07. Financial Statements

Financial statements refer to a specific set of reports produced in an entity’s accounting system. The objective of these reports is to provide information about the entity.

A complete set of financial statements includes 5 components.

1. Statement of Comprehensive Income

The Income Statement, also known as Profit and Loss Statement (P&L Statement), shows the results of operations of an entity over a particular period of time. The income statement presents the period’s income and expenses and the resulting net income or loss.

Many large companies today prepare a Statement of Comprehensive Income. The Statement of Comprehensive Income presents a company’s results of operations (net income or loss) and its other comprehensive income (OCI). If the company has no other comprehensive income, then the contents of the Income Statement and Statement of Comprehensive Income would be the same.

Other comprehensive income include gains and losses that cannot be reported in the Income Statement such as revaluation surplus, translation adjustments, and unrealized gains, for a given period. Other comprehensive income is covered in higher financial accounting studies.

Income Statement Example

Here is a sample income statement of a service type sole proprietorship business. Let us name the company Strauss Printing Services. All amounts are assumed and simplified for illustration purposes.

Strauss Printing Services
Income Statement
For the Year Ended December 31, 2019
Service Revenue	$ 160,000
Less: Expenses
	Salaries Expense	$ 40,000
	Supplies Expense	26,100
	Rent Expense	20,500
	Utilities Expense	11,300
	Depreciation Expense	5,000	102,900
Net Income	$   57,100

Explanation and Pointers

1. An income statement shows the net income or net loss of a business. This is achieved by deducting all expenses from all income.
2. A typical income statement starts with a heading which consists of three lines. The first line presents the name of the company; the second describes the title of the report; and the third states the period covered in the report.
3. Notice that the third line is worded “For the Year Ended…” This means that the income statement presents information for a specific span of time. In the above example, the period covers 1 year that ends on December 31, 2019. Hence, the amounts presented in the report are income and expenses from January 1, 2019 to December 31, 2019.
4. Income accounts are presented before expenses. In the above statement, the income account is Service Revenue. Other income accounts for service type businesses include Professional Fees, Rent Income, Tuition Fees, etc.
5. Expenses are presented after the income accounts. It is a good practice to arrange expenses according to amount (largest to smallest). Some users who are interested in the company’s expenses are concerned about the size of each expense. Arranging the expenses from largest to smallest results in a more useful and organized report. Nonetheless, Miscellaneous Expense or Sundry Expense is presented last.
6. If income exceeds expenses, there is a net income. If expenses exceed income, there is a net loss. Notice how computations are presented. A single line is drawn every time an amount is computed. The resulting amount is double-ruled when it is no longer followed by any operation. For example, $57,100 (net income).
7. The income statement complies with the accrual basis of accounting. Income is recognized when earned regardless of when collected. Expenses are recognized when incurred regardless of when paid.This means that income and expenses presented in the income statement have been earned and incurred, respectively. Nonetheless, it does not mean that they have all been collected or paid.
8. International accounting standards suggest that companies should present other comprehensive income in their financial statements. A Statement of Comprehensive Income shows the contents of an income statement followed by a list of “other comprehensive income”.
9. Other comprehensive income includes gains and losses that cannot be reported as profit and loss, such as unrealized gains and losses, and revaluation surplus. This is taken up in higher financial accounting studies.
10. When the company does not have other comprehensive income, the contents of the income statement and the statement of comprehensive income are the same. In any case, international accounting standards favor the use of the title “Statement of Comprehensive Income”.

Statement of Comprehensive Income

Here’s a sample Statement of Comprehensive Income, which includes other comprehensive income. This topic is taken up in higher accounting so you need not worry about it yet.

Strauss Printing and Publishing, Inc.
Statement of Comprehensive Income
For the Year Ended December 31, 2019
Service Revenue	$ 160,000
Less: Expenses
	Salaries Expense	$ 40,000
	Supplies Expense	26,100
	Rent Expense	20,500
	Utilities Expense	11,300
	Depreciation Expense	5,000	102,900
Net Income	$   57,100
Other Comprehensive Income
	Revaluation Surplus	$ 20,000
	Unrealized Translation Gain	10,200	30,200
Total Comprehensive Income		$  87,300

2. Statement of Changes in Capital

The Statement of Changes in Capital (or Statement of Changes in Equity) shows the balance of the capital account at the beginning of the period, the changes that occurred during the period, and the ending balance as a result of such changes. Capital is affected by contributions and withdrawals of owners, income, and expenses.

The title used for this report varies depending upon the form of business ownership. It is called Statement of Owner’s Equity in sole proprietorships, Statement of Partners’ Equity in partnerships and Statement of Stockholders’ Equity in corporations.

Statement of Owner’s Equity Example

Here is a sample Statement of Owner’s Equity of a service type sole proprietorship business, Strauss Printing Services. All amounts are assumed and simplified for illustration purposes.

