CHAPTER 2

FINANCIAL STATEMENTS FOR

A SERVICE BUSINESS AND
THE FUNDAMENTAL
ACCOUNTING EQUATION
What is FINANCIAL
STATEMENTS?
 Records that outline the financial activities of a
business, an individual or any other entity.
Financial statements are meant to present the
financial information of the entity in question as
clearly and concisely as possible for both the entity
and for readers. Financial statements for
businesses usually include: income statements,
balance sheet, statements of retained earnings and
cash flows, as well as other possible statements.
Types of Financial Statements
1. Balance Sheet- Shows the financial condition/position of a
business as of a given period. It consist of the Assets, Liabilities,
and Capital
2. Income Statement-Shows the result of operations for a given
period. It consist of the revenue, cost and expenses.
3. Owner’s Equity Statement- Shows the changes in the capital or
owners Equity as a result of additional investment or withdrawals
by the owner, plus or minus the net income or net loss for the year.
4. Cash Flow Statement-Summarizes the cash receipts and cash
disbursement for the accounting period (to be fully discussed in
higher accounting).
Typical Account titles Used
Balance Sheet
Assets-These are economic resources owned by the
business expected for future gain. They are property and rights of
value owned by the business.

Liabilities-these include debts, obligations to pay,and

claims of the creditors on the assets of the business.

Owner’s Equity or Capital- this includes the interest of

the owners on the business; claims of the owners on the assets of
the business; and the investment of the owner plus or minus the
results of operations. Owner’s equity or capital comes from two
main sources-investment of owners and earnings of the business.
The Fundamental Accounting Equation
ASSETS= LIABILITIES + OWNER’S EQUITY

Illustration:
1. Assets=Liabilities + Owner’s Equity
? P 40,000 + P 60,000
2. Assets=Liabilities + Owner’s Equity
P 150,000= P ? + 70,000
3. Assets=Liabilities + Owner’s Equity
P200,000= P 110,000 + P?
Assets
Classification of Assets
1. Current Assets
Improvements to International Accounting Standards 1
(December 2003)classifies assets as current assets when it is:
a. Expected to be realized in, or it is intended for sale or consumption
in, the entity's normal operating cycle;
b. Held primarily for the purpose of being traded;
c. Expected to be realized within twelve months of the balance sheet
date; or
d. Cash or a cash equivalent unless it is restricted from being exchange
or used to settle a liability for at least twelve months after the balance
sheet date.
 Classification of Current Assets
 Cash includes coins, currencies,checks,bank deposits, and other cash items readily
available for use in the operations of the business.
 Cash Equivalents are short-term investments that are readily convertible to known
amounts of cash which are subject o an insignificant risk to changes in value (per SFAS
no. 22,revised 2000)
 Marketable securities are stocks and bonds purchased by the enterprise and are to be
held for only a short span of time or short duration. They usually purchased when a
business has excess cash.
 Accounts Receivable is the amount collectibles from the customer in exchange for
services or goods have been rendered on account or credit.
 Notes Receivable is a promissory note issued by the client or the customer in exchange
for services or goods received as evidence of his/her obligation to pay.
 Inventories represents the unsold goods at the end of the accounting period. This is
applicable only to a merchandising business.
 Prepaid Expenses are items that will be used in the operations of the business that have
been paid in advance.
Classification of Non-Current Assets
Long Term Investments are assets held by an enterprise for the accretion of wealth
through capital distribution such as interests, royalties, dividends and rentals, for
capital appreciation or for other benefits to the investing enterprise such as those
obtained through trading relationships. Investments are classified as long-term when
they are intended to be held for an extended period of time (International Accounting
Standards No.25)
Property, Plant an Equipment are tangible assets that are held by an enterprise for use
in the production or supply of goods or services, or for administrative purposes and
which are expected to be used for more than one period ( International Accounting
Standards no. 16)

Example Plant, Property and Equipment

Land- is a piece of lot or real estate owned by the enterprise on which a building can be
constructed for business purposes.
Building is a edifice or structure used to accommodate the office, store or factory of a
business enterprise in the conduct of its operations.
Equipment includes typewriter, air- conditioner, calculator, filing cabinet,
computer,electricfan, trucks,cars used by the business in its office, store or factory.
Specific account titles may be used such as Office Equipment, Store Equipment,
Delivery Equipment, Transportation Equipment, Machinery and Equipment.

