Financial statement

1. Financial Statements
 LEARNING OBJECTIVES
By the end of this section, you will be able to:
Prepare a simple: Income Statement, Statement
of Owner’s Equity, Balance Sheet

2. Financial statements are how companies communicate their story. Thanks to GAAP, there are four basic financial statements
everyone must prepare . Together they represent the profitability and strength of a company. The financial statement that reflects
a company’s profitability is the income statement. The statement of retained earnings – also called statement of owners
equity shows the change in retained earnings between the beginning and end of a period (e.g. a month or a year). The balance
sheet reflects a company’s solvency and financial position. The statement of cash flows shows the cash inflows and outflows for
a company over a period of time.
There are several accounting activities that happen before financial statements are prepared. Financial statements are prepared in
the following order:
 Income Statement
 Statement of Retained Earnings – also called Statement of Owners’ Equity
 The Balance Sheet
 The Statement of Cash Flows
Remember the transaction analysis we were working on for Metro Courier? Let’s use those numbers to prepare the financial
statements for Metro Courier Inc. The final balances for January were:

4. Income Statement
• The income statement, sometimes called an earnings statement or profit and loss statement, reports the
profitability of a business organization for a stated period of time. In accounting, we measure profitability for a
period, such as a month or year, by comparing the revenues earned with the expenses incurred to produce these
revenues. This is the first financial statement prepared as you will need the information from this statement for
the remaining statements. The income statement contains:
• Revenues are the inflows of cash resulting from the sale of products or the rendering of services to customers. We
measure revenues by the prices agreed on in the exchanges in which a business delivers goods or renders services.
• Expenses are the costs incurred to produce revenues. Expenses are costs of doing business (typically identified as
accounts ending in the word “expense”).
• REVENUES – EXPENSES = NET INCOME. Net income is often called the earnings of the company. When expenses
exceed revenues, the business has a net loss.

6. Statement of Retained Earnings (or Owner’s
Equity)
The statement of retained earnings, explains the changes in retained earnings between two balance
sheet dates. We start with beginning retained earnings (in our example, the business began in January
so we start with a zero balance) and add any net income (or subtract net loss) from the income
statement. Next, we subtract any dividends declared (or any owner withdrawals in a partnership or
sole-proprietor) to get the Ending balance in Retained Earnings (or capital for non-corporations)
The Ending balance we calculated for retained earnings (or capital) is reported on the balance
sheet.

7. Balance Sheet
The balance sheet, lists the company’s assets, liabilities, and equity (including dollar amounts) as of a specific moment
in time. That specific moment is the close of business on the date of the balance sheet. Notice how the heading of the
balance sheet differs from the headings on the income statement and statement of retained earnings. A balance sheet
is like a photograph; it captures the financial position of a company at a particular point in time. The other two
statements are for a period of time. As you study about the assets, liabilities, and stockholders’ equity contained in a
balance sheet, you will understand why this financial statement provides information about the solvency of the
business.
Remember in the transaction analysis, our final accounting equation was: Assets $88,100 (Cash $66,800 + Accounts
Receivable $5,000 + Supplies $500 + Prepaid Rent $1,800 + Equipment $5,500 + Truck $8,500) = Liabilities $200 + Equity
$87,900 (Common Stock $30,000 + Net Income $57,900 from revenue of $60,000 – salary expense $900 – utility
expense $1,200). The balance sheet is the same equation in an easier to read format.

8. Statement of Cash Flows
The statement of cash flows shows the cash inflows and cash outflows from operating, investing, and financing
activities. Operating activities generally include the cash effects of transactions and other events that enter into the
determination of net income. Management is interested in the cash inflows to the company and the cash outflows from
the company because these determine the company’s cash it has available to pay its bills when due. We will examine
the statement of cash flows in more detail later but for now understand it is a required financial statement and is
prepared last. The statement of cash flows uses information from all previous financial statements.
You should be able to update the Financial Statements column of our chart of accounts spreadsheet (need another
copy, click Chart of Accounts)

9. KEY POINTS
There are four financial statements produced by accountants, including
 The income statement reports the revenues and expenses of a company and shows the profitability
of that business organization for a stated period of time. The net income (or loss) calculated is used
in the statement of retained earnings.
 The statement of retained earnings shows the change in retained earnings between the beginning
of the period (e.g. a month) and its end. The ending retained earnings is used by the balance sheet.
 The balance sheet lists the assets, liabilities, and equity (including dollar amounts) of a business
organization at a specific moment in time and proves the accounting equation.
 The statement of cash flows which shows the cash inflows and cash outflows for a company for a
stated period of time. The statement of cash flows uses information from all previous financial
statements.

10. • END