1,Chapter 2 Financial Statements,Learning Objectives 1.Explain the nature and general purpose of financial statements. 2.Explain certain accounting principles that are important for an understanding of financial statements. 3.Demonstrate how certain business transactions affect the elements of the accounting equation: Assets=Liabilities + Owners equity,2,4.Explain that the statement of financial position, often referred to as the balance sheet, is an expansion of the basic accounting equation. 5.Explain that the income statement reports an enterprises financial performance for a period of time in term of the relationship of revenues and expenses. 6.Explain that the statement of cash flows presents the change in cash for a period of time in terms of the companys operating, investing, and financial activities.,3,2.1 The Balance Sheet,The balance sheet is a position statement that shows where the company stands in financial terms at specific date. It is sometimes described as a snapshot of the business in financial or dollar terms (that is, what the enterprise “looks like” at specific date).,4,Every business prepares a balance sheet at the end of the year, and many companies prepare one at the end of each month. It consists of listing of the assets, the liabilities, and the owners equity of a business. The date is important, as the financial position of a business may change quickly. A balance sheet is most useful if it is relatively recent. The following statement (Exhibit 2.1) shows the financial position of Vagabond Travel Agency on December 31, 2010.,5,6,2.1.1 Assets,Assets are economic resources that are owned by a business and are expected to benefit future operations. In most cases, the benefit to future operations comes in the form of positive future cash flows. The positive future cash flows may come directly as the asset is converted into cash (collection of a receivable) or indirectly as the asset is used in operating the business to create other assets that result in positive future cash flows (building and land used to manufacture a product for sale).,7,In reading a balance sheet, it is important to bear in mind that the dollar amounts listed do not indicated the prices at which the assets could be sold or the prices at which they could be replaced. Perhaps the greatest limitation of a balance sheet is that it does not show how much the business currently is worth.,8,2.1.2 Liabilities ,Liabilities are debts. They represent negative future cash flows for the enterprise. The person or organization to which the debt is owned is called a creditor.,9,All businesses have liabilities; even the largest and most successful companies often purchase merchandise, supplies, and services “on account”. The liabilities arising from such purchases are called accounts payable. Many businesses borrow money to finance expansion or the purchase of highcost assets. When obtaining a loan, the borrower usually must sign a formal note payable. A note payable is a written promise to repay the amount owed by a particular date and usually calls for the payment of interest as well.,10,2.1.3 Owners Equity ,Owners equity represents the owners claim to the assets of the business. Because creditors claims have legal priority over those of the owner, owners equity is a residual amount. If you are the owner of a business, you are entitled to assets that are left after the claims of creditors have been satisfied in full. Therefore, total assets minus total liabilities always equal to owners equity.,11,1)Increases in Owners Equity. The owners equity in a business comes from two sources: （1）Investments of cash or other assets from the owner. （2）Earnings from profitable operation of the business.,12,2)Decreases in Owners Equity. Decreases in owners equity also are caused in two ways: （1）Withdrawals of cash or other assets by the owner. （2）losses from unprofitable operation of the business.,13,2.1.4 The Accounting Equation ,A fundamental characteristic of every statement of financial position is that the total for assets always equals the total of liabilities plus owners equity. This agreement or balance of total assets with the total of liabilities and owners equity is the reason for calling this financial statement a balance sheet.,14,The equity of assets on the one hand and of the claims of the creditors and the owner on the other hand is expressed in the following accounting equation: Assets = Liabilities + owners Equity,15,2.2 The Income Statement,e income statement is an activity statement that shows details and results of the companys profitrelated activities for a period of time (for example, a month, quarter three months, or year).,16,Alternative titles for the income statement include Earnings Statement, Statement of Operations, and Profit and Loss Statement. However, income statement is by far the most popular term for this important financial statement. In brief, w