20 Chapter 1 Accounting in Action

action plan 1. The owner invested $25,000 cash in the business.

✔ Analyze the effects of 2. The company purchased $7,000 of office equipment on credit.
each transaction on the 3. The company received $8,000 cash in exchange for services performed.
accounting equation.
4. The company paid $850 for this month’s rent.
✔ Use appropriate category
names (not descriptions). 5. The owner withdrew $1,000 cash for personal use.
✔ Keep the accounting
equation in balance.

Solution
Assets Liabilities Owner’s Equity
Office Accounts A.Virmari, A.Virmari,
Cash Equipment Payable Capital Drawings Revenues Expenses
1. $25,000 $25,000
2. $7,000 $7,000
3. 8,000 $8,000
4. 850 $850
5. 1,000 $1,000
$31,150 $7,000 $7,000 $25,000 $1,000 $8,000 $850
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

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
$38,150 $38,150

Related exercise material: BE1-6, BE1-7, BE1-8, BE1-9, E1-6, E1-7, E1-8, E1-10, E1-11, and DO IT! 1-3.

✓ The Navigator

FINANCIAL STATEMENTS
STUDY OBJECTIVE 8 Companies prepare four financial statements from the summarized ac-
Understand the four financial counting data:
statements and how they are 1. An income statement presents the revenues and expenses and result-
prepared.
ing net income or net loss for a specific period of time.
2. An owner’s equity statement summarizes the changes in owner’s equity for a
specific period of time.
3. A balance sheet reports the assets, liabilities, and owner’s equity at a specific date.
4. A statement of cash flows summarizes information about the cash inflows (re-
ceipts) and outflows (payments) for a specific period of time.

HELPFUL HINT These statements provide relevant financial data for internal and external users.
The income statement, Illustration 1-9 (page 21) shows the financial statements of Softbyte. Note that
owner’s equity state- the statements are interrelated:
ment, and statement of
1. Net income of $2,750 on the income statement is added to the beginning bal-
cash flows are all for a
period of time, whereas
ance of owner’s capital in the owner’s equity statement.
the balance sheet is for 2. Owner’s capital of $16,450 at the end of the reporting period shown in the
a point in time. owner’s equity statement is reported on the balance sheet.
3. Cash of $8,050 on the balance sheet is reported on the statement of cash flows.
Also, explanatory notes and supporting schedules are an integral part of every
set of financial statements. We illustrate these notes and schedules in later chapters
of this textbook.
Be sure to carefully examine the format and content of each statement in
Illustration 1-9. We describe the essential features of each in the following sections.
 Illustration 1-9
SOFTBYTE Financial statements and
Income Statement their interrelationships
For the Month Ended September 30, 2010
Revenues HELPFUL HINT
Service revenue $ 4,700 The heading of each
Expenses statement identifies the
Salaries expense $900 company, the type of
Rent expense 600 statement, and the spe-
Advertising expense 250 cific date or time period
Utilities expense 200 covered by the state-
Total expenses 1,950 ment.
Net income $ 2,750
1
SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2010

R. Neal, Capital September 1 $ −0− HELPFUL HINT

Add: Investments $15,000 Note that final sums are
Net income 2,750 17,750 double-underlined.
17,750
Less: Drawings 1,300
R. Neal, Capital, September 30 $16,450

SOFTBYTE
Balance Sheet
September 30, 2010
Assets

Cash $ 8,050
Accounts receivable 1,400
2
Supplies 1,600
Equipment 7,000
Total assets $18,050

Liabilities and Owner’s Equity

Liabilities
Accounts payable $ 1,600
Owner’s equity
R. Neal, Capital 16,450
Total liabilities and owner’s equity $18,050
HELPFUL HINT
3 SOFTBYTE
Statement of Cash Flows 1. Net income is com-
For the Month Ended September 30, 2010 puted first and is
needed to determine
Cash flows from operating activities the ending balance in
Cash receipts from revenues $ 3,300 owner’s equity.
Cash payments for expenses (1,950) 2. The ending balance
in owner’s equity is
Net cash provided by operating activities 1,350
needed in preparing the
Cash flows from investing activities
balance sheet.
Purchase of equipment (7,000)
3. The cash shown on
Cash flows from financing activities
the balance sheet is
Investments by owner $15,000)
needed in preparing the
Drawings by owner (1,300) 13,700
statement of cash flows.
Net increase in cash 8,050
Cash at the beginning of the period 0
Cash at the end of the period $ 8,050

