Purpose of Financial Statements

1) It provides information about the financial position, performance and cash

inflows of an enterprise that is useful to wide range of users in making economic
decisions.
2) It shows the results of the managements’ stewardship of the resources
entrusted to it.
3) It provides information about an enterprise’s asset, liabilities, equity, income
and expenses, including gains and losses and cash flows.

Financial Statements is composed of the following:

❖ Balance sheet
❖ Income Statement
❖ Statement of changes in Owner’s equity
❖ Cash flow statement
❖ Notes of Financial Statement

❖ BALANCE SHEET

Balance Sheet is a report showing the financial position of a company on a

particular date.

Standard accounting conventions present the balance sheet in one of two formats:
the Account form(Horizontal presentation) and the the Report Form (vertical
presentation). Most companies favor the vertical report form, which doesn’t conform to
the typical explanation in investment literature of the balance sheet as having “two sides”
that balance out.

ACCOUNT FORM (Horizontal presentation)

REPORT FORM (Vertical presentation)

Accounting Elements or Values

The three Accounting elements or values are assets, liabilities and equity.

ASSETS

Classification of Assets

1) Current Assets
2) Non-current Assets

Assets are current when it is expected to be realized in or held for sale of

consumption in normal course of enterprise’s operating cycle. It is held primarily for
trading purposes or for the short term and expected to be realized when 12 months
of the balance sheet.

⚫ Operating Cycles are time between the acquisition of material put into
process and realization in cash and an instrument that is readily convertible
to cash
⚫ Account Titles are assigned name and titles for the accountant and used for
conversation for each of reference.
 The following are the account titles used in current and non-current
assets;

◼ CURRENT ASSETS

Current Assets are those assets which can be reasonable converted into cash
within a short period of time, usually within one accounting period or within the regular
operation of the business or normal operating cycle of the business. Regular operation of
the business or normal operating cycle of the business is the period between the render
service, in case of service concern, to the receipt of cash, and the period between
acquisition of materials to their conversion into cash, in case of merchandising and
manufacturing concern.

The following illustrations show this process:

SERVICE CONCERN

Cash
Service rendered Accounts Receivable Cash
Notes Receivable Cash (Upon maturity)

MERCHANDISING CONCERN

Purchase or Selling of goods Cash

Acquisition Selling of goods Account Receivable Cash
Good or Merchandise Selling of goods Notes Receivable Cash

MANUFACTURING CONCERN

Purchase or Acquisition
Manufacturing
of Raw Materials Finished goods

Selling of finished goods Cash

Finish goods Selling of finished goods Account Receivable Cash
Selling of finished goods Notes Receivable Cash

The above illustration shows that assets such as Account Receivables, Note
Receivables, Merchandise are considered current assets because they are eventually
converted into cash within the normal operating cycle of the business.

The following are among the current assets used by the business:

 Cash is any medium of exchange that a bank will accept at face value. It
includes coins and currencies, checks, money orders and bank drafts.
 Accounts Receivables are claims against debtors, customers or clients
arising from services rendered on account and the sale of merchandise on
account.
 Notes Receivables are claims against debtors, customers or client for the
services rendered evidenced by written promise to pay issued by the debtor.
 Merchandise Inventories are goods on hand available for sale.
  Supplies on Hand are consumable goods used in the course of business. It
represents the cost of supplies on hand. It can be classified as office, or store
supplies, Examples are papers, pencils,pens, folders etc.
 Prepaid Expenses are expensExample: six months rental paid in advance
(prepaid rent), one year insurance premium (prepaid Insurance)
 es paid in advance.

◼ NON-CURRENT ASSETS

Non-current Assets are those assets not classified as current.

 Property,Plant and Equipment/Fixed Assets these are the tangible assets

that are held by enterprise for use in the production or supply of goods and
service or for rental to others for administrative purposes which are expected to
be used during more than one period.
 Accumulated Depreciation is an account that contains the sum of periodic
depreciation charges. It is a contra-account that represents the whole amount
from depreciation expenses charged in the past and current periods.
 Equipment are tangible assets which are tools or instruments used for the
operation of business. It has its own specific design and style to handle activities
both for production and administrative purposes. It can be classified as store
equipment or office equipment. Examples: computers, air-conditioning units,
calculator, typewriter, cash register etc.
 Delivery Equipment include assets used for transporting merchandise
 Machinery is tangible assets that has its own system to work in order to
produce products and to provide services to customers.
 Furniture and Fixture are properties owned by the business which are not part
of the building property. These quickly depreciate compared to other assets.
Examples: Office tables, filing cabinets, chairs, showcases and other similar
items used in the operation of business.

⚫ Intangible Assets are the identifiable non-monetary assets without physical

substance. They provide future economic benefits to the company.Examples:
franchise, copyright, patent, trademarks and computer software.

LIABILITIES

These are debts and obligation of the business to creditors which is not
recognized unless incurred. It can be settled through cash or promissory note.

