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The financial statements for RCS are shown in Exhibit 1.4. The information used to prepare these statements was drawn from the ledger accounts. Information in one statement may relate to information in another statement. For example, the amount of net income reported on the income statement also appears on the statement of changes in stockholders’ equity. Accountants use the term articulationA term used to describe interrelationships among the financial statements. For example, the amount of net income reported on the income statement is added to beginning retained earnings as a component in the calculation of the ending retained earnings balance reported on the statement of stockholders' equity. to describe the interrelationships among the various elements of the financial statements. The key articulated relationships in RCS’s financial statements are highlighted with arrows (Exhibit 1.4). A description of each statement follows.
Income Statement and the Matching ConceptBusinesses consume assets and services in order to generate revenues, thereby creating greater quantities of other assets. For example, RCS may pay cash (asset use) to an employee who maintains the camp sites. Maintaining the sites is necessary in order to collect cash (obtain assets) from customers. The income statementStatement that reports the difference between the revenues and the expenses associated with running a business. matches asset increases from operating a business with asset decreases from operating the business.5 Asset increases resulting from providing goods and services to customers in the course of normal operations are called revenues. Asset decreases resulting from consuming assets and services for the purpose of generating revenues are called expenses. If revenues are greater than expenses, the difference is called net incomeIncrease in net assets resulting from operating the business.. If expenses exceed revenues, the difference is a net lossDecrease in net assets resulting from operating the business.. The income statement in Exhibit 1.4 indicates that RCS has earned more assets than it has used. The statement shows that RCS has increased its assets by $35,000 (net income) as a result of operating its business. Observe the phrase For the Year Ended December 31, 2004, in the heading of the income statement. Income is measured for a span of time called the accounting periodSpan of time covered by the financial statements, normally one year, but may be a quarter, a month or some other time span.. While accounting periods of one year are normal for external financial reporting, income can be measured weekly, monthly, quarterly, semiannually, or over any other desired time period. Notice that the cash RCS paid to its stockholders (dividends) is not reported as expense. The decrease in assets for dividend payments is not incurred for the purpose of generating revenue. Instead, dividends are transfers of wealth to the owners of the business. Dividend payments are not reported on the income statement.
Statement of Changes in Stockholders’ EquityThe statement of changes in stockholders’ equityStatement that summarizes the transactions occurring during the accounting period that affected the owners' equity. explains the effects of transactions on stockholders’ equity during the accounting period. It starts with the beginning balance in the common stock account. In the case of RCS, the beginning balance in the common stock account is zero because the company did not exist before the 2004 accounting period. The amount of stock issued during the accounting period is added to the beginning balance to determine the ending balance in the common stock account. In addition to reporting the changes in common stock, the statement describes the changes in retained earnings for the accounting period. RCS had no beginning balance in retained earnings. During the period, the company earned $35,000 and paid $4,000 in dividends to the stockholders, producing an ending retained earning balance of $31,000 ($0 + $35,000 – $4,000). Since equity consists of common stock and retained earnings, the ending total equity balance is $151,000 ($120,000 + $31,000). This statement is also dated with the phrase For the Year Ended December 31, 2004, because it describes what happened to stockholders’ equity during 2004. Balance SheetThe balance sheetbalance sheet Statement that lists the assets of a business and the corresponding claims (liabilities and equity) on those assets. draws its name from the accounting equation. Total assets balances with (equals) claims (liabilities and stockholders’ equity) on those assets. The balance sheet for RCS is shown in Exhibit 1.4. Note that total claims (liabilities plus stockholders’ equity) are equal to total assets ($551,000 = $551,000). Note the order of the assets in the balance sheet. Cash appears first, followed by land. Assets are displayed in the balance sheet based on their level of liquidityAbility to convert assets to cash quickly and meet short-term obligations.. This means that assets are listed in order of how rapidly they will be converted to cash. Finally, note that the balance sheet is dated with the phrase As of December 31, 2004, indicating that it describes the company’s financial condition on the last day of the accounting period.
Statement of Cash FlowsThe statement of cash flowsStatement that explains how a business obtained and used cash during an accounting period. explains how a company obtained and used cash during the accounting period. Receipts of cash are called cash inflows, and payments are cash outflows. The statement classifies cash receipts (inflows) and payments (outflows) into three categories: financing activities, investing activities, and operating activities. Businesses normally start with an idea. Implementing the idea usually requires cash. For example, suppose you decide to start an apartment rental business. First, you would need cash to finance acquiring the apartments. Acquiring cash to start a business is a financing activity. Financing activitiesCash inflows and outflows from transactions with investors and creditors (except interest). These cash flows include cash receipts from the issue of stock, borrowing activities, and cash disbursements associated with dividends. include obtaining cash (inflow) from owners or paying cash (outflow) to owners (dividends). Financing activities also include borrowing cash (inflow) from creditors and repaying the principal (outflow) to creditors. Because interest on borrowed money is an expense, however, cash paid to creditors for interest is reported in the operating activities section of the statement of cash flows. After obtaining cash from financing activities, you would invest the money by building or buying apartments. Investing activitiesOne of the three categories of cash inflows and outflows shown on the statement of cash flows; includes cash received and spent by the business on productive assets and investments in the debt and equity of other companies. involve paying cash (outflow) to purchase productive assets or receiving cash (inflow) from selling productive assets. Productive assetsAssets used to operate the business; frequently called long-term assets. are sometimes called long-term assets because businesses normally use them for more than one year. Cash outflows to purchase land or cash inflows from selling a building are examples of investing activities. After investing in the productive assets (apartments), you would engage in operating activities. Operating activitiesCash inflows and outflows associated with operating the business. These cash flows normally result from revenue and expense transactions including interest. involve receiving cash (inflow) from revenue and paying cash (outflow) for expenses. Note that cash spent to purchase short-term assets such as office supplies is reported in the operating activities section because the office supplies would likely be used (expensed) within a single accounting period. The primary cash inflows and outflows related to the types of business activity introduced in this chapter are summarized in Exhibit 1.5. The exhibit will be expanded as additional types of events are introduced in subsequent chapters.
The statement of cash flows for Rustic Camp Sites in Exhibit 1.4 shows that the amount of cash increased by $51,000 during the year. The beginning balance in the Cash account was zero; adding the $51,000 increase to the beginning balance results in a $51,000 ending balance. Notice that the $51,000 ending cash balance on the statement of cash flows is the same as the amount of cash reported in the asset section on the December 31 year-end balance sheet. Also, note that the statement of cash flows is dated with the phrase For the Year Ended December 31, 2004, because it describes what happened to cash over the span of the year.
Exercises 1-10A, 1-13A, 1-10B, 1-13B Problems 1-30A, 1-31A, 1-30B, 1-31B 5 This description of the income statement is expanded in subsequent chapters as additional relationships among the elements of financial statements are introduced. | |||||||||||||
