Financial Statements & Core Accounting Principles

Income Statement: Financial Performance

Measures a company's financial performance over a specific period of time.

• Revenue: First amount on right (credit)
• Expense: Second amount on left (debit)
• Revenues - Expenses = Net Income
• If net income is negative, it is called a Net Loss.
• Net income is allocated to either Dividends or Retained Earnings.

Retained Earnings: Company Profits

Represents the portion of net income that the firm has kept (as opposed to paying out as dividends).

• Ending Retained Earnings (ERE) = Beginning Retained Earnings (BRE) + Net Income (NI) - Dividends
• In a Statement of Stockholders' Equity, it would include common stock: ERE = BRE + Common Stock (Owner Contribution) + NI - Dividends

Balance Sheet: Financial Position Snapshot

Reports assets and claims to assets (liabilities and equity) at a specific point in time.

The Accounting Equation: A = L + SE

• Assets = Liabilities + Stockholders' Equity
• Assets are listed first, followed by Liabilities and Stockholders' Equity.
• Assets: Economic resources used to produce future benefit (items owned or owed to the company), listed in order of liquidity.
• Liabilities: Outsider claims and debts owed to others, listed in order of maturity.
• Stockholders' Equity: Insider claims, representing ownership by stockholders.

Statement of Cash Flows: Cash Movement

Categorizes cash inflows and outflows into three main activities:

Operating Activities

• Relates to revenues or expenses.

Investing Activities

• Involves buying or selling Property, Plant, and Equipment (PPE).

Financing Activities

• Includes borrowing from banks or stockholders.

• The ending cash balance must equal the cash amount reported on the Balance Sheet.

Trial Balance: Verifying Debits & Credits

A list of accounts and their balances (typically from the bottom of T-accounts).

• Accounts are listed in the order they appear on the ledger: Assets, Liabilities, Stockholders' Equity, Revenues, Expenses.
• Purpose: To prove that Debits = Credits.
• May also uncover errors in journalizing and posting.
• Useful in the preparation of financial statements.

Unearned Revenue: Liability for Future Service

The firm receives cash for goods or services it will deliver later. It is a liability because the company owes a good or service. Recording the transaction:

Recording Unearned Revenue (Initial Receipt)

• Cash (Balance Sheet) is debited.
• Unearned Revenue (Liability on Balance Sheet) is credited.

Recording Unearned Revenue (When Earned)

• Later, the firm makes an entry to record that the revenue has been earned.
• Unearned Revenue (Liability on Balance Sheet) is debited.
• Revenue (Income Statement) is credited.

Prepaid Expenses: Asset for Future Benefit

The firm pays cash for goods, services, or supplies that it will receive or use later. Prepaid expenses are assets because the company is owed a future benefit. Examples include prepaid insurance, prepaid rent, and supplies. Recording the transaction:

Recording Prepaid Expenses (Initial Payment)

• Prepaids (Asset on Balance Sheet) are debited.
• Cash (Balance Sheet) is credited.

Recording Prepaid Expenses (When Used)

• The firm makes an entry to record the expenses that have occurred.
• Expenses (Income Statement) are debited.
• Prepaid (Asset on Balance Sheet) is credited.
• Note: Paying rent for one month, if not prepaid, goes directly to an expense account.

Owner Investment Transaction Example

An owner invests $10,000 cash in the business in exchange for stock.

Transaction Impact:

1. Since it is cash, add $10,000 to Cash under Assets.
2. Add $10,000 to Common Stock (C.C.) under Stockholders' Equity. (Note: Common Stock is part of Equity, not Liabilities).