◼ CURRENT LIABILITIES. It is a present obligation that is expected to be settled

in the normal operating cycle of the business. It is due to be settled within one
year from the balance sheet.

 Accounts Payable are the amount due to creditors for assets acquired in
account
 Notes Payable are the amount due to creditors supported by promissory
note.
 Salaries Payable are unpaid salaries to the employees at the end of the
accounting period.
 Taxes Payable are present obligation due to the government
 Interest Payable are interest incurred on the loan but they are not yet paid
at the end of the period.

◼ NON-CURRENT LIABILITIES. It is long term liabilities expected to be settled for

more than a year.

 Mortgage Payable is long term debts secured by collateral

CAPITAL/EQUITY
  Owner’s Capital is the account that represents the equity or claims of the
owner on the assets of the business. It is the residual interest in the assets of
the business. It is the difference of total assets and total liabilities.
 Owner’s Drawing. Account charged to the owner’s drawing are cash or other
assets withdrawn or taken by the owner from the business for personal use.

❖ INCOME STATEMENT

This is a report showing the financial performance of an enterprise for a

given period time. It shows the income results and the expenses incurred during
the operation of the business.

Forms of Income Statement

➢ Natural Form – presents expenses according to nature. This type of income

statement is used in a service business
➢ Functional Form – presents expenses according to function.(e.g cost of sales,
selling expenses, administrative expenses). This type is used in a merchandising
business.

EXAMPLES:

Natural Form Income Statement

Apple Fresh Laundry Services

Income Statement

For the Year ended 20xx

Service Revenue P298,000.00

Other Income 55,000.00
Total Income P353,000.00
Expenses:
Salaries P 160,000.00
Depreciation 13,000.00
Supplies 10,000.00
Rent 7,000.00
Insurance 2,000.00
Other Expenses 2,600.00
Finance Cost 3,400.00 P198,000.00
Net Income P155,000.00

Functional Form Income Statement

MAYA TRADING

Income Statement

For the Year ended 20xx

Net Sales P749,104.00

Cost of good sold 467,510.000
Gross Profit 281,594.00
Other Income 6,960.00
Total Income P288,554.00
Expenses:
Distribution P 94,472.00
Administrative Expenses 169,218.00
Finance Cost 8,362.00 P272,052.00
Net Income P16,502.00

❖ REVENUE OR INCOME

It is the income earned in providing services to customers and from the

sales of merchandise as well.

According to ASC revenue is defined as “gross inflow of economic benefits

during the period in the form of inflows or enhancement on assets or decrease in
liabilities that results in increase in equity, other those relating to contributions from
the owner or owners”.

The following are the common income titles used:

Sales are total sales of merchandise sold

Professional fee income is income earned after rendering professional

services such as CPA’s, doctors, lawyers.

Rent Income is the amount of lease/rental earned for the period.

Service Income/Revenue is the amount of income earned from services

rendered from service concern business

Interest Income is the amount earned for lending money

❖ EXPENSES

The ASC defined expenses as the “gross outflow of economic outflows

benefits during the period in the course of ordinary activities when these results in
decrease in equity other that those relating to distribution owners.” The cost
incurred during the course of business.

The following are the account titles used in expenses:

Cost of Sales is the cost of goods purchased and sold merchandise or sold
manufactured and sold.

Advertising expense are expenses incurred to promote the product of the

business

Salesperson’s Salaries are the compensation given to sales agent

Salesperson’s Commission is the incentive given to sales agents based

on their total amount of sales earned.

Salesperson’s travelling expenses are travelling allowances given to

sales agents.

Office salaries are compensations given to administrative employees.

Supplies expense are the amount of supplies used during the operation of
business.
 Taxes are governmental duties incurred in the current period.

Utilities expenses are expenses incurred for light and water consumed
during the operation of business.

Repairs and maintenance are expenses paid for repairing the assets of
the business.

Bad Debts is the estimated amount of losses from uncollectible account of

business.

Depreciation expense is the allocated cost of fixed assets in the current

period.

❖ STATEMENT OF CHANGES IN OWNER’S EQUITY

Statement of Owner’s Equity is a report that summarizes the changes to

equity in a given period time. The accounts that affect owner’s equity are the
following changes to equity, income/losses, drawing account.

❖ CASH FLOW STATEMENT

Statement of Cash Flow is the report that shows the cash inflow and cash
outflow which resulted from three business activities, operating, investing and
financing activities during the period.

Cash inflows are receipts or increase in cash balance.

Cash outflows are disbursement/payment out of cash or decrease in cash

as of balance sheet date.

Operating activities involved the production or merchandise and the sale

of goods or service to customers.

Investing activities transactions that involve making and collecting loans

or that involve purchasing and selling assets.

Financing activities are transactions that involve proceeds of equity

securities, short term/long term borrowing, payment of dividends to investors.