Furnitures and Fixtures include tables, chairs,carpets,curtains,lamp and lighting

fixtures, and wall decors. Specific account titles maybe used such as Office Furniture's
and Fixtures and Store Furniture and Fixtures.

Accumulated Depreciation is a contra-asset account representing expires cost of

plant,property and equipment as a result of usage and passage of time. This is
deducted from the cost of the realted asset account.

Liabilities
Improvements to international Accounting Standards 1 (December 2003)
classifies a liability as a current liability when it is:
a. Expected to be settled in the entity’s normal cycle;
b. Held primarily for the purpose of being traded;
c. Due to be settled within twelve months after the balance
sheet date; or the enity does not have an unconditional
right to defer settlement of the liability for at least twelve
months after the balance sheet date.
Classification of Current Liabilities
Accounts Payable includes debts arising from purchase of an asset or acquisition
of services on account.

Notes Payable includes debts arising from purchase of an asset or acquisition of

services on account evidenced by a promissory note.

Loan Payable is a liability to pay the or other financing institution arising from
funds borrowed by the business from these institutions.

Utilities Payable is an obligation to pay utility companies for services received

from them. Examples of this are telephone services to PLDT, electricity to
BASELCO, and water services to LAMWAD.

Unearned Revenues- represents obligations of the business arising from advance

payments received before goods or services are provided to the customer. This will
be settled when certain goods or services are delivered or rendered.
Accrued Liabilities include amounts owed to others for expenses already
incurred but not yet paid. Examples of these are salaries payable, utilities
payables, taxes payables, and interest payables.
Classifications of non-current Liabilities
Non-Current Liabilities are long term liabilities or obligations which are
payable for a period longer than one year. Example of non-current
Liabilities are as follows:
Mortgage Payable is a long term debt of the business with
security or collateral in the form of real properties. In case the business
fails to pay the obligation, the creditor can foreclose or cause the
mortgaged asset to be sold and the proceeds of the sale be used to settle
the obligation.
Bonds Payable is a certificate of indebtedness under the seal of
a corporation, specifying the terms of repayment and the rate of interest
to be charged.
Owners Equity
Capital is an account bearing the name of the owner representing the
original and additional investment of the owner of the business increased
by the amount of ne income earned during the year. It is decreased by the
cash or other assets withdrawn by the owner as well as the net loss
incurred during the year.

Drawing represents the withdrawals made by the owner of he busness

either in cash or other assets.

Income Summary is a temporary account used at the end of the

accounting period to close income and expenses accounts. The balance of
this account shows the net income or net loss for the period it is closed to
the capital account.
Income Statement
 Service Income includes revenues earned or generated by the business in preforming
services for a customer or client.
Examples: Laundry Services by a laundry shop
Medical Services by a doctor
Dental services by a dentist

Salaries and Wages Expense includes all payments made to employees or workers for
rendering services to the company. Examples are salaries or wages, 13th month pay, cost
of living allowances, and other related benefits given to them.

Utilities Expense is an expense related to the use of electricity, fuel,water and

telecommunications facilities.

Supplies Expense covers office supplies used by the business in the conduct of its daily
operations.

Insurance Expense is the expired portion of premiums paid on insurance coverage such
as premiums paid for health or life insurance,motor vehicles or other properties.
Depreciation Expense is the annual portion of the cost of a tangible asset such as
buildings, machineries, and equipment charged as expense for the year.

Uncollectible Account Expense/Doubtful accounts Expense/ Bad Debts Expense

means the amount of receivables charged as expense for the period bacause they
are estimated to be doubtful of collection.

Interest Expense is the amount of money charged to the borrower for the used of
borrowed funds.
Forms of Balance Sheet

 1. Account Form follows the accounting equation where assets are listed on the
left-hand column of the report with the liabilities and owner’s equity listed on
the right-hand column.
 2. Report Form shows in one straight column the assets, followed by the
liabilities

Classification
Items in the balance sheet are classified, wih assets and liabilities separated into two or more
categories. Subclasification is as follows:
1. Assets are classified as current assets and non-current assets.
2. Liabilities are either current liabilities or non-current liabilities.

 Current assets are classified and presented according to liquidity with the most liquid
first followed by those with lesser liquidity. Since cash is the most liquid. It is always
listed first followed by other current assetsaccording to their proximity to cash.
Liabilities are classified and presented based on their maturity.
Obligations presently due for payment are listed first.

