Review of Modules 2 and 3:
Financial Statements and
Transaction Analysis
1
Course Overview

Financial Accounting
–
–
–
–

External users
Emphasis on decision making of users
Subject to regulation
Publicly available
Managerial Accounting
– Internal users (within the company)
– Emphasis on use to plan activities, make pricing
decisions, and measure performance
– Proprietary information
2
Module 2 Review
Financial statements report the
company activity during the year and
the financial condition of the company at
the end of the year.
 The required financial statements are:
– Balance Sheet
– Income Statement
– Statement of Stockholders’ Equity
(Statement of Owner’s Equity)
– Statement of Cash Flows

3
The Balance Sheet
The balance sheet reports the financial
position at a point in time (end of the
quarter or year).
 The balance sheet is divided into three
major categories:
– Assets
– Liabilities
– Stockholders’ equity

4
The Balance Sheet
The balance sheet is represented by the
fundamental accounting equation:
Assets = Liabilities + Stockholders’ Equity
A =
L
+
SE
 The effects of all described business
transactions may be represented in this
formula.

5
The Balance Sheet (B/S)



Assets - represent future benefit to the
company, and are classified in order of liquidity
(current assets; property and equipment; longterm investments; intangibles)
Liabilities - represent obligations of the
company, and are classified according to
payment date (current liabilities, long-term
liabilities)
Stockholders’ equity - represents the residual
claims of the owners, and is classified based
on source (contributed capital and retained
earnings)
6
B/S Assets: Current Assets

Current assets include
– Cash: checking and savings accounts;
petty cash.
– Short-term investments: investments in
stocks and bonds of other companies.
– Accounts receivable: amounts owed to a
company from its customers.
– Inventory: products on hand designated
for sale to customers.
– Prepaid expenses: amounts paid for
future expenses.
7
B/S Assets:
Property and Equipment

Property and equipment are assets that are
used in the production of goods and
services. These productive assets are longterm in nature, and include the following:
– Land: property upon which the productive
facilities are located.
– Building: the physical structure of the
company’s operations.
– Machinery and Equipment: include
operating machinery, vehicles, computers,
copy machines, etc.
8
B/S Assets: Long-term Investments

Long-term investments are assets acquired by
the company to provide long-term benefits to the
company. Long-term investments include:
– Long-term notes receivable owed to the
company (from customers or others).
– Investments in stock of other companies: held
for expectation of dividends and/or stock price
increase.
– Investment in bonds of other companies: held
for expectation of dividends and/or stock price
increase.
– Other assets, like land, held for the long term,
but not part of operations.
9
B/S Assets: Intangible Assets

Intangible assets are long-lived assets that have
no physical substance. Examples include:
– Patents: legal claim to produce and sell a
product.
– Copyrights: legal claims to books, art, music
and other created works.
– Goodwill: recognized when one company
buys another company, and the purchase
price is greater than the fair value of the
identifiable net assets.
10
B/S Liabilities: Current Liabilities

Current liabilities are obligations expected to
be paid (or services expected to be
performed) within the next year or operating
cycle. The elimination of the current liabilities
requires the use of current assets (most
commonly cash). Examples include:
– Accounts payable
– Wages payable
– Interest payable
– Short-term notes payable
– Current maturities of long-term debt
– Deferred (unearned) revenues
11
B/S Liabilities: Long-term Liabilities

Long-term liabilities are obligations expected to
require payments beyond the current year.
Examples of long-term liabilities include:
– Notes payable: amounts owed to banks and
other creditors beyond the current year.
– Mortgage payable: amounts owed to
mortgage company beyond the current year.
– Bonds payable: amounts owed to investors
holding bond investments issued by the
company, where payments of principal and
interest are beyond the current year.
12
B/S Stockholders’ Equity:
Contributed Capital

Contributed capital is generated when owners
(shareholders) of the company contribute
cash and other assets into the company.
Components of contributed capital include
– Common stock: shares of stock issued to
owners to to reflect ownership.
– Additional paid in capital: excess amounts
contributed by shareholders for various
activities.
13
B/S Stockholders’ Equity:
Retained Earnings

Retained earnings represent the excess
earnings retained in the company after
dividends have been paid to shareholders.
This represents the equity generated by
the company for the shareholders.
14
The Statement
of Stockholders’ Equity (SSE)
The following formula represents the
basic SSE:
Beginning stockholders’ equity
Plus: Issuance of stock
Plus: Net income
Less: Dividends
Ending stockholders’ equity
SEBegin + Issue + NI - D = SEEnd
15
The Statement
of Retained Earnings
The statement of retained earnings is a
subset of the SSE, and calculates the
changes in the retained earnings component.
Beginning retained earnings
Plus: Net income
Less: Dividends
Ending retained earnings
REBegin + NI - Div = REEnd
16
The Income Statement (I/S)
The income statement shows the
components of net income in detail.
 Revenues represent the inflow of assets
(or decrease in liabilities) due to a
company’s operating activities.
 Expenses represent the outflow of assets
(or increases in liabilities) due to a
company’s operating activities.
 The general formula for the I/S is:
Revenues - Expenses = Net Income

