cabinets used as display racks and storage in the
store.
c. Mira has a small office inside the store. Allocate 15% of rent and utilities to general
and administrative expense.
d. 25% of Emily’s salaries are allocated to General and Administrative expense. Aside
from tending the store, she was also tasked to file receipts and maintain some
records.
Requirements:
1. Prepare the year ended SCI using the single step approach.
2. Prepare the year ended SCI using the multi-step approach.

Performance Name Grade Level 12 Score

Task
No. 2 Section Learning Area Fundamentals of ABM 2
1st Semester
2020-2021 Date Topic Statement of
Comprehensive Income

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11. Hyzel Company provided the following information for the year 2018:
Sales 10,000,000
Merchandise inevntory, January 1 2,000,000
Merchandise inevntory, December 31 1,800,000
Purchases 6,000,000
Freight-in 200,000
Offi ce salaries 600,000
Sales salaries 800,000
Offi ce supplies 150,000
Store supplies 100,000
Depreciation - building 500,000
Depreciation - offi ce quipment 200,000
Depreciation - store quipment 300,000
Sales returns and allowances 120,000
Sales discounts 80,000
Purchase returns and allowances 140,000
Purchase discounts 100,000
Income tax expense 297,000

Sales 10,000,000
Me rchandise inevntory, January 1 2,000,000
Me rchandise inevntory, December 31 1,800,000
Purchases 6,000,000
Fre ight-in 200,000
Offi ce salarie s 600,000
Sales salaries 800,000
Offi ce supplies 150,000
Store supplie s 100,000
Depre ciation - building 500,000
Depre ciation - offi ce quipment 200,000
Depre ciation - store quipment 300,000
Sales returns and allowance s 120,000
Sales discounts 80,000
Purchase re turns and allowances 140,000
Purchase discounts 100,000
Income tax e xpense 297,000

Prepare the statement of comprehensive income for the year using

a. Nature of expense method
b. Function of expense method

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Module in Fundamentals of ABM 2
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Lesson 3: Statement of Changes in

Equity
At the end of the lesson, the students will be able to:
1. Understand the purpose of the Statement of Changes in Equity;
2. Appreciate that the presentation of the Statement of Changes in Equity is dependent on the form of business
organization;
3. Identify the elements of the Statement of Changes in Equity;
4. Determine the nature of the different equity accounts used by the corporations; and
5. Prepare a Statement of Changes in Equity

What Is a Statement of Changes in Equity?

Statement of Changes in Equity is prepared to meet the requirements of the readers

to understand the transactions that caused the movements in equity accounts. The SCE is a
statement dated “for the year ended.” The report shows a reconciliation of the beginning and
ending balances of the equity accounts. It summarizes the transactions with the owners of the
business that occurred during the year.

Forms of Business Organization

The business organization determined the presentation of the SCE and equity portion of
the SFP. There are three basic forms of business organizations:
1. Sole proprietorship is the simplest form of a business organization. There is only
one owner referred to as sole proprietor. The business has no legal personality
separate from its owner.
2. Partnership is a business owned by two or more owners called partners. They pool
their resources together such as money, property, and industry, to operate a
business and divide the profit among themselves. Partners are generally involved in
the management if the business. A partnership has a legal personality separate from
its owners. It is taxed separately from the partners except for those formed for the
practice of the profession of the partners. However, the claims of the partnership
creditors may extend to the partners’ personal asset.
3. Corporation is the most complex form of business organization. A corporation is
owned by many owners called stockholders or shareholders. Ownership is divided
into common stocks or shared of stocks. One of the characteristics of a corporation is
the separation of ownership and management. Stockholders have limited liability.
Creditors of corporation only have claims to the corporation’s assets. A corporation is
a legal entity separate from its owners.

Preparation of Statement of Changes in Equity

The form of business organization determined the equity accounts reported on the
financial statements. The form of business organization differs in terms of number of owners
and the transferability of ownership. This inherent characteristic of business organizations led to
the difference in the presentation of equity.

Sole Proprietorship

The SFP and SCE will present one capital account because there in only one owner. The
owner’ capital account follows this naming convention: <Owner’s name>, Capital. Accountants
uses the owner’s Drawings account to record withdrawals of the owner.

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Module in Fundamentals of ABM 2
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The owner’s Capital account tracks the following transactions of the owner: (1)capital
contributions; (2) withdrawals; and (3) net income or net loss generated by the business.

ABC Company
Statement in Changes in Equity
For the period ended December 31, XXXX

Owner, Capital, January 1, XXXX XXXXX

Add: Net Income XXXXX
Owner's Contribution XXXXX
Less: Drawings XXXXX
Owner, Capital, December 31, XXXX XXXXX

Problem 1. Juana Dela Cruz is the owner of the Friendly Convenience Store. The store was established on January 1, 2010. Juana
deposited P10,000 to a bank account in the name of Friendly Convenience Store. She made three more deposits of P2,500 each during
the year from her personal account. The store generated a net income of P35,670 in 2010. Juana regularly withdraws P1,000 per month
from the store’s bank account for her personal expenses.

1. Determine the 2010 yearend balance of the Juana Dela Cruz, Drawings account.
2. Prepare a Statement of Changes in Equity for the year ended December 31, 2010.

Answer

1. The 2010 year-end balance of the Juana Dela Cruz, Drawing account is ₱12,000. This is computed as ₱1,000 per month for
12 months.
2. Statement of Changes in Equity

Friendly Convenience Store

Statement of Changes in Equity
For the year ended December 31, 2010

Juana Dela Cruz, Capital, January 1, 2010 ₱ 0

Add:
Owner’s Contribution (₱10,000 + ₱7,500) 17,000
Net Income 35,670
Less:
Drawings (₱1,000 x 12) (12,000)
Juana Dela Cruz, Capita, December 31, 2010 ₱41,170

Partnership

A partnership is owned by two or more partners. The number of capital accounts that will
be reported on SCE is equal to number of partners. A Drawing account is also maintained for
each partner.

Net income is allocated based on the profit and loss sharing agreement stipulated in the
partnership contract. Allocation of net income is unique only to partnership.

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ABC Partnership
Statement of Chnages in Equity
For the period ended December 31, XXXX

Partner A Partner B Partner C

Capital Capital Capital
Balance, January 1, XXXX XXXX XXXX XXXX
Add:
Net Income XXXX XXXX XXXX
Partner's contribution XXXX XXXX XXXX
Less: Drawings XXXX XXXX XXXX
Balance, December 31, XXXX XXXXX XXXXX XXXXX

Problem 2. The DEF Partnership was established in 2010. The partners Diana, Emina and Fanny have January 1, 2011 outstanding
capital balances of 25,600, P43,800 and P37,655, respectively. Diana contributed P15,000 during 2011. Emina and Fanny also
contributed P10,000 each in 2011. The 2011 year end balances of each partner’s Drawings accounts are as follows: Diana P12,000,
Emina P15,000 and Fanny P14,000.

The partnership reported 2011 net income of P75,650. According to the partnership agreement, the partner’s profit sharing ratio is
30%, 40% and 30% for Diana, Emina and Fanny.

Prepare the 2011 SCE of DEF Partnership.

Answer:

DEF Partnership
Statement of Changes in Equity
For the Year ended December 31, 2010

Diana, Capital Emina, Capital Fanny, Capital Total

Balance, January 1, 2010 ₱25,600 ₱43,800 ₱37,655 ₱107,055
Add:
Partner’s Contributions 15,000 10,000 10,000 35,000
Net Income 22,695 30,260 22,695 75,650
Less:
Drawings (12,000) (15,000) (14,000) (41,000)
Balance, December 31, 2010 ₱51,295 ₱69,060, ₱56,350 ₱176,705

Corporation

A corporation is owned by many stockholders that could number to thousands.

Moreover, the ease of transferring ownership in corporations’ results in fast turnover of owners.
There is no capital account for each shareholder. Accounts that will be used are capital stock,
additional paid in capital and retained earnings. Three equity transactions will also be focused
to: capital contributions, drawings and accumulation of net income.

The stockholders’ equity of a corporation is divided into two parts, namely, paid in
capital and retained earnings. Paid-in capital is the amount of contributions given or will be
given or will be given to the corporation in exchange for its common stocks. Paid-in capital is
composed of capital stock and additional paid-in capital. The balance of Capital Stock reflects
the par value of the issued common shares. Par value is the minimum price by which
corporations can issue stocks to shareholders. However, corporations generally issue stocks in
exchange for an amount greater than par. The excess of the issue price over the par is reported
as Additional Paid-in Capital.

The second half of the stockholders’ equity is the Retained Earnings. This account
reports the undistributed earnings of the corporation. The balance of retained earnings is

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computed as follows: net income minus net losses and dividends from the date of incorporation
up to the cut-off date or date of SFP. Dividends are distributions to stockholders, similar to
owners’ drawings in sole proprietorship and partnership. Dividends are deducted from retained
earnings because dividends are taken from income generated by the corporation.
ABC Incorporated
Statement of Changes in Equity
For the Period ended December 31, XXXX

Additional
Paid-in Retained
Capital Stock Capital Earnings Total
Balance, January 1 XXXX XXXX XXXX XXXX
Add:
Net Income XXXX XXXX
Issuance of new stocks XXXX XXXX XXXX
Less:
Dividends (XXXX) (XXXX)
Balance, December 31 XXXX XXXX XXXX XXXX

Problem 3. GHI Incorporated was established in 2010. The corporation issued 10,000 P10 par value shares of stock at an issue price
of P20 per share. On July 15, 2011, the corporation issued 1,000 new shares at an issue price of P25 per share.