Examples of the four statements, namely,

1. balance sheet (Report Form)
2. balance sheet (Account Form)
3. Income statement
4. Statement of owner’s equity are shown on the ff pages.
 REVIEW
 The Fundamental of Accounting Equation
ASSETS= LIABILITIES + OWNER’S EQUITY
Assets
Classification of Non- Current
Classification of Assets Assets
1. Current Assets 2. Non-Current Assets
 Cash  Long Term Investment
 Property, Plant and Equipment
 Cash Equivalents
*Examples of Plant, Property and
 Marketable Securities Equipment.
 Accounts Receivable  Land
 Building
 Notes Receivable
 Equipment
 Inventories  Furniture's and Fixtures
 Prepaid Expenses  Accumulated Depreciation
 Intangible Assets
Liabilities
Classification of Classification of Non- Current
1. Current Liabilities Liabilities
 Accounts Payable 2. Non-Current Liabilities
 Notes Payable  Mortgaged Payable
 Loan Payable  Bonds Payable
 Utilities Payable
 Unearned Revenues Owner’s Equity
 Accrued Liabilities  Capital
 Drawing
 Income Summary
Income Statement
Service Income
Ex: Laundry Services Forms of Balance Sheet
Medical Services
Dental Services
1. Account Form
2. Report Form
 Salaries and Wages
 Utilities Expense
 Supplies Expense
 Insurance Expense
 Depreciation Expense
 Uncollectible Account/
Doubtful Account/Bad Debts
 Interest Expense
REPORT FORM BALANCE SHEET
APPLE FRESH LAUNDRY SERVICES
BALANCE SHEET
December 31, 200x

ASSETS
Current Assets:

Cash Php 450,000.00

Accounts Receivable 31,000.00
Supplies 27,000.00
Prepaid Insurance 37,000.00

Total Current Assets Php 545,000.00

Non-Current Assets

Plant, Property & Equipment

Land Php 200,000.00
Equipment Php 560,000.00

Less: Accumulated Depreciation 67,000.00 493,000.00 Php 693,000.00

Total Non-Current Assets Php 1,238,000.00
TOTAL ASSETS

LIABILITIES
Current Liabilities:
Accounts Payable Php 75,000.00
Notes Payable 190,000.00
Unearned Laundry Revenue 39,000.00
TOTAL CURRENT
LIABLITIES Php 304,000.00
OWNERS EQUITY

A. CAPITAL 934,000.00
TOTAL LIABILITIES &
CAPITAL Php 1,238,000.00
ACCOUNT FORM BALANCE
SHEET
APPLE FRESH LAUNDRY SERVICES
BALANCE SHEET
December 31, 200x

ASSETS LIABILITIES
Current
Current Assets: Liabilities:
Accounts
Payable Php 75,000.00

Cash Php 450,000.00 Notes Payable 190,000.00

Unearned Laundry
Accounts Receivable 31,000.00 Revenue 39,000.00
Suppli TOTAL CURRENT
es 27,000.00 LIABLITIES Php 304,000.00
Prepaid
Insurance 37,000.00

Total Current Assets Php 545,000.00

Non-Current OWNERS
Assets EQUITY

A. CAPITAL 934,000.00
Plant, Property & TOTAL LIABILITIES
Equipment & CAPITAL Php 1,238,000.00

Land Php 200,000.00

Equipment Php 560,000.00

Less: Accumulated
Depreciation 67,000.00 493,000.00 Php 693,000.00
Total Non-Current
Assets Php 1,238,000.00
TOTAL
ASSETS
 Apple Fresh Laudry Services
INCOME STATEMENT
For Year Ended December 31, 200x

Service Revenue P 312,000.00

Less: Operating Expenses
Salaries Expense P 125,000.00
Depreciation Expense 13,000.00
Supplies Expense 10,000.00
Rent Expense 7,000.00
Insurance Expense 2,000.00
Total Operating Expenses 157,000.00
NET INCOME P 155,000.00

Apple Fresh Laudry Services

STATEMENT OF OWNERS EQUITY
For Year Ended December 31, 200x

A,Capital P 759,000.00
Add: Additional Investment P 50,000.00
Net Income 155,000.00 205,000.00
Total P 964,000.00
Less: Drawings 30,000.00
Total Owner's Equity P 934,000.00
End of Chapter 2