LESSON NUMBER 3

LESSON TITLE: INTERRELATIONSHIP OF FINANCIAL STATEMENTS

Lesson Objectives: At the end of the lesson, students are expected to:

1. Define and know the importance of the financial statements.

2. Understand how the financial statements are interrelated.

DISCUSSION OF CONTENT / APPLICATION

FINANCIAL STATEMENTS

Generally, the term financial statement could be referring to:

 General-purpose, external financial reports that are distributed by a company to people
outside of the company
 A more-detailed, internal financial report that remains inside of the company for use by the
company's management.

The general-purpose financial statements are those that are made available to users outside the
company. These consist mainly of the income statement, statement of changes in owner’s equity, statement
of financial position, and statement of cash flows.

Mr. N Travel and Tours

Statement of Comprehensive Income
For the month ended January 31, 2020
Service Income P 51,000
Less: Operating Expenses:
Rent Expense P 10,000
Salaries Expense 9,000
Repairs Expense 1,000
Gas & Oil Expense 500
Utilities Expense 500 21,000
NET INCOME P 30,000

Mr. N Travel and Tours

Capital Statement
For the month ended January 31, 2020
Mr. N, Capital Jan. 1 P800,000
Add: Net Income 30,000
Total 830,000
Less: Drawings 5,000
Mr. N, Capital Jan. 30 P825,000

Mr. N Travel and Tours

Statement of Cash Flows
For the month ended January 31, 2020
Cash flows from operating activities:
Cash received from customers P33,000
Cash paid for expenses - 21,000
Net cash provided by operating activities P 12,000
Cash flows from investing activities:
Acquisition of furnitures & fixtures - 45,000
Acquisition of equipment - 55,000
Net cash used by investing activities - 100,000
Cash flows from financing activities:
Contribution by Mr. N 50,000
Withdrawal by Mr. N - 5,000
Loan from bank 100,000
Net cash provided by financing activities 145,000
Cash balance January 31 P 57,000

Mr. N Travel and Tours

Statement of Financial Position
January 31, 2020

Cash P 57,000 Loans Payable P100,000

Accounts Receivable 18,000 Mr. N, capital 825,000
Cars 750,000
Equipment 55,000
Furnitures & Fixtures 45,000
Total P 925,000 Total P925,000
Shown in our illustration above are the financial statements derived from our illustrative problems in the
travel and tours business of Mr. N as of January 31, 2020. The illustration shows the relationship of the
revenues and expenses appearing in the income statement to the assets, liabilities and owner’s equity
appearing in the statement of financial position. The arrows points to the amounts computed in one financial
statement that is carried forward to another financial statement to be used in its computation.

Statement of Comprehensive Income/ Income Statement is also known as the statement of operations,
profit and loss statement, and statement of earnings. It is one of a company's main financial statements. The
purpose of the income statement is to report a summary of a company's revenues, expenses, gains, losses,
and the resulting net income that occurred during a year, quarter, or other period of time.

Examples of Items Appearing in the Income Statement

1. Revenues, which are the amounts earned through the sale of goods and/or the providing of
services
2. Expenses, which include the cost of goods sold, SG&A expenses, and interest expense
3. Gains and losses, such as the sale of a noncurrent asset for an amount that is different from its
book value
4. Net income, which is the result of subtracting the company's expenses and losses from the
company's revenues and gains. Corporations with shares of common stock that are publicly
traded often refer to net income as earnings and their income statements must include the
earnings per share of common stock.

The income statement for Mr. N’s business shows total revenues earned of P51,000 and total expenses
incurred of P21,000 resulting in a net income of P30,000 which is carried forward to the capital
statement or the statement of comprehensive income.

Statement of Changes in Owner's Equity shows the changes in the capital account due to contributions,
withdrawals, and net income or net loss.

The Capital Statement shows the starting capital of Mr. N of P800,000 which increased by P30,000 because
of net income and decreased by P5,000 because of owner’s personal drawings. The ending capital became
P825,000 which is carried forward to the statement of financial position as claim over the net assets.

The Statement of Financial Position is already explained in Lesson Number 2 of this module. 

The Statement of Financial Position shows the assets owned by the business of P925,000 of which P100,000
represented as claim of the creditors and P825,000 as claim of the owner. Note that the cash balance is
supported by the cash balance end in the statement of cash flows.

Statement of Cash Flows shows the changes (cash flows) in the business activities: starting with the
operating activities appearing in the income statement, and the investing and financing activities appearing
in the statement of financial position. Like the income statement, this is prepared for a certain period of
time.

Of what use is this statement?

1. To evaluate cash stewardship of the finance officer,
2. To guide the planning of future cash flows, and
3. To assess ability of the business in generating cash from operation
 Date Cash Operating Activities Investing Activities Financing Activities
1 50,000 Contribution of Mr. N
3 100,000 Loan from bank
7 - 45,000 Furniture Paid
18 - 5,000 Cash withdrawn by Mr. N
20 - 55,000 Equipment Paid
21 15,000 Collected from clients
22 - 1,500 Paid for expenses
25 - 500 Paid for expenses
27 10,000 Collected from clients
30 8,000 Collected from clients
31 - 19,000 Paid for expenses

The company obtained cash from three sources: contribution of the owner (March 1), loan from
bank (March 3), and collection from clients (March 21, 27, and 30). The business becomes financially
strong and stable when more cash comes from its operation rather than from loans borrowed (risky) and
from contribution of the owner (safe but very conservative). The business must grow on its own.

The cash flows from investing activities represent payments from acquisition of assets. The effect
is a decrease in cash of P100,000 or a net cash outflow for investing activities for furniture and equipment
purchased and paid for.

Cash flows from financing activities represent increase in cash coming from the owner’s
contribution and from the amount borrowed from the bank against a cash decrease because of the owner’s
personal drawings. The effect is a net cash inflow of P145,000 or net cash provided by financing activities.

Comparing the net income of P30,000 against the net cash inflow from operation of P12,000,
gives us a difference of P18,000 representing customer’s uncollected account, again a proof that
information found in one financial statement is related to another financial statement.

SUMMARY OF THE LESSON

 The accrual concept recognizes revenues and expenses based on their occurrence regardless of
whether cash is collected or paid. The cash concept recognizes revenues and expenses only at the
time of collection or payment.
 Revenues are cash INFLOWS resulting from the services rendered or merchandise sold.
 Expenses are cash OUTFLOWS resulting from the use of asset or service in generating income.
 Revenues > Expenses = Net Profit/Income
 Revenues < Expenses = Net Loss
 Revenues = Expense = Breakeven
 Fundamentally related financial statements show the effect of revenues and expenses in the Income
Statement to the assets, liabilities and owner’s equity in the Statement of Financial Position.
 The four basic financial statements are: a. Statement of Financial Position; b. Income Statement;
c. Statement of Cash Flows; d. Statement of Changes in Owner’s Equity
 Assets are classified according to liquidity or nearness to cash while liabilities are classified
according to length of maturity.
 Accounting period, which usually is one year, is the time basis used in the preparation of financial
statements. In practice, companies present interim financial statements after a month or a quarter,
as needed by the users.
REFERENCES
1. Simplified Accounting for Business 2 nd Edition. Cruz-Manuel. 2016
2. https://www.accountingcoach.com/blog/what-is-a-financial-statement
3. https://www.accountingcoach.com/blog/what-is-the-income-statement
4. https://www.accountingverse.com/accounting-basics/statement-of-owners-equity.html