The corporation reported net income of P56,785 and P65,870 in 2010 and 2011, respectively. Dividends of P2.15 per share were
declared and distributed to shareholders in February 1, 2011. There were no dividends distributed on the first year of operations of the
corporation.

Prepare the 2011 Statement of Changes in Equity of GHI Incorporated.

Answer

GHI Incorporation
Statement of Changes in Equity
For the Year ended December 31, 2011

Capital Stock Additional Paid-in Retained Earnings Total

Capital
Balance, January 1, 2011 ₱ 100,000 ₱ 100,000 ₱ 56,785 ₱ 256,785
Add:
Issuance of Shares 10,000 15,000 25,000
Net Income 65, 870 65,870
Less:
Dividends _________ __________ (21,500) (21,500)
Balance, December 31, 2011 ₱110,000 ₱115,000 ₱101,155 ₱365,155

Computations
1. Capital stock, January 1, 2011
Number of stocks issued as of January 1, 2010 10,000
Par Value ₱10
Capital stock, January 1, 2011 ₱100,000
2. Additional paid in capital, January 1, 2011
Number of stocks issued as of January 1, 2011 10,000
Issue price in excess of par value (₱20-₱10) ₱10
Additional paid-in capital, January 1, 2011 ₱100,000
3. Capital stock, Issuance
Number of stocks issued on July 1, 2011 1,000
Par Value ₱10
Capital stock, issuance ₱10,000
4. Additional paid-in capital, Issuance
Number of stocks issued on July 1, 2011 1,000
Issue price in excess of par value (₱25-₱10) ₱15
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Additional paid in capital, issuance ₱15,000

5. Dividends
Number of stocks issued as of February 1, 2011 1,000
Dividend per share ₱2,10
Dividends for 2011 ₱21,000
Exercises
1. On February 1, 2014, Mira Delamar opened a store that sells school supplies. Mira wanted to
know the balance of her capital account. The following were taken from the accounting records of
Mira’s Store:

Mira started her business by depositing P30,000 to open the checking account. On October 15,
2014, the business is in need of additional cash so Mira deposited P5,000 to the checking account
from her personal account. Mira also withdrew P15,000 from the business over the year. The
business earned a net income of P37,450 for 2014.

Prepare the Statement of Changes in Equity for the year Ended December 31, 2014.

2. In February 15, 2011, Everly Ferrer opened Cookie Fantasy Bakeshop. She invested P75,000 to
purchase an oven and bakery supplies. The business generated a net income of P37,545 in 2011.
Moreover, Everly used P15,000 from the account of Cookie Fantasy to pay the electricity and
phone bills of her house.

Everly invested an additional P13,400 and P17,650 on March 16, 2012 and August 19, 2012,
respectively. Net income for 2012 was reported P48,950. Everly’s Drawings account has a balance
of P20,000 on December 31, 2012.

Prepare a Cookie Fantasy Bakeshop’s Statement of Changes in Equity for the year ended
December 31, 2011 and December 31, 2012.

3. The Playdate Kiddie Gym is owned and managed by Cris Roxas. The balance of the Cris Roxas,
Capital is P765,430 and P857,340 on December 31, 2011 and December 31, 2012, respectively.
Net income for 2012 is P115,465. Cris did not make additional contribution to the business in
2012. Determine the balance of the Cris, Roxas, Drawings account on December 31, 2012.

4. The following balances of some accounts are presented by YVONEE Trading for the year ended
December 31, 2018 prior to the closing of Income and Expense Summary Account

Cash ₱125,000
Accounts Receivable 90,000
Merchandise Inventory 280,000
Accounts Payable 80,000
YVONNE, Capital 680,000
YVONNE, Drawing 30,000

Net income for the year was P128,000. During the year, YVONNE made an additional investment
of P250,000.

Prepare the statement of changes in equity of YVONNE Trading.

5. The following are taken from the accounting records of MNO Partnership.

December 31, 2013

Mario, Capital P 58,960

Nancy, Capital 63,200

Olga, Capital 64,890

The partnership generated net income of P75,400 in 2014. According to the partnership contract,
the profit and loss sharing ratios are as follows: Mario (25%), Nancy (37.5%), and Olga (37.5%).

The following were transactions with the partners during the year.

 Mario made additional contribution of P7,640.

 Nancy withdrew P5,000 from the business.
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 Olga contributed P12,000 but withdrew P5,430.

Prepare the partnership’s statement of changes in equity.

6. The following are taken from the accounting records of JKL Partnership.

December 31, 2013 December 31, 2014

Jamie, Capital P54,900 P64,900
Kristine, Capital 53,200 63,900
Lally, Capital 44,890 50,890
The partnership generated net income of P51,600 in 2014. According to the partnership contract,
Jamie, Kristine and Lally share profit and loss equally. The partnership contract allows each
partner to withdrew P1,000 monthly. Jamie and Kristine each contributed P5,000 during the year.
Lally did not make any contribution during the year.

Required:

a. Prepare the partnership SCE.

b. Determine if any partners violated the partnership contract provision on drawings.

Performance Name Grade Level 12 Score

Task
No. 3 Section Learning Area Fundamentals of ABM 2
1st Semester
2020-2021 Date Topic Statement of Changes
in Equity

7. The Retained Earnings of PQR, Inc. shows a January 1, 2012 balance of P199,760. The Board of
Directors of PQR Inc. distributed cash dividends of P11,000 to the company’s stockholders. As of
December 31, 2012, the retained earnings reported a balance of P280,990. Determine the PQR’s
net income for 2012.

8. At the start of the fiscal year, STU Company has 100,000 shares of its P10 par value common
stock. The stocks were initially issued at P18 per share. On June 16, the company issued additional
20,000 shares at P20 per share. STU has retained earnings of P246,600 at the beginning of the
fiscal year. The company reported net income of P89,540. On September 30, cash dividend of
P60,000 was distributed to stockholders.

Prepare the SCE for STU Company for the fiscal year ended October 30, 2013.

Lesson 4: Statement of Cash Flows

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At the end of the lesson, the students will be able to:

1. Appreciate the significance of information presented in the Statement of Cash Flows;
2. Identify the sections of the Statement of Cash Flows;
3. Classify cash flows into operating, investing and financing activities;
4. Understand the transactions recorded in the t-account of cash;
5. Prepare the operating section of the Statement of Cash Flows from completed Statements of Financial Position
and Statement of Comprehensive Income; and
6. Prepare a complete Statement of Cash Flows using direct and indirect method.

The Statement of Cash Flows: Purpose and Format

Purpose of the Statement of Cash Flows
The purpose of the statement of cash flows is to provide information about the
cash receipts and cash payments of an entity during a period. A secondary objective is
to provide information about the operating, investing and financing activities of the
entity during the period. The statement of cash flows reports the cash receipts, cash
payments and net change in cash resulting from the operating, investing and financing
activities of an enterprise during a period in a format that reconciles the beginning and
ending cash balances.
Meaning of “Cash Flow”
The statement of cash flows if generally prepared using “cash and cash
equivalents” as its basis. Cash and cash equivalents are short-term, highly liquid
investments that are both:
1. Readily convertible to known amounts of cash, and
2. So near their maturity that their market value is relatively insensitive to changes
in interest rates.
Cash is an important asset. It is an account affected by many transactions. The
debit and credit side of the cash account generally represent cash receipts and cash
disbursements, respectively. Cash receipts may come from (1) cash sales to
customers, (2) collection of customer accounts, (3) loans and other borrowings, and
(4) owner’s contributions. On the other hand, cash disbursements may be for
payments of (1) business expenses, (2) purchases of inventories and other assets (3)
liabilities to creditors, and (4) dividends to owners.
Classification of Cash Flow
The statement of cash flows classifies cash receipts and cash payments by
operating, investing and financing activities. Transactions and other events
characteristic of each kind of activity are as follows:
1. Operating activities include the cash effects of transactions that create
revenues and expenses and thus enter into the determination of net income.
2. Investing activities include (a) acquiring and disposing of investments and
productive long-lived assets, and (b) lending money and collecting the loans.
3. Financing activities include (a) obtaining cash from issuing debt and repaying
the amounts borrowed, and (b) obtaining cash from stockholders and providing
them with a return on their investment.

Types of Cash Inflows and Outflows

Operating activities

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Cash inflows:
From sale of goods or services
From returns on loans (interest received) and on equity securities
(dividends received).
Cash outflows:
To suppliers for inventory
To employees for services
To government for taxes
To lenders for interest
To others for expenses.
Investing activities
Cash inflows:
From sale of property, plant and equipment
From sale of debt or equity securities of other entities.
From collection of principal on loans to other entities.
Cash outflows:
To purchase property, plant and equipment
To purchase debt or equity securities of other entities
To make loans to other entities
Financing activities
Cash inflows:
From sale of equity securities (company’s own stock).
From issuance of debt (bonds and notes)
Cash outflows:
To stockholders as dividends
To redeem long-term debt or reacquire capital stock.

