Lecture 2
The Basic Financial Statements &
Recording Process
Dr Asma Abdul Rehman
Learning outcomes
• Will be able to understand the basic
terminology used in accounts
• Learn about the basic financial statements
• Describe how accounts, debits, and credits are
used to record business transactions.
Introduction to Financial Statements
Companies prepare interim
financial statements and annual
financial statements.
2000
X
Financial statements
•
•
•
•
Income statements
Balance sheet
Statement of cash flow
Owners equity statement
Introduction to Financial Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the
revenue and
expenses for a
designated
period of time.
Introduction to Financial Statements
Revenues
result in
positive cash
flow.
Expenses
result in
negative cash
flow.
Either in the past, present, or future.
Introduction to Financial Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Net income (or
net loss) is
simply the
difference
between
revenues and
expenses.
Introduction to Financial Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the
ways cash has
changed during
a designated
period of time.
Income statement
• Income statement presents the revenue, expenses and
resulting net income or net loss for a specific period of
time.
• Also known as statement of operations, earnings
statement, or profit and loss statement.
• Income statement lists revenues first followed by
expenses. Finally income statement shows the net income
or net loss.
• Net income results when the revenues exceed expenses.
• A net loss occurs when expenses exceed revenues.
• Note that Income statement does not include investment
and withdrawal transactions between the owner &
business in measuring net income.
INCOME STATEMENT:EXAMPLE
Owner’s Equity Statement
• An owner’s equity statement summarizes or report the
changes in owner’s equity for a specific period of time.
• The time period is same as covered by the income
statement.
• Data comes from the owner’s equity column and
income statement.
• The first row of the statement shows the beginning
owner’s equity amount; then come the owner’s
investment, net income (or Loss) and the owner’s
drawings.
• This statement indicates why owner’s equity has
increased or decreased during the period.
Financial Statements
Net income is needed to determine the
ending balance in owner’s equity.
SOFTBYTE
Income Statement
For the Month Ended September 30, 2017
Illustration 1-9
Financial statements and
their interrelationships
SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017
LO 5
SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017
The ending
balance in
owner’s equity
is needed in
preparing the
balance sheet.
Illustration 1-9
Financial statements
and their
interrelationships
Illustration 1-9
SOFTBYTE
Balance Sheet
September 30, 2017
The Concept of the Business Entity
Vagabond Travel
Agency
A business
entity is
separate from
the personal
affairs of its
owner.
A Starting Point: Statement of
Financial Position
Vagabond Travel Agency
Statement of Financial Position
December 31, 2002
Assets
Liabilities & Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity:
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Assets
Vagabond Travel Agency
Statement of Financial Position
December 31, 2002
Assets
Liabilities & Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity:
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Assets are
economic resources
that are owned by
the business and
are expected to
provide positive
future cash flows.
Liabilities
Vagabond Travel Agency
Statement of Financial Position
December 31, 2002
Assets
Liabilities & Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity:
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Liabilities are
financial
obligations that
represent negative
future cash flows
for the enterprise.
Owners’ Equity
Vagabond Travel Agency
Statement of Financial Position
December 31, 2002
Assets
Liabilities & Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity:
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Owners’ equity
represents the
owner’s claims to
the assets of the
business.
Owners’ Equity
Changes in Owners’
Equity
•Owners’
Investments
•Payments to
Owners/Drawing
•Business
Earnings
•Business
Losses
Balance Sheet

Reports the assets, liabilities, and owner's equity at a
specific date.

Lists assets at the top, followed by liabilities and owner’s
equity.

Total assets must equal total liabilities and owner's
equity.

Is a snapshot of the company’s financial condition at a
specific moment in time (usually the month-end or yearend).
LO 5
Statement of Cash Flows

Information on the cash receipts and payments for a
specific period of time.

Answers the following:
►
Where did cash come from?
►
What was cash used for?
►
What was the change in the
cash balance?
LO 5
DO IT!
Financial Statement Items
Presented below is selected information related to Falcon Company at
December 31, 2017. Falcon reports financial information monthly.
Equipment
Cash
Service Revenue
Rent Expense
Accounts Payable
$10,000
8,000
36,000
11,000
2,000
Utilities Expense
Accounts Receivable
Salaries and Wages Expense
Notes Payable
Owner’s Drawings
$ 4,000
9,000
7,000
16,500
5,000
(a) Determine the total assets of at December 31, 2017.
(b) Determine the net income reported for December 2017.
LO 5
DO IT!
Financial Statement Items
Presented below is selected information related to Falcon Company at
December 31, 2017. Falcon reports financial information monthly.
Equipment
Cash
Service Revenue
Rent Expense
Accounts Payable
$10,000
8,000
36,000
11,000
2,000
Utilities Expense
Accounts Receivable
Salaries and Wages Expense
Notes Payable
Owner’s Drawings
$ 4,000
9,000
7,000
16,500
5,000
(a) Determine the total assets of at December 31, 2017.
The total assets are $27,000, comprised of
•
Cash $8,000,
•
Accounts Receivable $9,000, and
•
Equipment $10,000.
LO 5
DO IT!
Financial Statement Items
Presented below is selected information related to Falcon Company at
December 31, 2017. Falcon reports financial information monthly.
Equipment
Cash
Service Revenue
Rent Expense
Accounts Payable
$10,000
8,000
36,000
11,000
2,000
Utilities Expense
Accounts Receivable
Salaries and Wages Expense
Notes Payable
Owner’s Drawings
$ 4,000
9,000
7,000
16,500
5,000
(b) Determine the net income reported for December 2017.
LO 5
Forms of Business Organizations
Sole
Proprietorship
Partnership
Corporation
Reporting Ownership Equity in the
Balance Sheet
Sole
Proprietorship
Ow ner's equity:
Jill Jones, capital
$
8,000
Partnership
Partners' equity
Jill Jones, capital $ 4,000
Bill Jones, capital
4,000
Total partners' equity
$ 8,000
Corporation
Owners' equity
Capital stock
$ 7,000
Retained earnings
1,000
Total stockholders' equity $ 8,000
The Need for Adequate Disclosure
Balance Sheet
Income Statement
Statement of Cash Flows
Notes to the
financial
statements often
provide facts
necessary for the
proper
interpretation of
the statements.
The Recording Process
The account