17
The Income Statement Format
Operating revenues
Sales
Fees earned
Other revenues
Less: Operating expenses
Cost of goods sold
Wage expense
Rent expense
Selling expense
Depreciation expense
Other expenses
Net Income
18
The Statement of Cash Flows

Cash flows from operating activities:
– Collections from sales, rent, interest, etc.
– Cash paid to suppliers and employees, and for
rent, selling activities, interest, and taxes etc.
 Cash flow from investing activities:
– Proceeds from sale of investment securities,
land, buildings, equipment, etc.
– Purchase of investment securities, land,
buildings, equipment, etc.
 Cash flow from financing activities:
– Proceeds from issuance of notes, debt, sale of
equity, etc.
– Payments on notes, debt, dividends, etc.
19
Relationships Among the
Financial Statements
Ending
Balance Sheet
Beginning
Balance Sheet
Assets
(Cash)
=
Statement of
Cash Flows
Income
Statement
=
Liabilities
Liabilities
+
Equity
Assets
(Cash)
+
Statement of
Stockholders’ Equity
Equity
20
Module 3 Review
The first step in the accounting process is
transaction analysis.
 This process examines relevant, objectively
measurable economic events through their
effect on the accounting equation:
Assets = Liabilities + Equity

21
Transaction Analysis
Transaction analysis and the effect on
stockholders’ equity:
Assets = Liabilities
+
Stockholders’ Equity
Retained
Earnings
Common
Stock
Net Income Dividends
Revenues Expenses
22
Spreadsheet Analysis
Using a spreadsheet template, analyze
the transactions on the next slide. (Fullsize spreadsheet at the back of your
handouts.)
 Note that effects may be on both sides of
the equation, in the same direction, or
effects may be on one side of the
equation with offsetting directions.

23
Transactions
Anna Corporation began on Dec. 1, 2008, and had
the following activity during its first month:
1. Investors contributed $30,000 to start up the
company.
2. The company purchased land for a future
building site for $20,000.
3. The company borrowed $9,000 from the bank.
4. The company completed a consulting contract,
and billed the customer $8,000 (provided
services on account).
5. The company paid $5,500 for salaries to
employees.
6. The company distributed $500 of cash dividends
to its investors.
24
Spreadsheet Template
1.
2.
3.
4.
5.
6.
Cash + A/R + Land =
=
=
=
=
=
_____ _____ _____=
N/P
+
_____
CS +
_____
RE
_____
25
Financial Statements
Income Statement
Revenues
Expenses
Net Income
$8,000
5,500
$2,500
Statement of Stockholders’ Equity
CS
RE
Beginning
$
0
$
0
Issue CS
30,000
Net Income
2,500
Less: Dividends
500
Ending
$30,000
$2,000
26
Financial Statements
Balance Sheet
Assets
Cash
$13,000
A/R
8,000
Land
20,000
Total
$41,000
Liabilities and S.E.
N/P
$ 9,000
CS (from SSE) 30,000
RE (from SSE) 2,000
Total
$41,000
27
Double Entry System
Note that the transaction analysis was
relatively simple with a few transactions
and a few accounts. However, with
thousands of transactions and hundreds
of accounts, the spreadsheet program is
not sufficient.
 Therefore accountants use a “double
entry” system based on debits and
credits.

28
Double Entry Accounting
Debit (dr) - means an entry to the left
hand side of an account.
 Credit (cr) - means an entry to the right
hand side of an account.
 Note that a debit or credit, per se, does
not indicate increase or decrease.
 To decide the effect of a debit or credit,
the type of account must be considered.

29
Effect of Debits and Credits
Based on the accounting equation, we
can increase or decrease various
accounts depending on their classification:
Assets = Liabilities + Equity
Increase
DR =
CR
CR
Decrease CR =
DR
DR


Note that we use debits and credits
instead of plusses and minuses.
30
Effect of Debits and Credits
Expanded rules for debits and credits based
on financial statement relationships:
Assets = Liabilities
+
Stockholders’ Equity
Retained
Earnings
Common
Stock
Net Income Dividends
Revenues Expenses
31
The following rules can be derived from
the basic formula:





Assets have normal debit balances and are
increased with a debit.
Liabilities and equities have normal credit
balances and are increased with a credit.
Revenues (a part of equity) have normal credit
balances and are increased with a credit.
Expenses (which decrease equity) have normal
debit balances and are increased with a debit.
Dividends (which decrease equity) have a
normal debit balance and are increased with a
debit.
32
The Format of a Journal Entry
To initially record transactions, we use a journal
entry to represent the debits and credits.
For example, in Item 1:
Debit Credit
Cash
30,000
Common Stock
30,000
Note that the debit is to the left and the credit is
to the right. First we list the account (left hand
entry on top), then the amount.
33
Now back to Anna Corp., and
prepare the other journal entries:
2: Purchased land for $20,000 cash.
3: Borrowed $9,000 cash from bank.
34
Now back to Anna Corp. and prepare
the other journal entries:
4: Consulting services (on account) $8,000.
5: Paid $5,500 cash for salaries.
35
Now back to Anna Corp., and
prepare the other journal entries:
6: Paid $500 cash dividend to investors.
Note that dividends is a contra equity and
reduces retained earnings.
36
The Accounting Cycle
Components of the accounting cycle include:
A. Preparation of General Journal Entries
-Post to the General Ledger
-Unadjusted Trial Balance
B. Preparation of Adjusting Journal Entries
-Post to the General Ledger
-Adjusted Trial Balance
C. Financial Statements
D. Closing Journal Entries (or closing process)
-Final Trial Balance
37
A. General Journal Entries (GJEs)