Some cash flows relating to investing or financing activities are classified as

operating activities. For example, receipts of investment revenue (interest and
dividends) and payment of interest to lenders are classified as operating activities
because these items are reported in the income statement.
Note that generally, (1) operating activities involve income determination items,
(2) investing activities involve cash flows resulting from changes in investments and
long-term asset items, and (3) financing activities involves cash flows resulting from
changes in long-term liability and stockholders’ equity items.

Format of the Statement of Cash Flows

The three activities discussed above – operating, investing and financing –
constitute the general format of the statement of cash flows. A widely used form of the
statement of cash flows is shown below:

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Cash Flow From Operating Activities

Cash transactions XXXX
Net cash provided by (used in) operating activities XXXX

Cash Flow From Investing Activities

Cash transactions XXXX
Net cash provided by (used in) investing activities XXXX

Cash Flow From Financing Activities

Cash transactions XXXX
Net cash provided by (used in) financing activities XXXX
Net increase (decrease) in cash and cash equivalents XXXX
Cash and cash equivalents at the beginning of the year XXXX
Cash and cash equivalents at the end of the year XXXX

The cash flows from operating activities section always appears first followed by
the investing activities and the financing activities sections. Also, the individual
inflows and outflows from investing and financing activities are reported
separately. The reported operating, investing, and financing activities result in either
net cash provided or used by each activity. The net cash provided or used by each
activity is totaled to show the net increase (decrease) in cash for the period. The net
increase (decrease) in cash and cash equivalents for the period is then added to or
subtracted from the beginning-of-the-period cash and cash equivalents balance to
obtain the end of the period cash and cash equivalents balance.

Usefulness of the Statement of Cash Flows

The information in a statement of cash flows should help investors, creditors,
and other assess various aspects of the firm’s financial position:
1. The entity’s ability to generate future cash flows.
2. The entity’s ability to pay dividends and meet obligations.
3. The reasons for the difference between net income and net cash provided (used)
by operating activities.
4. The cash investing and financing transactions during the period.

Preparing the Statement of Cash Flows

The statement of cash flows is prepared differently from the three other basic
financial statements. First, it is not prepared from an adjusted trial balance. Because
the statement requires detailed informing concerning the changes in account balances
that occurred between two periods of time, an adjusted trial balance will not provide
the necessary data for the statement. Second, the statement of cash flows deals with
cash receipts and payments. As a result, the accrual concept is not used in the
preparation of a statement of cash flows.

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The information to prepare this statement usually comes from three sources:
1. Comparative statement of financial position. Information in this statement
indicates the amount of the changes in assets, liabilities, and stockholders’
equities from the beginning to the end of the period.
2. Current statement of comprehensive income. Information in this statement
helps the reader determine the amount of cash provided by or used by
operations during the period.
3. Additional information. Additional information includes transaction data that
are needed to determine how cash was provided or used during the period.
Indirect and Direct Methods
Three major steps in preparing the statement of cash flows
Step 1: Determine the net increase/decrease in cash. The difference
between the beginning and ending cash balances can be easily computed from
comparative statements of financial position.
Step 2: Determine net cash provided/used by operating activities. This
step involves analyzing not only the current year’s statement of comprehensive
income but also comparative statements of financial position and selected
additional data.
Step 3: Determine the net cash provided/used by investing and
financing activities. This step involves analyzing comparative statements of
financial position data and selected additional information for their effects on
cash.
In step 2, the operating activities section of the statement of cash flows must
be converted from an accrual basis to cash basis. This conversion may be done by
either of two methods: (1) the indirect methods or (2) the direct method. Both
methods arrive at the same total amount for “Net cash and cash equivalent
provided by operating activities,’ but they differ in disclosing the items that comprise
the total amount.
The indirect method is used extensively in practice. Companies favor the indirect
method for two reasons: (1) it is easier to prepare, and (2) it focuses on the
differences between net income and net cash flow from operating activities.
Others, however, favor the direct method. The direct method shows operating
cash receipts and payments. Thus, it is more consistent with the objective of a
statement of cash flows.

Indirect Method
To explain and illustrate the indirect method, we will use the transactions of the
Computer Services Company for two years – 1996 and 1997.
Basic Year of Operations – 1996
Computer Services Company started on January 1, 1996, when it issued 50,000
shares of $1.00 par value common stock for $50,000 cash. The company rented its
first office space and furniture and performed consulting services throughout the first
year. The comparative statement of financial position at the beginning and end of
1996, showing increases or decreases.

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COMPUTER SERVICES COMPANY

Comparative Statement of Financial Position

Assets Dec. 31, 1996 Jan. 1, 1996 Change

Cash $34,000 $0 $34,000 Increase
Accounts receivable 30,000 - 30,000 Increase
Equipment 10,000 - 10,000 Increase
Total $74,000 $0

Liabilities and Stockholder's Equity

Accounts payable $4,000 $0 $4,000 Increase
Common stock 50,000 - 50,000 Increase
Retained earnings 20,000 - 20,000 Increase
Total $74,000 $0

The statement of comprehensive income and additional information for

Computer Services Company are shown below:
COMPUTER SERVICES COMPANY
Statement of Comprehensive Income

Revenues $85,000
Operating expenses 40,000
Income before income taxes 45,000
Income tax expense 10,000
Net income $35,000

Additional information:
(a ) Exami nati on of s el ecte d da ta i ndi ca tes tha t a di vi dend of $15,000 wa s decl a red and pa i d duri ng the yea r
(b) The equi pment wa s purcha s ed at the end of 1996. No depreci a ti on wa s ta ken i n 1996

STEP 1. Determine the Net Increase/Decrease in Cash

Helpful Hint: You may wish to insert the beginning and ending cash balances and he
increase/decrease in cash necessitated by these balances immediately into the
statement of cash flows. The net increase/decrease is the target amount. The net cash
flows from the three classes of activities must equal the target amount.
STEP 2. Determine Net Cash Provided by Operating Activities
To determine net cash provided by operating activities under the indirect
method, net income is adjusted for items that did not affect cash. The indirect
method (or reconciliation method) starts with net income and converts it to net cash
provided by operating activities. In other words, the indirect method, adjusts net
income for items that affected reported net income but did not affect cash.
That is, noncash charges in the income statement are added back to net income and
noncash credits are deducted to compute net cash provided by operating activities. A

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useful starting point in identifying the adjustments to net income is the current asset
and current liability accounts other than cash.
1. Increase in Accounts Receivable. When accounts receivable dung the year,
revenues on an accrual basis are higher than revenues on a cash basis. In other
words, operations of the period led to increase revenues, but not all of these
revenues resulted in an increase in cash; some of the increase in revenues
resulted in an increase in accounts receivable. Therefore, an increase in accounts
receive must be deducted from net income.
2. Increase in Accounts Payable. When accounts payable crease during the
year, operating expenses on an accrual basis are higher than they are on cash
basis. The increase in accounts payable must be added to net income.
STEP 3. Determining Net Cash Provided/Used by Investing and
Financing Activities
The third and final step in preparing the statement of cash flows begins with a
study of the balance sheet to determine changes in noncurrent accounts. The changes
in each noncurrent account are then analyzed using selected transaction data to
determine the effect, if any, the changes had on cash.
In computer Services Company, the three noncurrent accounts are Equipment,
Common Stock and Retained Earnings, an all three have increased during the year.
What caused these increases? No transaction data are given for the increase in
Equipment of $10,000 and Common Stock of $50,000. In solving your homework, you
can conclude that any unexplained differences in noncurrent accounts involve
cash. Thus, the increase in equipment is assumed to be a purchase of equipment for
$10,000 cash. This purchase is reported as a cash outflow in the investing activities
section. The increase in common stock is assumed to result from the issuance of
common stock for $50,000 cash. It is reported as an inflow of cash in the financing
activities section of the statement of cash flows.
The reasons for the net increase of $20,000 in the Retained Earnings account
are determine by analysis. First, net income increased retained earnings by $35,000.
Second, the additional information provided below the income statement indicates that
a cash dividend of $15000 was declared and paid. The $35 increase due to net income
is reported in the operating activities. The cash dividend paid is reported in the
financing activities section.

Statement of Cash flows – 1996

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COMPUTER SERVICES COMPANY

Statement of Cash Flow

Cash flows from operating activities

Net income $35,000.00
Adjustments to reconcile net income to net cash provided by
operating activities:
Increase in accounts receivable $ (30,000)
Increase in accounts payable 4,000 (26,000)
Net cash provided by operating activities 9,000
Cash flows from investing activities
Purchase of equipment (10,000)
Net cash used by investing activities (10,000)
Cash flows from financing activities
Issuance of common stock 50,000
Payment of cash dividends (15,000)
Net cash provided by financing activities 35,000
Net increase in cash 34,000
Cash at beginning of period -
Cash at end of period $34,000

Problem 1: Prepare the Statement of Cash Flows for Computer Services

Company on the Second Year of Operation – 1997 based on the given
information.

