Chapter 2 - Financial Statements

There are four major financial statements used to communicate information to external users (creditors, investors,
suppliers, etc.)

1. Statement of Financial Position or Balance Sheet (assets, liabilities, and Shareholder’s equity)
2. Statement of Comprehensive Income or Income Statement (revenues and expenses)
3. Statement of Changes in Shareholder’s Equity (contributed capital and retained earnings)
 Statement of Retained Earnings
4. Statement of Cash Flows

Statement of Financial Position/Balance Sheet

 Financial statement that presents the financial position of the company on a particular date.
 Summarized by the accounting equation which must always be in balance (Assets=Liabilities + Shareholder’s
Equity) According to PAS#1:
 Three categories of accounts: Assets are considered to be current
a. Assets when:
Three Characteristics of Assets 1. It is cash or cash equivalent
▪ It has probable future benefit that involves a capacity to contribute directly or indirectly to future net 2. The company intends to hold
cash flows the asset for the purpose of
▪ A particular entity can obtain the benefit and control other’s access to the asset trading it
▪ The transaction that resulted in the entity’s right to the benefit of the asset has already occurred 3. The company expects to realize
the assets within 12 months
Examples: Cash, Accounts Receivable, Land, Equipment, Construction in Progress, Patents, Copyrights, 4. The company expects to realize
Goodwill, etc. the asset or intends to sell or
use it within the entity's normal
b. Liabilities operating cycle.
Amounts that company owes to its creditors.
Liabilities are considered to be current
Examples: Notes Payable, Accounts Payable, Unearned Revenue, etc. when:
1. The firm is expected to pay the
c. Owner’s Equity (Stockholder’s Equity or Shareholder’s Equity) liability within its normal
▪ The owner’s claims to the assets of the company operating cycle.
▪ Includes both retained earnings and capital stock (common stock, preferred stock) 2. The firm holds the liability
▪ Three basic components: primarily for the purpose of
□ Share capital - represents contributions from stockholders gathered through the issuance of trading.
stocks 3. The liability can be paid within
 Ordinary share capital - It represents ownership in a corporation. Common stockholders 12 months.
are given rights to receive dividends and voting rights in electing a board of directors.
 Preference share capital - Preferred stockholders enjoy fixed dividend rates and are paid
first before the common stockholders.
□ Reserves - include unrealized gains and losses, appropriations, and additional paid-in capital. Ordinary shareholders receive their share of capital
□ Retained earnings - represents the accumulated earnings of the business from the time it first after the preference shareholders are paid. However,
started. preference shareholders do not have voting rights on
preference shares.
Stockholders' Equity (SHE) = Capital Stock + Reserves + Retained Earnings - Treasury Stock

✔ Most companies prepare a classified balance sheet which is the same as a regular balance sheet except assets
Treasury Stocks are shares issued by the company
and liabilities are categorized as current and non-current.
and were later re-acquired. The cost of treasury
stocks is deducted from stockholders' equity.
 Current—will be used or paid for within the next year
Examples:
○ Current Assets: Cash, Accounts Receivable, Inventory
○ Current Liabilities: Accounts Payable, Unearned Revenue

 Non-current—will not be used or paid for within the next year

Examples:
○ Non-Current Assets: Land, Notes Receivable, Equipment
○ Non-Current Liabilities: Notes Payable, Bonds Payable

Statement of Comprehensive Income/Income Statement

 Financial statement that reports the company’s revenues and expenses over an interval of time (usually one
accounting period)
 Shows whether the company was able to generate enough revenue to cover the expenses of running the business
○ Revenue - Expenses = Net Income or Net Loss
○ Revenues equal the selling price of a good or service
○ Expenses are costs incurred to earn revenue
○ Example: Tom sells Jane a t-shirt for P120. It cost Tom P115. Tom’s revenue is P120, his cost of goods sold
(expense) is P115, and his net income is P5.

 Multiple Step Income Statement

Sales xx
Less: Cost of goods sold xx
Gross Profit xx

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 Less: Operating Expenses xx
Operating Income xx For manufacturing:
Add: Other Income xx Direct materials (raw materials) xx
Less: Other Expenses xx Direct labor xx
Net Income before taxes xx Factory overhead xx
Less: Income Tax Expenses xx Manufacturing cost xx
Net Income xx Add: Work in process, beg. xx
Less: Work in process, end. xx
Cost of goods sold is computed as follows:
Cost of goods manufactured xx
For merchandising: Add: Finished goods, beg. xx
Merchandise inventory, beg. xx Less: Finished goods, end. xx
Add: Net Purchases Cost of goods sold xx
Purchases xx
Freight In xx
Less: Purchase returns and allowances xx
Purchase discounts xx xx
Cost of goods available for sale xx
Less: Merchandise Inventory, end. xx
Cost of goods sold xx

Statement of Changes in Shareholder’s Equity

 Contributed Capital and retained earnings
 Retained Earnings:

Beginning Retained Earnings xx

Less: Dividends xx
Less: Appropriations xx
Add: Net Income or Minus Net Loss xx
Ending Retained Earnings xx

Statement of Cash Flows

 Financial statement that measures activities involving cash receipts and cash payments over an interval of time
(usually one accounting period).
 Cash flows can be classified into one of three categories:
1. Operating Activities - day-to-day general activities to run the business
Examples: Purchasing inventory for cash, selling inventory for cash, paying cash for a business license, paying cash for
utilities, etc.
2. Investing Activities - purchase and sale of assets that last longer than one year
Examples: Purchasing land for cash, selling property for cash, etc.
3. Financing Activities - cash transactions involving a company’s long-term creditors or owners
Examples: Receiving cash from a bank loan, receiving cash from the issue of common stock, receiving cash from the sale
of bonds, paying cash for dividends, paying cash for principal on a loan

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Chapter 2 - Preparing Financial Statements
Preparation of Financial Statements:
Example 1:
The following items were taken from the accounting records of CBA Incorporated. The income statement
account balances are for the year ending December 31, 2012. The balance sheet account balances are the
balances at December 31, 2012 except for the retained earnings balance which is the balance at 1/1/2012:

Accounts Payable 61,000 Accounts Receivable 11,000

Equipment 132,000 Advertising Expense 26,200
Cash 54,500 Common Stock 5,000
Administrative Expense 12,300 Dividends 2,200
Insurance Expense 3,000 Notes Payable (long-term) 70,000
Prepaid Insurance 6,550 Rent Expense 17,000
Retained Earnings (beg) 16,310 Salaries Expense 32,000
Service Revenue 117,700 Office Supplies 4,000
Supplies Expense 6,000 Salaries Payable 3,100
Accumulated Depreciation 20,000 Additional Paid in Capital 20,000
Income tax rate 30%

Instructions: Prepare an income statement, a statement of retained earnings, and a classified balance sheet
for CBA Incorporated for the year 2012.

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 CBA Incorporated
Statement of Financial Position
At December 31, 2012

Note: The amount of Retained Earnings in the Shareholders’ Equity section came from the Statement
of Retained Earnings of CBA Incorporated for the year ended 2012.

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