Assume that the company started the year 2019 with $100,000 capital. During the year, the owner made $10,000 additional contributions and $20,000 total withdrawals. The Statement of Owner’s Equity would look like this:

Explanation and Pointers

1. A Statement of Owner’s Equity (SOE) shows the owner’s capital at the start of the period, the changes that affect capital and the resulting capital at the end of the period. It is also known as “Statement of Changes in Owner’s Equity”.
2. A typical SOE starts with a heading that consists of three lines. The first line shows the name of the company; the second the title of the report; and the third the period covered.
3. The title of the report is Statement of Owner’s Equity. This is used for sole proprietorships. For partnerships, the title used is “Statement of Partners’ Equity” and for corporations, “Statement of Stockholders’ Equity”.
4. Notice that the third line is worded “For the Year Ended…” This means that the SOE presents information for a specific span of time. In the above example, the period covers 1 year that ends on December 31, 2019. Hence, the amounts presented pertain to changes to owner’s equity from January 1, 2019, to December 31, 2019.
5. The capital account used in the illustration is Strauss, Capital. The capital account used would vary from company to company.
6. Income increases capital. Expenses decrease it. Net income is equal to income minus expenses. Hence, net income would increase the capital account. If expenses exceed income, there is a net loss. In such a case, net loss will decrease the capital account.
7. Notice that the net income above, $ 57,100, is the bottom-line amount in the company’s Income Statement.
8. Strauss, Drawings represent the total withdrawals made by the owner during the period. The owner made $ 20,000 total drawings. This amount is deducted to get the capital balance.
9. The Statement of Owner’s Equity example above shows that the company has $147,100 in the capital as a result of the following: $100,000 balance at the beginning of the year, plus $10,000 owner’s contributions during the year, plus $57,100 net income, and minus $20,000 withdrawals.
10. Good accounting form suggests that a single line is drawn every time an amount is computed (it signifies that a mathematical operation has been completed). The bottom-line amount is double-ruled, i.e. $ 147,100.

3. Statement of Financial Position

A Balance Sheet presents an entity’s assets, liabilities, and capital as of a given point in time. This report shows the entity’s financial position and condition, hence, also called Statement of Financial Position.

All asset amounts are added. All liability and capital accounts are also added. The total amount of assets should be equal to the total amount of liabilities plus capital.

Balance Sheet Example

Moving on from our previous illustrations, here is a sample balance sheet for Strauss Printing Services, a service type sole proprietorship business.

All amounts are assumed and simplified for illustration purposes.

Strauss Printing Services
Statement of Financial Position
As of December 31, 2019
ASSETS
Current Assets:
	Cash	$ 21,000
	Accounts Receivable	16,000
	Prepaid Expenses	4,500	$   41,500
Non-current Assets:
	Property, Plant and Equipment		145,000
Total Assets	$  186,500
LIABILITIES AND OWNER’S EQUITY
Current Liabilities:
	Accounts Payable	$   8,400
	Rent Payable	8,000	$   16,400
Non-current Liability:
	Loans Payable		23,000
Strauss, Capital	147,100
Total Liabilities and Owner’s Equity	$   186,500

Explanation and Pointers

1. A Balance Sheet shows the financial position or condition of the company; thus, it is also called a “Statement of Financial Position”.
2. A typical balance sheet starts with a heading that consists of three lines. The first line presents the name of the company; the second describes the title of the report; and the third state the date of the report.
3. Notice that the third line is worded “As of…” Unlike the other components of the financial statements which cover a span of time (“For the period ended..”), the balance sheet presents information as of a certain date (at a specific point in time). In the above example, the contents of the balance sheet pertaining to the financial condition of the company on December 31, 2019.
4. A balance sheet summarizes the assets, liabilities, and capital of a company. Assets refer to properties owned and controlled by the company. Liabilities are obligations to creditors, lenders, etc. And capital represents the portion left for the owners of the business after all liabilities are paid. For detailed lessons about assets, liabilities and capital, check out the Elements of Accounting.
5. Assets and liabilities are classified as either current or non-current. Current assets are properties that will be converted into cash within 12 months or within the operating cycle of the business. Current liabilities are due within 12 months or within the operating cycle. Non-current assets and non-current liabilities are those that do not meet the above qualifications.
6. “Total assets” and “total liabilities and capital” should always be equal.
7. The capital amount, $147,100 for Strauss, Capital, was actually taken from the Statement of Owner’s Equity.
8. The balance sheet may be presented in two forms: account form and report form. In account form, assets are presented on the left side while liabilities and capital are presented on the right. In report form, assets are presented first and then followed by liabilities and capital. The example above is presented using the report form.
9. Good accounting form suggests that a single line is drawn every time an amount is computed. It signifies that a mathematical operation has been completed. The “total assets” and “total liabilities and capital” amounts are double-ruled.