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COMPUTER SERVICES COMPANY

Comparative Statement of Financial Position

Assets 1997 1996 Change

Cash $56,000 $34,000 $22,000 Increase
Accounts receivable 20,000 30,000 10,000 Decrease
Prepaid expenses 4,000 - 4,000 Increase
Land 130,000 - 130,000 Increase
Building 160,000 - 160,000 Increase
Accumulated Depreciation - Building (11,000) - 11,000 Increase
Equipment 27,000 10,000 17,000 Increase
Accumulated Depreciation - Equipment (3,000) - 3,000 Increase
Total $383,000 $74,000

Liabilities and Stockholder's Equity

Accounts payable $59,000 $4,000 55,000 Increase
Bonds payable $130,000 - 130,000 Increase
Common stock 50,000 50,000 -
Retained earnings 144,000 20,000 124,000 Increase
Total $383,000 $74,000

COMPUTER SERVICES COMPANY

Statement of Comprehensive Income

Revenues $507,000
Operating expenses (excluding depreciation) $ 261,000
Depreciation expense 15,000
Loss on sale of equipment 3,000 $279,000
Income from operations 228,000
Income tax expense 89,000
Net income $139,000

Additional information:
(a ) In 1997, the compa ny decl a red a nd pa i d a $15,000 ca s h di vi dend.
(b) The compa ny obta i ned l and through the i s s ua nce of $130,000 of l ong-term bonds .
(c) The bui l di ng cos ti ng $160,000 wa s purha s ed for ca s h; equi pment cos ti ng $25000 wa s a l s o purchas ed for ca s h.
(d) Duri ng 1997, the company s ol d e qui pment wi th a book val ue of $7,000 (cos t $8,000, l es s a ccumula ted
depreci a ti on $1,000) for $4,000 ca s h.

Summary of Conversion to Net Cash Provided by Operating Activities – Indirect

Method

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Current Assets and Current Liabilities Adjustments to Convert Net Income to

Net Cash Provided by Operating
Activities
Add to Net Deduct from Net
Income Income
Accounts receivable Decrease Increase
Inventory Decrease Increase
Prepaid expenses Decrease Increase
Accounts payable Increase Decrease
Accrued expenses payable Increase Decrease

Adjustments for the noncash charges reported in the income statement are made as
shown below:
Noncash Charges Adjustments to Convert Net
Income to Net Cash Provided
by Operating Activities
Depreciation expense Add
Patent amortization expense Add
Depletion expense Add
Loss on sale of asset Add

Problem 2. Presented below is information related to Reynolds Company. Use

it to prepare a statement of cash flows using the indirect method.
REYNOLDS COMPANY
Comparative Statement of Financial Position

Assets 1997 1996 Change

Cash $54,000 $37,000
Accounts receivable 68,000 26,000
Inventories 54,000 -
Prepaid expenses 4,000 6,000
Land 45,000 70,000
Building 200,000 200,000
Accumulated Depreciation - Building (21,000) (11,000)
Equipment 193,000 68,000
Accumulated Depreciation - Equipment (28,000) (10,000)
Total $569,000 $386,000

Liabilities and Stockholder's Equity

Accounts payable $23,000 $40,000
Accrued expenses payable $10,000 $0
Bonds payable $110,000 150,000
Common stock ($1 par) 220,000 60,000
Retained earnings 206,000 136,000
Total $569,000 $386,000

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REYNOLDS COMPANY
Statement of Comprehensive Income
For the year ended December 31, 1997

Revenues $890,000
Cost of Goods Sold $465,000
Operating expenses 221,000
Interest expense 12,000
Loss on sale of equipment 2,000 700,000
Income from operations 190,000
Income tax expense 65,000
Net income $125,000

Additional Information
(a) Operating expenses include depreciation expense of $33,000 and charges from prepaid expenses of $2,000.
(b) Land was sold at its book value for cash.
(c) Cash dividends of $55,000 were declared and paid in 1997.
(d) Interest expese of $12,000 was paid in cash.
(e) Equipment with a cost of $166,000 was purchased for cash. Equipment with a cost of $41,000 abd a book value of
$36,000 was sold for $34,000 cash.
(f) Bonds of $10,000 were redeemed at their book value for cash; bonds of $30,000 were converted into common stock.
(g) Common stock ($1 par) of $130,000 was issued for cash.
(h) Accounts payable pertain to merchanside suppliers.

Direct Method
To explain and illustrate the direct method, we will use the transactions of Juarez
Company for two years, 1996 and 1997. Annual cash flows be prepared.
First Year of Operation – 1996
Juarez Company began business on January 1, 1996, when it issued 300,000
shares of $1 par value common stock for $300,000 cash. The company rented office
and sales space along with equipment. The comparative statement of financial position
at the beginning and end of 19996 and the changes in each account, statement of
comprehensive income and additional information for Juarez Company are shown
below.

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JUAREZ COMPANY
Comprehensive Statement of Financial Position

Assets Dec.31,1996 Jan. 1, 1996 Change

Cash $159,000 $0 $159,000 Increase
Accounts receivable 15,000 - 10,000 Decrease
Inventory 160,000 - 160,000 Increase
Prepaid expenses 8,000 - 8,000 Increase
Land 80,000 - 80,000 Increase
Total $422,000 $0

Liabilities and Stockholder's Equity

Accounts payable $60,000 $0 60,000 Increase
Accrued expenses payable 20,000 - 20,000 Increase
Common stock 300,000 - 300,000 Increase
Retained earnings 42,000 - 42,000 Increase
Total $422,000 $0

JUAREZ COMPANY
Statement of Comprehensive Income
For the year ended December 31, 1996

Revenues from sales $780,000

Cost of Goods Sold 450,000
Gross profit 330,000
Operating expenses 170,000
Income before income taxs 160,000
Income tax expense 48,000
Net income $112,000

Additional Information
(a) Dividends if $70,000 were declared and paid in cash.
(b) The accounts payable increase resulted from the purchase of merchandise.

Step 1: Determine the net increase/decrease in cash

Step 2: Determine the net cash provided/used by operating activities
Under the direct method, net cash provided by operating activities is computed
by adjusting each item in the income statement from the accrual basis to the cash
basis. To simplify and condense the operating activities section, only major classes
of operating cash receipts and cash payments are reported. The difference
between these major classes of cash receipts and cash payments is the net cash
provided by operating activities.
An efficient way to apply the direct method is to analyze the revenues
and expenses reported in the income statement in the order in which they are
listed. Cash receipts and cash payments related to these revenues and expenses are
then determined.
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Cash receipts from customers. To determine cash receipts from customers, it

is necessary to consider the change in accounts receivable during the year. When
accounts receivable increase during the year, revenues on the accrual basis are higher
than cash receipts from customers. In other words, operations led to increased
revenues, but not all of these revenues resulted in cash receipts. To determine the
amount of cash receipts, the increase in accounts receivable is deducted from sales
revenues. Conversely, a decrease in accounts receivable is added to sales revenues,
because cash receipts from customers the exceed sales revenues.
Revenues from sales $780,000
Deduct: Increase in accounts receivable 15,000
Cash receipts from customers $765,000

Cash payments to suppliers. To determine the cash payments to suppliers, it

is first necessary to find purchases for the year. To find purchases, cost of goods sold is
adjusted for the change in inventory. When inventory increases during the year, it
means that the purchases this year exceed cost of goods sold. As a result, the increase
in inventory is added to cost of goods to arrive at purchases.
Cost of goods sold $450,000
Add: Increase in inventory 160,000
Purchases $610,000

After purchases are computed, cash payments to suppliers are determined by

adjusting purchases for the change in accounts payable. When accounts payable
increase during the year, purchases on accrual basis are higher than they are on a
cash basis. As a result, an increase in accounts payable is deducted from purchases to
arrive at cash payments to suppliers. Conversely, a decrease in accounts payable is
added to purchases because cash payments to suppliers exceed purchases.

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Purchases $610,000
Deduct: Increase in accounts payable 60,000
Purchases $550,000

Cash payments for operating expenses. To determine cash paid for

operating expenses, the amount in the income statement must be adjusted for any
changes in prepaid expenses and accrued expenses payable. For example, when
prepaid expenses increased $8,000 during the year, cash paid for operating expenses
was $8,000 higher than operating expenses reported on the income statement. To
convert operating expenses to cash payments for operating expenses, the increase of
$8,000 must be added to operating expenses. Conversely, if prepaid expenses
decrease during the year, the decrease must be deducted from operating expenses.
Operating expenses must also be adjusted for changes in accrued expenses
payable. When accrued expenses payable increase during the year, operating expenses
on an accrual basis are higher than they are in a cash basis. As a result, an increase in
accrued expenses payable is deducted from operating expenses to arrive at cash
payments for operating expenses. Conversely, a decrease in accrued expenses payable
is added to operating expenses because cash payments exceed operating expenses.
Operating expenses $170,000
Add: Increase in prepaid expenses $8,000
Deduct: Increase in accrued expenses payable (20,000)
Purchases $158,000

Cash payments for income taxes. The income statement for Juarez shows
income tax expense of $48,000. This amount equals the cash paid because the
comparative statement of financial position indicated no income taxes payable.

Step 3: Net Cash provided/used by investing and financing activities

Preparing the investing and financing activities sections of the statement of cash
flows begins with a determination of the changes in noncurrent accounts reported in
the comparative statement of financial position. The change in each account is then
analyzed using the additional information to determine the effect, if any, the change
has on cash.

