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)
 Three categories of accounts:
a. Assets
Three Characteristics of Assets
▪ It has probable future benefit that involves a capacity to contribute directly or indirectly to future net
cash flows
▪ A particular entity can obtain the benefit and control other’s access to the asset
▪ The transaction that resulted in the entity’s right to the benefit of the asset has already occurred
Examples: Cash, Accounts Receivable, Land, Equipment, Construction in Progress, Patents, Copyrights,
Goodwill, etc.
b. Liabilities
Amounts that company owes to its creditors.
Examples: Notes Payable, Accounts Payable, Unearned Revenue, etc.
c. Owner’s Equity (Stockholder’s Equity or Shareholder’s Equity)
▪ The owner’s claims to the assets of the company
▪ Includes both retained earnings and capital stock (common stock, preferred stock)
▪ Three basic components:
□ Share capital - represents contributions from stockholders gathered through the issuance of
stocks
 Ordinary share capital - It represnts ownership in a corporation. Common stockholders 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.
□ Retained earnings - represents the accumulated earnings of the business from the time it first
started.
According to PAS#1:
Assets are considered to be current
when:
1. It is cash or cash equivalent
2. The company intends to hold
the asset for the purpose of
trading it
3. The company expects to realize
the assets within 12 months
4. The company expects to realize
the asset or intends to sell or
use it within the entity's normal
operating cycle.
Liabilities are considered to be current
when:
1. The firm is expected to pay the
liability within its normal
operating cycle.
2. The firm holds the liability
primarily for the purpose of
trading.
3. The liability can be paid within
12 months.
Ordinary shareholders receive their share of capital
after the preference shareholders are paid. However,
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
and liabilities are categorized as current and non-current.
 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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Treasury Stocks are shares issued by the company
and were later re-acquired. The cost of treasury
stocks is deducted from stockholders' equity.
Less: Operating Expenses
xx
Operating Income
xx
Add: Other Income
xx
Less: Other Expenses
xx
Net Income before taxes
xx
Less: Income Tax Expenses
xx
Net Income
xx
Cost of goods sold is computed as follows:
For manufacturing:
For merchandising:
Merchandise inventory, beg.
xx
Add: Net Purchases
Direct materials (raw materials)
xx
Direct labor
xx
Purchases
xx
Factory overhead
xx
Freight In
xx
Manufacturing cost
xx
Less: Purchase returns and allowances
xx
Add: Work in process, beg.
xx
xx
Less: Work in process, end.
xx
xx
Cost of goods manufactured
xx
xx
Add: Finished goods, beg.
xx
xx
Less: Finished goods, end.
xx
Cost of goods sold
xx
Purchase discounts
xx
Cost of goods available for sale
Less: Merchandise Inventory, end.
Cost of goods sold
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
Equipment
61,000
Accounts Receivable
11,000
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
Salaries Expense
32,000
Office Supplies
4,000
Salaries Payable
3,100
Additional Paid in Capital
20,000
Retained Earnings (beg)
Service Revenue
Supplies Expense
Accumulated Depreciation
16,310
117,700
6,000
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.
Financial Management Page 4