This note belongs to the Financial Accounting Principles, so if

you note anything alternative to ITB, please make sure that

you read the correct document!

Could you describe the four financial statements and how they are
prepared?
1. Presenting the revenues and expenses and resulting net income
or loss for a specific period of time is known as income statement,
statement of operation, earning statement, or statement of
profits & losses.
2. The summarization of change of owner’s equity for a specific
period of time is known as owner’s equity statement.
3. Reporting the assets, liabilities, and owner’s equity at a specific
date is known as balance sheet.
4. Summarized information about the cash flows (receipts) and
outflows (payment) for a specific period of time is known as
statement of cash flows.
Income Statement
The income statement reports the revenues and expenses for a specific
period of time. Net income always results when revenues exceed
expenses, and a net loss always occurs when expenses exceed
revenues. In addition, the income statement does not include
investment and withdrawal transactions between the owner and the
business.
Owner’s Equity Statement
Reporting any changes in the owner’s equity for a specific period of
time is known as owner’s equity statement. Data for the preparation of
the owner’s equity statement come from the owner’s equity columns
of the tabular summary.

Balance Sheet (Statement of Financial Position)

 What is it? The balance sheet shows the financial position of a

company at a specific point in time. It’s like a snapshot of what
the company owns (assets) and owes (liabilities), as well as the
ownership interest in the company (equity).
 Components:
o Assets: Everything the company owns, like cash, inventory,
and property.
o Liabilities: Debts and obligations, such as loans and accounts
payable.
o Equity: The residual interest in the assets after deducting
liabilities (think of it as the owner's stake in the company).
 How is it prepared? The balance sheet is usually prepared by
listing all assets on one side, and then liabilities and equity on the
other side, making sure the two sides balance out (hence the
name balance sheet). The formula used is: Assets = Liabilities +
Equity.

1. Income Statement (Statement of Profit or Loss):

o Purpose: Shows the company's performance over a specific
period, typically a fiscal quarter or year. It presents
revenues, expenses, and profits or losses during that period.
o Components:
 Revenues: Income from sales of goods or services.
 Cost of Goods Sold (COGS): Direct costs attributable to
the production of goods sold by the company.
 Gross Profit: Revenue minus COGS.
  Operating Expenses: Costs related to the day-to-day
operations (e.g., salaries, rent).
 Operating Income (EBIT): Gross profit minus operating
expenses.
 Net Income: The "bottom line," which is the profit or
loss after all expenses, including taxes and interest,
have been deducted.
2. Balance Sheet (Statement of Financial Position):
o Purpose: Provides a snapshot of the company's financial
position at a specific point in time. It shows what the
company owns (assets), what it owes (liabilities), and the
value remaining for shareholders (equity).
o Components:
 Assets: Divided into current (e.g., cash, inventory) and
non-current (e.g., property, equipment).
 Liabilities: Divided into current (e.g., accounts payable)
and non-current (e.g., long-term debt).
 Equity: The residual interest in the assets of the entity
after deducting liabilities, often called shareholders'
equity.
3. Statement of Cash Flows:
o Purpose: Details the cash inflows and outflows from the
company’s operations, financing, and investing activities
over a period.
o Components:
 Operating Activities: Cash flow from primary revenue-
generating activities, such as sales and expenses.
 Investing Activities: Cash used for or generated from
investments, such as buying or selling assets.
 Financing Activities: Cash flow from transactions with
the company's owners or debtors, like issuing shares or
borrowing money.
4. Statement of Changes in Equity:
 o Purpose: Explains the changes in a company’s equity during
a specific period. It links the Income Statement and Balance
Sheet by showing how profits are either retained in the
company or distributed as dividends.
o Components:
 Opening Balance: The equity at the start of the period.
 Additions: Profits, new share capital, or revaluation
reserves.
 Deductions: Losses, dividends paid, or buyback of
shares.
 Closing Balance: The equity at the end of the period.

Preparation of Financial Statements:

1. Income Statement: Prepared first to determine net income,

which is needed for the Statement of Changes in Equity.
2. Statement of Changes in Equity: Shows the impact of net income
and dividends on retained earnings.
3. Balance Sheet: Prepared next, using the ending equity from the
Statement of Changes in Equity.
4. Statement of Cash Flows: Often prepared last because it requires
information from all the other financial statements.

Should we expand our financial statements beyond the income

statement, owner’s equity statement, balance sheet, and statement
of cash flows?

Expanding your financial statements beyond the traditional four—

Income Statement, Owner’s Equity Statement, Balance Sheet, and
Statement of Cash Flows—can provide deeper insights and more
transparency to stakeholders, which is particularly beneficial depending
on the complexity and scale of your operations. Here are some
considerations for why you might want to expand your financial
reporting:
1. Notes to the Financial Statements:
 Purpose: Provide detailed disclosures and additional context that
can’t be captured in the main financial statements. This includes
accounting policies, explanations of significant transactions, and
risk management practices.
 Benefits: They help in understanding the numbers presented in
the financial statements by explaining accounting methods,
providing detailed breakdowns (e.g., breakdown of receivables),
and disclosing contingencies or commitments.
2. Statement of Comprehensive Income:
 Purpose: Goes beyond the Income Statement by including items
that affect equity but are not reflected in net income, such as
foreign currency translation adjustments or unrealized gains and
losses on certain investments.
 Benefits: Provides a fuller picture of a company’s financial
performance, particularly for companies with significant foreign
operations or financial instruments.
3. Segment Reporting:
 Purpose: Breaks down financial data by divisions, regions, or
products, showing the performance of different segments of the
business.
 Benefits: Useful for diversified companies as it helps stakeholders
understand which parts of the business are performing well or
poorly.
4. Sustainability or Corporate Social Responsibility (CSR) Reports:
 Purpose: Report on non-financial aspects like environmental
impact, social responsibility, and governance practices.
 Benefits: Increasingly important for investors who consider ESG
(Environmental, Social, and Governance) factors in their
investment decisions. This can also enhance the company's
reputation and align with stakeholder values.
5. Management Discussion and Analysis (MD&A):
 Purpose: A narrative explanation from management discussing
the financial statements, business performance, risks, and
forward-looking information.
 Benefits: Provides context and management’s perspective on the
numbers, helping stakeholders understand the strategic direction
and challenges faced by the company.
6. Pro Forma Financial Statements:
 Purpose: Show the financial impact of specific events like
mergers, acquisitions, or major capital expenditures, projecting
future financial conditions.
 Benefits: Useful for planning and communicating the potential
impact of significant decisions before they occur.
7. Statement of Changes in Working Capital:
 Purpose: Focuses on the changes in current assets and liabilities,
helping to understand the company’s operational efficiency.
 Benefits: Provides insights into how well the company is
managing its short-term assets and liabilities, crucial for assessing
liquidity and operational performance.
When to Consider Expanding:
 Complex Business Operations: If your company operates in
multiple industries, countries, or with complex financial
instruments.
 Regulatory Requirements: Sometimes specific industries or
countries require additional disclosures.
 Investor Demands: Investors might demand more detailed
reports, especially if they focus on long-term value creation and
ESG factors.
 Strategic Communication: To communicate your strategy, risks,
and future outlook more effectively to stakeholders.
 The income statement, owner’s equity statement, and statement of
cash flows are all for a period of time, whereas the balance sheet is for
a point in the time.

Assets = Liabilities + Owner’s Equity

Cash Equipment A/R A/P N/P O/D Service Expenses Utilities
Revenues Expenses
$8000 10,000 9000 2000 16500 5000 36000 11000 4000
27000
= + 27000 = 9000 + 7000
7000 +
2000 +
16500