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Increase in land. No additional information is given for the increase in land. In

such case, you should assume that the increase affected cash. The purchase of land is
an investing activity.
Increase in Common Stock. As indicated earlier, 300,000 shares of $1 par
value stock were sold for $300,000 cash. The issuance of common stock is a financing
activity.
Increase in Retained Earnings. For the Retained Earnings account, the
reasons for the net increase of $42,000 are determined by analysis. First, net income
increased retained earnings by $112,000. Second, the additional information section
indicates that a cash dividend of $70,000 was declared and paid. The adjustment of
revenues and expenses to arrive at net cash provided by operations was done in step
2. The cash dividend paid is reported as an outflow of cash in the financing activities
section.
JUAREZ COMPANY
Statement of Cash Flow
For the year ended December 31, 1996

Cash flows from operating activities

Cash receipts from customers $765,000
Cash payments:
To suppliers $ 550,000
For operating expenses 158,000
For income taxes 48,000 756,000
Net cash provided by operating activities 9,000
Cash flows from investing activities
Purchase of land (80,000)
Net cash used by investing activities (80,000)
Cash flows from financing activities
Issuance of common stock 300,000
Payment of cash dividends (70,000)
Net cash provided by financing activities 230,000
Net increase in cash 159,000
Cash at beginning of period -
Cash at end of period $159,000

The statement of cash flows shows that operating activities provided $9,000 of
the net increase in cash of $159,000. Financing activities provided $230,000 of cash,
and investing activities used $80,000 of cash. The net increase in cash for the year of
$159,000 agrees with the increase in cash of $159,000 reported in the comparative
statement of financial position.
Second Year of Operation - 1997
Problem 3. Presented below is information related to Juarez Company on the
second year of operation. Use it to prepare a statement of cash flows using
the direct method.

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JUAREZ COMPANY
Comprehensive Statement of Financial Position
December 31

Assets 1997 1996 Change

Cash $191,999 $159,000 $32,999 Increase
Accounts receivable 12,000 15,000 3,000 Decrease
Inventory 130,000 160,000 30,000 Decrease
Prepaid expenses 6,000 8,000 2,000 Decrease
Land 180,000 80,000 100,000 Increase
Equipment 160,000 160,000 Increase
Accumulated depreciation - equipment - 16,000 - 16,000 Increase
Total $663,999 $422,000

Liabilities and Stockholder's Equity

Accounts payable $52,000 $60,000 8,000 Decrease
Accrued expenses payable 15,000 20,000.00 5,000 Decrease
Income tax payable 12,000 - 12,000 Increase
Bonds payable 90,000 - 90,000 Increase
Common stock 400,000 30,000 100,000 Increase
Retained earnings 94,000 42,000 52,000 Increase
Total $663,000 $152,000

JUAREZ COMPANY
Statement of Comprehensive Income
For the year ended December 31, 1997

Revenues from sales $975,000

Cost of Goods Sold $660,000
Operating expenses (excluding depreciation) 176,000
Depreciation expense 18,000
Loss on sale of store equipment 1,000 855,000
Income before income taxs 120,000
Income tax expense 36,000
Net income $84,000

Additional Information
(a) In 1997, the company declared and paid a $32,000 cash dividend.
(b) Bonds were issued at face value for $90,000 in cash.
(c) Equipment costing $180,000 ws purchased for cash.
(d) Equipment costing $20,000 was sold for $17,000 cash when the book value of the equipment was $18,000.
(e) Common stock of $100,000 was issued to acquire land.

Problem 4. Use the data in problem 2 of Reynolds Company. Use it to prepare

a statement of cash flows using the direct method.

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Problem 5. XYZ Company

The cash account of XYZ Company has a beginning balance of P129,937.50. Its year-
end balance stands at P254,925. The table below show the summarized transactions
from the cash account of XYZ Company.
Cash received from customers ₱725,175.00
Payment to suppliers 300,548
Payments for other operating expenses 58,850
Salaries pai 19,993
Purchase of equipment 253,000
Sale of delivery equipment (motorcycle) 6,875
Proceeds from sale of computer equipment 42,763
Withdrawals of owners 229,350
Proceeds from bank loan 82,500
Contributions of owners 137,500
Interest paid 8,085

Prepare the Statement of Cash Flows

Problem 6. The information on the table below are taken from the financial
statements of XYZ Corporation. Based on this information, compute for the amount of
cash that the company had received from the customers. (Show computation)
Accounts receivable, beginning of the year ₱156,750
Accounts receivable, end of the year 249,700
Sales 818,125

Problem 7. With the information on the table below compute for the amount of cash that the
company paid to suppliers. (Show computation)

Inventory, beginning 282,288

Inventory, ending 335,225
Accounts payable, beginning 132,770
Accounts payable, ending 158,675
Cost of goods sold 273,515

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Performance Name Grade Level 12 Score

Task
No. 4 Section Learning Area Fundamentals of ABM 2
1st Semester
2020-2021 Date Topic Statement of Cash
Flows

Problem 8. The statement of Comprehensive Income for the year ended December 31, 2014 of
ABC Company is given below:
Sales revenue ₱1,212,500
Cost of goods sold 780,000
Operating expenses, excluding depreciation 70,000
Depreciation 75,000
Net income 287,500
The following were taken from ABC Company’s comparative balance sheet as of December 31.
2014 2013
Accounts receivable ₱93,750 ₱75,000
Inventory 13,750 8,750
Accounts payable 51,250 35,000

Required:
1. Prepare the operating section of the Statement of Cash Flows of ABC Company
using indirect method.
2. Determine the amount of cash collected from ABC’s customers? Assume that all
ABC’s sales are made on credit.
3. Determine how much inventory was purchased by the ABC during the year.
4. Determine the amount of cash paid to ABC’s suppliers? Assume that all ABS’s
inventory purchases were made on credit.

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Lesson 5: Financial Statement

Analysis
At the end of the lesson, the students will be able to:
1. discuss the need for comparative analysis
2. identify the tools of financial statement analysis.
3. explain and apply horizontal analysis
4. describe and apply vertical analysis
5. identify and compute ratios and describe their purpose and use in analyzing a firm's liquidity, profitability and
solvency.
6. recognize the limitations of financial statement analysis.

BASICS OF FINANCIAL STATEMENT ANALYSIS.

Analyzing financial statements involves evaluating three characteristics: a
company’s liquidity, profitability, and solvency. A short-term creditor, such as a
bank, is primarily interested in liquidity—the ability of the borrower to pay obligations
when they come due. The liquidity of the borrower is extremely important in evaluating
the safety of a loan. A long-term creditor, such as a bondholder, looks to profitability
and solvency measures that indicate the company’s ability to survive over a long period
of time. Long-term creditors consider such measures as the amount of debt in the
company’s capital structure and its ability to meet interest payments. Similarly,
stockholders look at the profitability and solvency of the company. They want to
assess the likelihood of dividends and the growth potential of the stock.

Need for Comparative Analysis

1. Intracompany basis. This basis compares an item or financial relationship
within a company on the current year with the same item or relationship in one
or more prior years. Intracompany comparisons are useful in detecting changes
in financial relationships and significant trends.
2. Industry averages. This basis compares an item or financial relationship of a
company with industry average (or norms) published by financial ratings
organizations. Comparison with industry averages provide information as to a
company’s relative performance within the industry.
3. Intercompany basis. This basis compares an item or financial relationship of
one company with the same item or relationship in one or more competing
companies. Intercompany company comparisons are useful in determining a
company’s competitive position.

Tools of Financial Statement Analysis

1. Horizontal analysis is a technique for evaluating a series of financial statement
data over a period of time.
2. Vertical analysis is a technique for evaluating financial statement data that
expresses each item in a financial statement in terms of a percent of a base
amount.
3. Ratio analysis expresses the relationship among selected items of financial
statement data.

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HORIZONTAL ANALYSIS
Horizontal analysis, also called trend analysis, is a technique for evaluating a
series of financial statement data over a period of time. Its purpose is to determine the
increase or decrease that has taken place, expressed as either an amount or a
percentage.
The percentage increase or decrease is measured from base period amount as
follows:
current year amount −base year amount
Change since base period=
base year amount
For example, the illustration below shows the net sales figures of Macy’s, Inc.

If we assume that 2011 is the base year, we can measure all percentage
increases or decreases from this base period amount as follows.
For example, we can determine that net sales for Macy’s increased from 2011 to
2012 approximately 4.9% [($27,686 - $26,405) ÷ $26,405]. Similarly, we can
determine that net sales increased from 2011 to 2013 approximately 5.8% [($27,931 -
$26,405) ÷ $26,405].
Alternatively, we can express current year sales as a percentage of the base
period. We do this by dividing the current year amount by the base year amount, as
shown below.
current year amount
Current results∈relation ¿ base period=
base year amount
The illustration below presents this analysis for Macy’s for a three-year period
using 2011 as the base period.

To further illustrate horizontal analysis, we will use the financial statements of

Quality Department Store Inc., a fictional retailer. The illustration below presents a
horizontal analysis of its two-year condensed balance sheets, showing dollar and
percentage changes.

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QUALITY DEPARTMENT STORE INC.