4. Statement of Cash Flows

The Statement of Cash Flows, or Cash Flow Statement, presents the beginning balance of cash, the changes that occurred during the period, and the cash balance at the end of the period as a result of the changes.

The cash flow statement shows the cash inflows and outflows from three activities: operating, investing, and financing.

Operating activities pertain to transactions that are directly related to the company’s main course of business. Investing activities refer to “where the company puts its money”. These activities include long-term investments, acquisition of property, plant, and equipment; and other transactions related to non-current assets. Financing activities include transactions in which a company acquires its funds. These include loans from banks (long-term liabilities) and contributions from owners.

Statement of Cash Flows Example

Here is a sample cash flow statement for Strauss Printing Services, a service type sole proprietorship business.

All amounts are assumed and simplified for illustration purposes.

Strauss Printing Services
Statement of Cash Flows
For the Year Ended December 31, 2019
Cash Flow from Operating Activities:
	Cash received from customers	$ 146,000
	Cash paid for expenses	(81,000)
	Cash paid to suppliers	(47,500)	$  17,500
Cash Flow from Investing Activities:
	Cash paid to acquire additional equipment		(20,300)
Cash Flow from Financing Activities:
	Cash received from investment of owner	$   10,000
	Cash received from bank loan	50,000
	Cash paid for bank loan – partial payment	(27,000)
	Cash paid to owner – withdrawal	(20,000)	13,000
Net Increase (Decrease) in Cash for the Year		$   10,200
Add: Cash – January 1, 2019	10,800
Cash – December 31, 2019	$   21,000

Explanation and Pointers

1. Statement of Cash Flows presents the inflows and outflows of cash in the different activities of the business, the net increase or decrease in cash, and the resulting cash balance at the end of the period. Cash inflows refer to receipts of cash while cash outflows to payments or disbursements.
2. A typical cash flow statement starts with a heading which consists of three lines. The first line presents the name of the company; the second describes the title of the report; and the third states the period covered in the report.
3. Notice that the third line is worded “For the Year Ended…” This means that the information included in the report covers a span of time. In the illustration above, the report presents inflows and outflows of cash for 1 year, i.e. from January 1 to December 31, 2019.
4. Cash inflows and outflows are classified in three activities: operating, investing, and financing.
5. Operating activities refer to the main operations of the company such as rendering of professional services, acquisition of inventories and supplies, selling of inventories for merchandising and manufacturing concerns, collection of accounts, payment of accounts to suppliers, and others. Generally, operating activities refer to those that involve current assets and current liabilities.
6. Investing activities may be summed up as: “where the company puts its money for long-term purposes”, such as acquisition of property, plant and equipment; and investment in long-term securities. Selling these properties are also considered investing activities. In general, investing activities include transactions that involve non-current assets.
7. Financing activities refer to: “where the company gets its funds”, such as investment of the owner/s, and cash proceeds from a bank loans and other long-term payables. The payment of such items (i.e. withdrawal of owner/s and payment of loans) are also financing activities. Generally, financing activities include those that affect non-current liabilities and capital.
8. All inflows are presented in positive figures while all outflows in the negative (in parentheses).
9. After inflows and outflows are presented, the net increase or decrease in cash is computed. Then it is added to the beginning balance of cash to get the balance at the end. Easy, right? In a simple sense, this report presents the cash balance at the beginning of the period, the changes during the period, and the resulting balance at the end of the period.
10. Notice that the cash balance at the end, $ 21,000, is the same as the cash balance presented in the company’s Balance Sheet.
11. Good accounting form suggests that a single line is drawn every time an amount is computed. It signifies that a mathematical operation has been completed. The computed balance at the end of the report is double-ruled.

5. Notes to Financial Statements

The Notes to Financial Statements, or Supplementary Notes, provide information in addition to those presented in the Balance Sheet, Income Statement, Statement of Changes in Equity, and Cash Flow Statement. The notes contain disclosures required by accounting standards, supporting computations, breakdown of line items in the face of the financial statements, and other information that users may be interested in.

Relationship among the Financial Statements

The financial statements contain interrelated information. This is the reason the financial statements are prepared in the sequence presented above. In fact, some of the figures in one financial statement component are actually taken from another component.

1. The net income from the Income Statement is used in the Statement of Changes in Equity. Remember that income and expenses affect capital.
2. The ending balance of capital in the Statement of Owner’s/Partners’/SH’s Equity is forwarded to the Balance Sheet (under Capital).
3. The cash balance presented in the Balance Sheet is supported by the Statement of Cash Flows. The ending balance of cash in the Statement of Cash Flows is the same amount presented in the Balance Sheet.
4. The notes to financial statements show supporting computations of the amounts and additional information about the items presented in the above reports.