21
22 Chapter 1 Accounting in Action

Income Statement
Alternative Terminology notes The income statement reports the revenues and expenses for a specific period of
introduce other terms you time. (In Softbyte’s case, this is “For the Month Ended September 30, 2010.”)
might hear or read.
Softbyte’s income statement is prepared from the data appearing in the owner’s
equity columns of Illustration 1-8.
A LT E R N AT I V E
TERMINOLOGY The income statement lists revenues first, followed by expenses. Finally the
statement shows net income (or net loss). Net income results when revenues ex-
The income statement is
sometimes referred to as
ceed expenses. A net loss occurs when expenses exceed revenues.
the statement of opera- Although practice varies, we have chosen in our illustrations and homework
tions, earnings state- solutions to list expenses in order of magnitude. (We will consider alternative for-
ment, or profit and loss mats for the income statement in later chapters.)
statement. Note that the income statement does not include investment and withdrawal
transactions between the owner and the business in measuring net income. For
example, as explained earlier, Ray Neal’s withdrawal of cash from Softbyte was not
regarded as a business expense.

Owner’s Equity Statement

The owner’s equity statement reports the changes in owner’s equity for a specific
period of time. The time period is the same as that covered by the income state-
ment. Data for the preparation of the owner’s equity statement come from the
owner’s equity columns of the tabular summary (Illustration 1-8) and from the in-
come statement. The first line of the statement shows the beginning owner’s
equity amount (which was zero at the start of the business). Then come the
owner’s investments, net income (or loss), and the owner’s drawings. This state-
ment indicates why owner’s equity has increased or decreased during the period.
What if Softbyte had reported a net loss in its first month? Let’s assume that
during the month of September 2010, Softbyte lost $10,000. Illustration 1-10 shows
the presentation of a net loss in the owner’s equity statement.

Illustration 1-10
Presentation of net loss SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2010

R. Neal, Capital, September 1 $ −0−

Add: Investments 15,000
15,000
Less: Drawings $ 1,300
Net loss 10,000 11,300
R. Neal, Capital, September 30 $ 3,700

If the owner makes any additional investments, the company reports them in the
owner’s equity statement as investments.

Balance Sheet
Softbyte’s balance sheet reports the assets, liabilities, and owner’s equity at a spe-
cific date (in Softbyte’s case, September 30, 2010). The company prepares the
 Financial Statements 23

balance sheet from the column headings of the tabular summary (Illustration 1-8)
and the month-end data shown in its last line.
Observe that the balance sheet lists assets at the top, followed by liabilities and
owner’s equity. Total assets must equal total liabilities and owner’s equity. Softbyte
reports only one liability—accounts payable—in its balance sheet. In most cases,
there will be more than one liability. When two or more liabilities are involved, a
customary way of listing is as follows.

Illustration 1-11
Liabilities Presentation of liabilities
Notes payable $10,000
Accounts payable 63,000
Salaries payable 18,000
Total liabilities $91,000

The balance sheet is a snapshot of the company’s financial condition at a specific

moment in time (usually the month-end or year-end).

ACCOUNTING ACROSS THE ORGANIZATION

What Do General Mills, Walt Disney, and Dunkin’
Donuts Have in Common?
Not every company uses December 31 as the accounting year-end. Some com-
panies whose year-ends differ from December 31 are General Mills, May 27; Walt Disney
Productions, September 30; and Dunkin’ Donuts Inc., October 31. Why do companies choose
the particular year-ends that they do? Many choose to end the accounting year when inven-
tory or operations are at a low. Compiling accounting information requires much time and
effort by managers, so companies would rather do it when they aren’t as busy operating the
business. Also, inventory is easier and less costly to count when it is low.

What year-end would you likely use if you owned a ski resort and ski rental business?
What if you owned a college bookstore? Why choose those year-ends?

Statement of Cash Flows

The statement of cash flows provides information on the cash receipts and pay-
ments for a specific period of time. The statement of cash flows reports (1) the cash
effects of a company’s operations during a period, (2) its investing transactions, (3) HELPFUL HINT
its financing transactions, (4) the net increase or decrease in cash during the period, Investing activities per-
and (5) the cash amount at the end of the period. tain to investments
Reporting the sources, uses, and change in cash is useful because investors, made by the company,
creditors, and others want to know what is happening to a company’s most liquid not investments made
resource. The statement of cash flows provides answers to the following simple but by the owner.
important questions.
1. Where did cash come from during the period?
2. What was cash used for during the period?
3. What was the change in the cash balance during the period?