Condensed Statement of Financial Position
December 31
Increase or Decrease
during 1996
Assets 1996 1995 Amount Percentgae
Current assets $1,020,000 $945,000 $75,000 7.9%
Plant assets (net) 800,000 632,500 167,500 26.5%
Intangible assets 15,000 17,500 (2,500) (14.3%)
Total assets $1,835,000 $1,595,000 $240,000 15.0%
Liabilities
Current liabilities $344,500 $303,000 $41,500 13.7%
Long-term liabilities 487,500 497,000 (9,500) (1.9%)
Total liabilities 832,000 800,000 32,000 4.0%
Stockholders' Equity
Common stockk, $1 par 275,400 270,000 5,400 2.0%
Retained earnnings 727,600 525,000 202,600 38.6%
Total stockholders' equity 1,003,000 795,000 208,000 26.2%
Total liabilities and stockholders' equuity $1,835,000 $1,595,000 $240,000 15.0%

It is difficult to comprehend the significance of a change when only the dollar

amount of change is examined. When the change is expressed in percentage form, it is
easier to grasp the true magnitude of the change.
The comparative statement of financial position shows a number of significant
changes occurred. In the asset section, plant assets (net) increased $167,500 or
26.5%. In the liabilities section, current liabilities increased $41,500 or 13.7%. in the
stockholders’ equity section, the retained earnings increased $202,600 or 38.6%. The
suggests that the company expanded its asset based during 1996 and financed this
expansion primarily by retaining income in the business rather than assuming
additional long-term debt.

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QUALITY DEPARTMENT STORE INC.

Condensed Statement of Comprehensive Income
December 31
Increase or Decrease
during 1996
1996 1995 Amount Percentgae
Sales $2,195,000 $1,960,000 $235,000 12.0%
Sales returns and allowances 98,000 123,000 (25,000) (20.3%)
Net sales 2,097,000 1,837,000 260,000 14.2%
Cost of goods sold 1,281,000 1,140,000 141,000 12.4%
Gross profit 816,000 697,000 119,000 17.1%
Selling expenses 253,000 211,500 41,500 19.6%
Administrative expenses 104,000 108,500 (4,500) (4.1%)
Total operating expenses 357,000 320,000 37,000 11.6%
Income from operations 459,000 377,000 82,000 21.8%
Other revenues and gains
Interest and dividends 9,000 11,000 (2,000) (18.2%)
Other expenses and losses
Interest expense 36,000 40,500 (4,500) (11.1%)
Income before income taxes 432,000 347,500 84,500 24.3%
Income tax expense 168,200 139,000 29,200 21.0%
Net income $263,800 $208,500 $55,300 26.5%

Note that while the anount column is additive (the total is $55,300), the
percentage column is not additive (the total is not 26.5%). A separate percentage has
been calculated for each item.
Horizontal analysis of the income statements shows the following changes:
1. Net sales increased $260,000 or 14.2%.
2. Cost of goods sold increased $141,000 or 12.4%.
3. Total operating expenses increased $37,000 or 11.6%.
Overall, gross profit and net income were up substantially. Gross profit, for
example, increased 17.1% and net income 26.5%. it appears therefore that Quality’s
profit trend is favorable.

QUALITY DEPARTMENT STORE INC.

Retained Earnings Statement
December 31
Increase or Decrease
during 1996
1996 1995 Amount Percentgae
Retained earnings, Jan. 1 $525,000 $376,500 $148,500 39.4%
Add: Net Income 263,800 208,500 55,300 26.5%
788,800 585,000 203,800
Deduct: Dividends 61,200 60,000 1,200 2.0%
Retained earnings, Dec. 31 $727,600 $525,000 $202,600 38.6%

Net income increased $55,300 or 26.5%, whereas dividends on the common

stock increased only $1,200 or 2%. Ending retained earnings increased 38.6%.

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The measurement of changes from period to period in terms of percentages in

relatively straightforward and is quite useful. However, complications can result in
making the computation. For example, if an item has no value in a base year or
preceding year and a value in the next year, no percentage change can be computed.
Similarly, if a negative amount appears in the base or preceding period and a positive
amount exists the following year, or vice versa, no percentage change can be
computed.

VERTICAL ANALYSIS

Vertical analysis, sometimes referred to as common size analysis, is a

technique for evaluating financial statement data that expresses each item within a
financial statement in terms of a percent of a base amount.

Statement of Financial Position

The base for the asset items is total assets, and the base for the liability and
stockholders’ equity items is total liabilities and stockholders’ equity.
QUALITY DEPARTMENT STORE INC.
Condensed Statement of Financial Position
December 31

1996 1995
Assets Amount Percent Amount Percentgae
Current assets $1,020,000 55.6% $945,000 59.2%
Plant assets (net) 800,000 43.6% 632,500 39.7%
Intangible assets 15,000 0.8% 17,500 1.1%
Total assets $1,835,000 100.0% $1,595,000 100.0%
Liabilities
Current liabilities $344,500 18.8% $303,000 19.0%
Long-term liabilities 487,500 26.5% 497,000 31.2%
Total liabilities 832,000 45.3% 800,000 50.2%
Stockholders' Equity
Common stockk, $1 par 275,400 15.0% 270,000 16.9%
Retained earnnings 727,600 39.7% 525,000 32.9%
Total stockholders' equity 1,003,000 54.7% 795,000 49.8%
Total liabilities and stockholders' equity $1,835,000 100.0% $1,595,000 100.0%

The formula for calculating these percentages is:

each itemon SFP
=%
total assets
In addition to showing the relative size of each category on the statement on the
balance sheet, vertical analysis may show the percentage change in the individual
asset, liability, and stockholders’ equity items. In this case, even though current assets
increased $75,000 from 1995 to 1996, they decreased from 59.2% to 55.6% of total
assets. Plant assets (net) have increased from 39.7% to 43.6% of total assets, and
retained earnings have increased from 32.9% to 39.7% of total liabilities and
stockholders’ equity. These results reinforce the earlier observations that Quality is
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choosing to finance its growth through retention of earnings rather than through the
issuance of additional debt.

Statement of Comprehensive Income

The formula for calculating the income statement percentages is:
each item on SCI
=%
Net sales
Vertical analysis of the comparative statement of comprehensive income of
Quality reveals that cost of goods sold as a percentage of net sales declined 1% and
total operating expenses declined 0.4%. As a result, it is not suppressing to see net
income as a percent of net sales increase from 11.4% to 12.6%. As indicated from the
horizontal analysis, Quality appears to be a profitable enterprise that is becoming even
more successful.
An associated benefit of vertical analysis is that it enables you to compare
companies of different sizes.

QUALITY DEPARTMENT STORE INC.

Condensed Statement of Comprehensive Income
For the year ended December 31

1996 1995
Amount Percent Amount Percentgae
Sales $2,195,000 104.7% $1,960,000 106.7%
Sales returns and allowances 98,000 4.7% 123,000 6.7%
Net sales 2,097,000 100.0% 1,837,000 100.0%
Cost of goods sold 1,281,000 61.1% 1,140,000 62.1%
Gross profit 816,000 38.9% 697,000 37.9%
Selling expenses 253,000 12.0% 211,500 11.5%
Administrative expenses 104,000 5.0% 108,500 5.9%
Total operating expenses 357,000 17.0% 320,000 17.4%
Income from operations 459,000 21.9% 377,000 20.4%
Other revenues and gains
Interest and dividends 9,000 0.4% 11,000 60.0%
Other expenses and losses
Interest expense 36,000 1.7% 40,500 2.2%
Income before income taxes 432,000 20.6% 347,500 18.9%
Income tax expense 168,200 8.0% 139,000 7.5%
Net income $263,800 12.6% $208,500 11.4%

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Condensed Statement of Comprehensive Income

Quality Department Store, Inc. J.C. Penny Company

(in thousands) Amount Percent Amount Percentgae
Net sales $2,097 100.0% $20,380,000 100.0%
Cost of goods sold 1,281 61.1% 13,970,000 68.5%
Gross profit 816 38.9% 6,410,000 31.5%
Selling and Administrative expenses 357 17.0% 4,783,000 23.5%
Income from operations 459 21.9% 1,627,000 8.0%
Other expenses and revenues 195 9.3% 570,000 2.8%
Net income $264 12.6% $1,057,000 5.2%

Although J.C. Penny’s net sales are 9,719 times greater than the net sales of
relatively tiny Quality Department Store, vertical analysis eliminates this difference in
size. The percentages show that Quality’s and Penny’s gross profit rates were
somewhat comparable at 38.9% and 31.5%, although the percentages related to
income from operations were significantly different at 21.9% and 8.0%. this disparity
can be attributed to Quality’s selling and administrative expense percentage which is
much lower than Penny’s. Although Penny earned net income more than 4,000 times
larger than Quality’s, Penny’s net income as a percent of each sales dollar is only 41%
of Quality’s.

RATIO ANALYSIS
Ratio analysis expresses the relationship among selected items of financial
statement data. The ratio expresses the mathematical relationship between one
quantity and another. The relationship is expressed in terms of either a percentage, a
rate, or a simple proportion. To illustrate, recently IBM Corporation had current assets
of $41,338 million and current liabilities of $29,226 million. The relationship is
determined by dividing current assets by current liabilities. The alternative means of
expression are:
Percentage: Current assets are 141% of current liabilities.
Rate: Current assets are 1.41 times greater than current liabilities.
Proportion: The relationship of current assets to liabilities is 1.41: 1.
For analysis of the primary financial statements, ratios can be classified as
follows:
1. Liquidity Ratios. Measures of short-term ability of the enterprise to pay its
maturing obligations and to meet unexpected needs for cash.
2. Profitability Ratios. Measures of the income or operating success of an
enterprise for a given period of time.
3. Solvency Ratios. Measures of the ability of the enterprise to survive over a
long period of time.
Ratios can provide clues to underlying conditions that may not be apparent from
individual financial statement components. However, a single ratio by itself is not very
meaningful. Thus, in the discussion of ratios we will use the following types of
comparisons.
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1. Intracompany comparisons for two years for Quality Department Store.