The first step in the accounting process.
Prepared for daily activity.
Usually journalized in special journals for
efficiency, but we will record in “General Journal”
format.
Identified through a document flow:
– cash receipt, record a cash sale
– charge receipt, record a credit sale
– bank note, record a notes payable
– employee time card, record wages
The transactions on Slide 23 are general journal
entries.
38
The General Ledger (G/L)
The G/L serves as a place to “total”
amounts by account titles.
 After GJEs and AJEs are recorded, they
are posted (by account) to the G/L.
 We will use “T” accounts to represent G/L
accounts where needed.

39
Posting to G/L, Anna Corp.
Now post transactions (for cash) to “T” account:
Cash
40
Unadjusted Trial Balance

Trial balances are prepared throughout the
accounting cycle.
 The Unadjusted Trial Balance represents G/L
totals (by account) at a particular point in time.
 For the GJEs on Slide 23, the Unadjusted Trial
Balance would consist of a list of all of the
ending debit or credit balances taken from the
various “T” account totals (illustrated on the
next slide).
 The Unadjusted Trial Balance is a preliminary
total, and is a starting point for the Adjusting
Journal Entries (discussed later in this
chapter).
41
Unadjusted Trial Balance - Anna Corp.
(after posting and totaling G/L accounts)
Cash
Accounts Receivable
Land
Notes Payable
Common Stock
Retained Earnings
Dividends
Service Revenue
Salary Expense
Totals
Debit
13,000
8,000
20,000
Credit
9,000
30,000
0
500
8,000
5,500
47,000
47,000
42
B. Adjusting Journal Entries (AJEs)




Prepared at the end of the accounting period
to align revenues and expenses (matching).
Usually NO document flow to trigger recording.
Based on the accrual system of accounting
which records revenues as earned and
expenses as incurred (rather than based on
cash flows).
Types of AJEs
1. Accrual of expenses
2. Accrual of revenues
3. Prepaid expenses
4. Unearned revenues
43
1. Accrual of Expenses

Probably the most common type of AJE.
Ex: accrue wages of $100 at the end of the
period:
Wages Expense
100
Wages Payable
100
 Other examples of expense/payable include
interest, rent, taxes.
44
2. Accrual of Revenues
For revenues that have not yet been
recorded at the end of the period.
 Ex: accrue interest revenue of $50:
Interest Receivable
50
Interest Revenue
50
 Another example of receivable/revenue
accruals relates to rent revenue, where
the rental payment has not yet been
received.

45
3.Prepaid Expenses

This category of AJE relates to the concept of
asset capitalization and the matching
principle.
 Asset capitalization occurs when a cost (with
future economic benefit) is incurred. An asset
is recognized at that time.
 As the asset is “used up” in the generation of
revenue, the related cost is recognized as an
expense (matching).
 Some expenses are deferred for a short period
of time (Supplies Expense), and some
expenses are deferred for many years
(Depreciation Expense).
46
3.Prepaid Expenses

Example: Purchase 1 year, $1,200 insurance
policy.
General JE at time of purchase:
Prepaid Insurance
1,200
Cash
1,200
AJE at end of the first month (for the portion
that has been used):
Insurance Expense
100
Prepaid Insurance
100
47
4.Unearned Revenues
Cash is received from customer before
goods/services are delivered (before
revenue can be recognized).
Ex: Received a 3-year subscription of
$360 in advance.
General JE at time cash received:
Cash
360
Unearned Revenues
360
AJE at end of the first quarter (for 3 mos.):
Unearned Revenues
30
Subscription Revenues
30

48
Adjusted Trial Balance
The Adjusted Trial Balance reflects totals
after the AJEs are posted to the general
ledger.
 The balance sheet accounts reflect the endof-year balances, and the income statement
accounts reflect the proper revenues and
expense to be recognized for the year.
 This list of accounts and amounts is used to
prepare the balance sheet and income
statement.

49
D. Closing Journal Entries (CJEs)
Prepared after the financial statements
have been completed.
 Close temporary accounts to retained
earnings, so that the balances in those
accounts at the start of the next accounting
period will be zero.
 Temporary accounts include revenues,
expenses and dividends.
 The final trial balance after closing will
display only permanent, balance sheet
accounts.

50
D. Closing Journal Entries (CJEs)
Back to Anna Corp. Trial Balance (Slide 40).
To close Revenues and Expenses and
Dividends:
Close Net Income to RE:
Service Revenue
8,000
Salary Expense
5,500
Retained Earnings
2,500
Close Dividends to RE:
Retained Earnings
500
Dividends
500
51