It is an individual accounting Record of increases and
decreases in a specific asset, liability, owners’ equity,
revenue, or expense item.

Debit = “Left”

Credit = “Right”
Account Name
Debit / Dr.
An account can be
illustrated in a Taccount form.
Credit / Cr.
The Account
DEBIT AND CREDIT PROCEDURES
Double-entry system

Each transaction must affect two or more accounts to
keep the basic accounting equation in balance.

Recording done by debiting at least one account and
crediting at least one other account.

DEBITS must equal CREDITS.
LO 1
Debits and Credits
If the sum of Debit entries are greater than the sum of
Credit entries, the account will have a debit balance.
Account Name
Debit / Dr.
Credit / Cr.
Transaction #1
$10,000
$3,000
Transaction #3
8,000
Balance
Transaction #2
$15,000
LO 1
Debits and Credits
If the sum of Credit entries are greater than the sum of
Debit entries, the account will have a credit balance.
Account Name
Transaction #1
Balance
Debit / Dr.
Credit / Cr.
$10,000
$3,000
Transaction #2
8,000
Transaction #3
$1,000
LO 1
Dr./Cr. Procedure
• A debit is an accounting entry that either
increases an asset or expense account. Or
decreases a liability or equity account. It is
positioned on the left in an accounting entry.
• A credit is an accounting entry that increases
either a liability or equity account. Or
decreases an asset or expense account. It is
positioned on the right in an accounting entry.
Debits/Credits Rules
Balance Sheet
Asset
= Liability
+ Equity
Income Statement
Revenue - Expense
Debit
Credit
LO 1
Debits and Credits
Assets
Debit / Dr.

Assets - Debits should exceed
credits.

Liabilities – Credits should
exceed debits.

Normal balance is on the
increase side.
Credit / Cr.
Normal Balance
Chapter
3-23
Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter
3-24
LO 1
Debits and Credits
Owner’s Equity

Owner’s investments and revenues
increase owner’s equity (credit).

Owner’s drawings and expenses
decrease owner’s equity (debit).
Credit / Cr.
Debit / Dr.
Normal Balance
Chapter
3-25
Owner’s Capital
Debit / Dr.
Chapter
3-25
Owner’s Drawing
Credit / Cr.
Debit / Dr.
Normal Balance
Normal Balance
Credit / Cr.
Helpful Hint Because
revenues increase owner’s
equity, a revenue account
has the same debit/credit
rules as the Owner’s
Capital account. Expenses
have the opposite effect.
Chapter
3-23
LO 1
Debits and Credits
Revenue
Debit / Dr.

The purpose of earning revenues
is to benefit the owner(s).

The effect of debits and credits on
revenue accounts is the same as
their effect on Owner’s Capital.

Expenses have the opposite effect:
expenses decrease owner’s equity.
Credit / Cr.
Normal Balance
Chapter
3-26
Expense
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter
3-27
LO 1
Debits/Credits Rules
Liabilities
Normal
Balance
Debit
Normal
Balance
Credit
Assets
Credit / Cr.
Normal Balance
Chapter
3-24
Owner’s Equity
Credit / Cr.
Debit / Dr.
Debit / Dr.
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-23
Expense
Debit / Dr.
Chapter
3-25
Revenue
Credit / Cr.
Debit / Dr.
Normal Balance
Chapter
3-27
Credit / Cr.
Normal Balance
Chapter
3-26
LO 1
Debits/Credits Rules
Question
Debits:
a. increase both assets and liabilities.
b. decrease both assets and liabilities.
c. increase assets and decrease liabilities.
d. decrease assets and increase liabilities.
LO 1
Debits/Credits Rules
Question
Accounts that normally have debit balances are:
a. assets, expenses, and revenues.
b. assets, expenses, and equity.
c. assets, liabilities, and owner’s drawing.
d. assets, owner’s drawing, and expenses.
LO 1
Summary of Debit/Credit Rules
Relationship among the assets, liabilities and owner’s equity
of a business:
Illustration 2-11
Basic
Equation
Assets = Liabilities +
Owner’s Equity
Expanded
Equation
Debit/Credit
Effects
The equation must be in balance after every transaction.
Total Debits must equal total Credits.
LO 1
Practice
• Page 107 PROBLEM 2.1B Preparing and Evaluating a Balance
Sheet
• Page 107 PROBLEM 2.2B Interpreting the Effects of Business
Transactions
• Page 108 PROBLEM 2.3B
• Page 109 PROBLEM 2.6B Preparing a Balance Sheet—A Second
Problem
Record debit and credit