2. Industry average comparisons based on median ratios for department stores.
3. Intercompany comparisons based on Macy’s, Inc. as Quality Department Store’s
principal competitor.

Liquidity Ratios
Liquidity ratios measures the short term ability of the enterprise to pay its
maturing obligations and to meet unexpected needs for cash. Short-term creditors
such as bankers and suppliers are particularly interested in assessing liquidity.

1. Current Ratio or Working Capital Ratio. The current ratio is a widely used
measure for evaluating a company’s liquidity and short-term debt-paying ability.
Current Assets
Current Ratio=
Current Liabilities

The ratio of 2.96:1 means that for every dollar of current liabilities, the company
has $2.96 of current assets. Quality’s current ratio has decreased in the current year.
But, compared to the industry average of 1.70:1, Quality appears to be reasonably
liquid. Macy’s has a current ratio of 1.52:1, which indicates it has adequate current
assets relative to its current liabilities.

The current ratio is sometimes referred to as the working capital ratio.

Working capital is current assets minus current liabilities. The current ratio is a more
dependable indicator of liquidity than working capital. Two companies with the same
amount of working capital may have significantly different current ratios.

The current ratio is only one measure of liquidity. It does not consider the
composition of the current assets. For example, a satisfactory current ratio does not
disclose the fact that a portion of the current assets may be tied up in slow-moving
inventory. A dollar of cash would be more readily available to pay the bills than a dollar
of slow-moving inventory.

2. Acid-Test Ratio. The acid-test ratio is a measure of a company’s immediate

short-term liquidity, computed by dividing the sum of cash, marketable
securities, and net receivables by current liabilities. Thus, it is an important
complement to the current ratio. It measures immediate liquidity.
Cash+ Marketable Securities+ Receivables ( Net )
Acid−Test Ratio=
Current Liabilities
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Cash, short-term investments, and accounts receivable (net) are highly liquid
compared to inventory and prepaid expenses. The inventory may not be readily
saleable, and the prepaid expenses may not be transferable to others. Thus, the
acid-test ratio measures immediate liquidity. The 2013 and 2012 acid-test ratios
for Quality Department Store and 2013 comparative data are as follows.

The ratio has declined in 2013. Is an acid-test ratio of 1.02:1 adequate? This
depends on the industry and the economy. When compared with the industry
average of 0.70:1 and Macy’s of 0.47:1, Quality’s acid-test ratio seems
adequate.

3. Accounts Receivables Turnover. Liquidity may be measured by how quickly

certain assets can be converted to cash. The ratio used to assess the liquidity of
the receivables is the receivables turnover ratio. This ratio measures the number
of times, on average, receivables are collected during the period. The
receivables turnover ratio is computed by dividing net credit sales (net sales less
cash sales) by average net receivables during the year. Unless seasonal factors
are significant, average net receivables outstanding can be computed from the
beginning and ending balance of the net receivables.
Net Credit Sales
Receivables Turnover=
Average Net Receivables

Assume that all sales are credit sales. The balance of net accounts receivable at
the beginning of 2012 is $200,000. Illustration 18-15 shows the accounts
receivable turnover for Quality Department Store and 2013 comparative data.
Quality’s accounts receivable turnover improved in 2013. However, the turnover
of 10.2
times is substantially lower than Macy’s 69.1 times and is also lower than the
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department store industry’s average of 46.4 times.

A popular variant of the receivables turnover is to convert it into an
average collection period in terms of days. This is done by dividing the
turnover ratio into 365 days. The average collection period is frequently used to
assess the effectiveness of a company’s credit and collection policies. The
general rule is that the collection period should not greatly exceed the credit
term period.

4. Inventory Turnover. The inventory turnover ratio measures the number of

times on average the inventory is sold during the period. Its purpose is to
measure the liquidity of the inventory. The inventory turnover is computed by
dividing cost of goods sold by the average inventory during the period.
Cost of Goods Sold
Inventory Turnover =
Average Inventory

Assuming that the inventory balance for Quality Department Store at the
beginning of 2012 was $450,000, its inventory turnover and 2013 comparative
data are as shown in Illustration 18-16. Quality’s inventory turnover declined
slightly in 2013. The turnover of 2.3 times is low compared with the industry
average of 4.3 and Macy’s 3.1. Generally, the faster the inventory turnover, the
less cash a company has tied up in inventory and the less chance a company has
of inventory obsolescence.

A variant of the inventory turnover ratio is to compute the average days to sell
the inventory. We calculate it by dividing the inventory turnover into 365. For
example, Quality’s 2013 inventory turnover of 2.3 times divided into 365 is
158.7 days. An average selling time of 158.7 days is also high compared with
the industry average of 84.9 days (365 ÷ 4.3) and Macy’s 117.7 days (365 ÷
3.1).

Inventory turnovers vary considerably among industries. For example, grocery

store chains have a turnover of 17.1 times and an average selling period of 21
days. In contrast, jewelry stores have an average turnover of 0.80 times and an
average selling period of 456 days.

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Profitability Ratios

Profitability ratios measures the income or operating success of an enterprise

for a given period of time. Income, or the lack of it, affects the company’s ability to
obtain debt and equity financing. It also affects the company’s liquidity position and the
company’s ability to grow. As a consequence, both creditors and investors are
interested in evaluating earning power—profitability. Analysts frequently use
profitability as the ultimate test of management’s operating effectiveness.

5. Profit Margin. The profit margin ratio is a measure of the percentage of each
dollar of sales that results in net income. It is computed by dividing net income
by net sales or the period.
Net Income
Profit Margin=
Net Sales

Quality experienced an increase in its profit margin from 2012 to 2013. Its profit
margin is unusually high in comparison with the industry average of 8% and
Macy’s 5.3%.

6. Asset Turnover. The asset turnover ratio measures how efficiently a company
uses its assets to generate sales. It is determined by dividing net sales by
average assets for the period. The resulting number shows the dollars of sales
produced by each dollar invested in assets.
Net Sales
Asset Turnover =
Average Assets

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Asset turnover shows that in 2013 Quality generated sales of $1.20 for each dollar it
had invested in assets. The ratio changed very little from 2012 to 2013. Quality’s asset
turnover is below the industry average of 1.4 times and Macy’s ratio of 1.3 times.

7. Return on Assets Ratio. An overall measure of profitability is the return on

assets ratio. This ratio is computed by dividing net income by average assets.
Net Income
Return on Assets=
Average Assets

Quality’s return on assets improved from 2012 to 2013. Its return of 15.4% is
very high compared with the department store industry average of 8.9% and
Macy’s 7.0%.

8. Return on Common Stockholders’ Equity. This ratio shows how many dollars
of net income were earned for each dollar invested by the owners. It is
computed by dividing net income by average com stockholders’ equity. When
preferred stock is present, preferred dividend requirements are deducted from
net income to compute income available to common stockholders. The par value
of preferred stock must be deducted from total stockholders’ equity to arrive at
the amount of common stock equity used in this ratio.
Net Income
Return of Common Stockholder s ' Equity=
Average Common Stockholder s' Equity

Quality’s rate of return on common stockholders’ equity is high at 29.3%,

considering an industry average of 18.3% and a rate of 24.2% for Macy’s.

When a company has preferred stock, we must deduct preferred dividend

requirements from net income to compute income available to common
stockholders. Similarly, we deduct the par value of preferred stock (or call price,
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if applicable) from total stockholders’ equity to determine the amount of

common stockholders’ equity used in this ratio. The ratio then appears as
follows.

Net Inco me−Preferred dividends

Return of Common Stockholder s ' Equity=
Average Common Stockholder s' Equity

Note that Quality’s rate of return on stockholders’ equity (29.3%) is substantially

higher than its rate of return on assets (15.4%). The reason is that Quality has
made effective use of leverage. Leveraging or trading on the equity at a gain
means that the company has borrowed money at a lower rate of interest than it
is able to earn by using the borrowed money. Leverage enables Quality to use
money supplied by nonowners to increase the return to the owners. A
comparison of the rate of return on total assets with the rate of interest paid for
borrowed money indicates the profitability of trading on the equity. Quality earns
more on its borrowed funds than it hasz to pay in the form of interest. Thus, the
return to stockholders exceeds the return on the assets, due to benefits from the
positive leveraging.

9. Earnings Per Share (EPS). Earnings per share of stock is a measure of the net
income earned on each share of common stock. It is computed by dividing net
income by the number of weighted average common shares outstanding during
the year. A measure of net income earned on a per share basis provides a useful
perspective for determining profitability
Net Income
Earnings Per Share=
Weighted Average Common SharesOutstanding

Note that no industry or specific competitive data are presented. Such

comparisons
are not meaningful because of the wide variations in the number of shares of
outstanding stock among companies. The only meaningful EPS comparison is an
intracompany trend comparison. Here, Quality’s earnings per share increased 20
cents per share in 2013. This represents a 26% increase over the 2012 earnings
per share of 77 cents.

When the term “Net income per share” or “earnings per share” is used, it refers
to the amount of net income applicable to each share of common stock.
Therefore, in computing EPS, if there are preferred dividends declared for the
period, they must be deducted from net income to arrive at income available to
the common stockholders.

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10. Price-Earnings Ratio. The price-earnings (P-E) ratio is a widely used

measure of the ratio of the market price of each share of common stock to the
earnings per share. The price-earnings (PE) ratio reflects investors’ assessments
of a company’s future earnings. It is computed by dividing the market price per
share of the stock by earnings per share.
Market Price Per Share of Stock
Price−E arning Ratio=
Earnings Per Share

In 2013, each share of Quality’s stock sold for 12.4 times the amount that the
company earned on each share. Quality’s price-earnings ratio is lower than the
industry average of 21.3 times but much closer to the ratio of 13.5 times for
Macy’s.

11. Payout Ratio. The payout ratio measures the percentage of earnings
distributed in the form of cash dividends. It is computed by dividing cash
dividends by net income. Companies that have high growth rates are
characterized by low payout ratios because they reinvest most of their net
income into the business.
Cash Dividends
Payout Ratio=
Net Income

Quality’s payout ratio is higher than the industry average payout ratio of 16.1%.

Solvency Ratios
Solvency ratios measure the ability of the enterprise to survive over a long
period of time. Long-term creditors and stockholders are interested in a company’s
long-run solvency, particularly its ability to pay interest as it comes due and to repay
the face value of the debt at maturity. Debt to assets and times interest earned are
two ratios that provide information about debt-paying ability.
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12. Debt to Total Assets Ratio. The debt to total assets ratio measures the
percentage of the total assets provided by creditors (this ratio indicates the
degree of leveraging). It is computed by dividing the total debt (both current
and long-term liabilities) by total assets. This ratio provides some indication of
the company’s ability to withstand losses without impairing the interest of
creditors. The higher the percentage of debt to total assets, the greater the risk
that the company may unable to meet its maturing obligations.
Total Debt
Debt ¿ Total Assets=
Total Assets

A ratio of 45.3% means that creditors have provided 45.3% of Quality

Department Store’s total assets. Quality’s 45.3% is above the industry average
of 34.2%. It is considerably below the high 71.1% ratio of Macy’s. The lower the
ratio, the more equity “buffer” there is available to the creditors. Thus, from the
creditors’ point of view, a low ratio of debt to assets is usually desirable.

The adequacy of this ratio is often judged in the light of the company’s earnings.
Generally, companies with relatively stable earnings (such as public utilities)
have higher debt to assets ratios than cyclical companies with widely fluctuating
earnings (such as many high-tech companies).

13. Times Interest Earned Ratio. The times interest earned ratio provides
an indication of the company’s ability to meet interest payments as they come
due. It is computed by dividing the net income before interest expense and
income taxes by interest expense.
Income Before Income Taxes∧Interest Expense
¿ Interest Earned=
¿ terest Expense

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Note that times interest earned uses net income before income tax expense and
interest expense. This represents the amount available to cover interest. For
Quality Department Store, the 2013 amount is computed by taking net income
of $263,800 and adding back the $36,000 of interest expense and the $168,200
of income tax expense.

Quality’s interest expense is well covered at 13 times. It is less than the industry
average of 16.1 times but significantly exceeds Macy’s 6.9 times.

Summary of Ratios

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EXERCISES

Problem 1

Schellhammer Corporation reported the following amounts in 2016, 2017, and

2018.

Instructions
(a) Identify and describe the three tools of fi nancial statement analysis.
(b) Perform each of the three types of analysis on Schellhammer’s current
assets.

Problem 2

Using the following data from the comparative balance sheet of Goody Company,

Instructions
(a) Illustrate horizontal analysis.
(b) Illustrate vertical analysis.

Problem 3

Financial information for Kurzen Inc. is presented below.

Instruction: Prepare a schedule showing a horizontal analysis for 2017 using

2016 as the base year.

Problem 4

Operating data for Navarro Corporation are presented below.

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Instruction: Prepare a schedule showing a vertical analysis for 2017 and 2016.

Problem 5

The comparative condensed balance sheets of Gurley Corporation are presented

below:

Instructions:

(a) Prepare a horizontal analysis of the balance sheet data for Gurley
Corporation using 2016 as a base.

(b) Prepare a vertical analysis of the balance sheet data for Gurley Corporation
in columnar form for 2017.

Problem 6
Frizell Company has the following comparative balance sheet data.

Additional information for 2017:

1. Net income was $25,000.
2. Sales on account were $410,000. Sales returns and allowances were $20,000.
3. Cost of goods sold was $198,000.

Instructions
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Compute the following ratios at December 31, 2017.

(a) Current ratio
(b) Acid-test ratio
(c) Accounts receivable turnover.
(d) Inventory turnover.

Problem 7

Selected comparative statement data for Queen Products Company are

presented below. All balance sheet data are as of December 31.

Instructions
Compute the following ratios for 2017.
(a) Profi t margin.
(b) Asset turnover.
(c) Return on assets.
(d) Return on common stockholders’ equity.

Problem 8
The income statement for Sutherland, Inc., appears below.

Additional information:
1. The weighted-average common shares outstanding in 2017 were 30,000
shares.
2. The market price of Sutherland, Inc. stock was $13 in 2017.
3. Cash dividends of $26,000 were paid, $5,000 of which were to preferred
stockholders.

Instructions
Compute the following ratios for 2017.
(a) Earnings per share.
(b) Price-earnings ratio.
(c) Payout ratio.
(d) Times interest earned.

Problem 9
Lingenfelter Corporation experienced a fi re on December 31, 2017, in which its

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financial records were partially destroyed. It has been able to salvage some of
the records and has ascertained the following balances.

Additional information:
1. The inventory turnover is 4.5 times.
2. The return on common stockholders’ equity is 16%. The company had no
additional paid-in capital.
3. The accounts receivable turnover is 8.8 times.
4. The return on assets is 12.5%.
5. Total assets at December 31, 2016, were $655,000.

Instructions
Compute the following for Lingenfelter Corporation.
(a) Cost of goods sold for 2017.
(b) Net sales (credit) for 2017.
(c) Net income for 2017.
(d) Total assets at December 31, 2017.

Problem 10
Wiemers Corporation’s comparative balance sheets are presented below

Wiemers’s 2017 income statement included net sales of $100,000, cost of goods
sold of $60,000, and net income of $15,000.

Instructions
Compute the following ratios for 2017.
(a) Current ratio. (f) Asset turnover.
(b) Acid-test ratio. (g) Return on assets.
(c) Accounts receivable turnover. (h) Return on common stockholders’
equity.
(d) Inventory turnover. (i) Debt to assets ratio.
(e) Profi t margin.
Problem 11

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Comparative statement data for Farris Company and Ratzlaff Company, two
competitors, appear below. All balance sheet data are as of December 31, 2017, and
December 31, 2016.

Instructions
(a) Prepare a vertical analysis of the 2017 income statement data for Farris
Company and Ratzlaff Company in columnar form.
(b) Comment on the relative profi tability of the companies by computing the
return on assets and the return on common stockholders’ equity for both
ompanies.

Problem 12
The comparative statements of Painter Tool Company are presented below

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All sales were on account.

Instructions
Compute the following ratios for 2017. (Weighted-average common shares in
2017 were 57,000.)
(a) Earnings per share. (f) Accounts receivable turnover.
(b) Return on common stockholders’ equity. (g) Inventory turnover.
(c) Return on assets. (h) Times interest earned.
(d) Current ratio. (i) Asset turnover.
(e) Acid-test ratio. (j) Debt to assets ratio.

Problem 13
Condensed balance sheet and income statement data for Landwehr Corporation
appear below

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Additional information:
1. The market price of Landwehr’s common stock was $4.00, $5.00, and $8.00
for 2016, 2017, and 2018, respectively.
2. All dividends were paid in cash.

Instructions
(a) Compute the following ratios for 2017 and 2018.
(1) Profi t margin.
(2) Asset turnover.
(3) Earnings per share. (Weighted-average common shares in 2018 were
32,000 and in 2017 were 31,000.)
(4) Price-earnings ratio.
(5) Payout ratio.
(6) Debt to assets ratio.
(b) Based on the ratios calculated, discuss briefl y the improvement or lack
thereof in financial position and operating results from 2017 to 2018 of
Landwehr Corporation

Performance Name Grade Level 12 Score

Task
No. 5 Section Learning Area Fundamentals of ABM 2
1st Semester
2020-2021 Date Topic Financial Statement
Analysis

Problem 14
An incomplete income statement and an incomplete comparative balance sheet
of
Deines Corporation are presented below:

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Additional information:
1. The accounts receivable turnover for 2017 is 10 times.
2. All sales are on account.
3. The profi t margin for 2017 is 14.5%.
4. Return on assets is 22% for 2017.
5. The current ratio on December 31, 2017, is 3.0.
6. The inventory turnover for 2017 is 4.8 times.

Instructions
Compute the missing information given the ratios above. Show computations. (Note:
Start with one ratio and derive as much information as possible from it before trying
another ratio. List all missing amounts under the ratio used to fi nd the information.)

Approved:

MARY BERNADETTE S. MANDARIAGA SALVADOR J. SEMBRAN, PHD

Subject Teacher Assistant Principal II

Noted:

LOURENE J. GUANZON

ABM Group Head

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