Overview of Business
Activities & financial
Statements
Learning Objectives
• Students would be able to,
I. Understand the differentiate among three basic financial
statements( Income Statement, Balance Sheet and Statement
of Retained Earnings)
II. Distinguish between different Audit Opinions.
I. Construct the whole accounting cycle( From General journal
to After closing trial balance)
Forms of Business Entities
Sole
Proprietorship Partnership Corporation
2 or more Numerous
Number of owners 1
(partners) (shareholders)
Legally separate from
No No Yes
owners
Owners liable for
Yes Yes No
business debts
To the
corporation as
To the earnings;
Profits taxable To the owner
owners to the owners
when dividends
are received
The Financial Statements
• Income statement
• Statement of retained eraning
• Balance sheet
• Statement of cash flows
• Support for the financial statements is
provided by notes
Statement of retained
earning
• The statement of retained
earnings is a financial statement
prepared by corporations that
details changes in the volume of
retained earnings over some
period.
Balance Sheet
Income Statement
Shows the financial condition of Revenue $ 120,000
an entity as of a particular date Expenses (100,000)
Net Income $ 20,000
– Assets: the resources of the
business Statement of Stockholders’ Equity
– Liabilities: the debts of the Capt. Stk. Ret. Earn.
business Beginning Balance $ 25,000
– Equity: the owners’ interest Net income 20,000
in the business Dividends (10,000)
Ending Balance $ 35,000
The Accounting Equation:
Balance Sheet
Assets = Liabilities + Assets $110,000
Stockholders’ Equity Liabilities 25,000
Stockholders’ Equity
Assets = Liabilities + Capital Stock 50,000
Capital Stock + Retained Earnings 35,000
Retained Earnings $110,000
Statement of Cash Flows
• Covers the same period as the income
statement
• Three sections
– Cash flows from operating activities
– Cash flows from investing activities
– Cash flows from financing activities
Classification of Cash Flows
Operations -- cash flows related to selling goods and services;
that is, the principle business of the firm.
Investing -- Investing activities include purchases of physical
assets, investments in securities, or the sale of securities or
assets.
Financing -- long term and short term cash flows related to
liabilities and owners’ equity.
When using GAAP, financing activity also includes dividends paid, which may be included in
the operating section when using IFRS standards. Interest paid is included in the
operating section under GAAP, but sometimes in the financing section under IFRS as
well.
Notes
• An integral part of the financial statements
• Required presentation
– Summary of significant accounting policies
– Contingent liabilities
– Subsequent events relating to conditions that
existed at the balance sheet date
• Disclose and adjustment of the financial statements
– Subsequent events relating to conditions that did
not exist at the balance sheet date
• Disclosure but no adjustment of the financial
statements
Steps in accounting cycle
• Various book wrote various accounting cycle
all are same but with little difference.
• Here are 10 steps involved in accounting cycle
• 1. Identifying and Analyzing Business
Transactions
• 2. Recording in the Journals
Steps in accounting cycle
• 3. Posting to the Ledger
• 4. Unadjusted Trial Balance
• 5. Adjusting Entries
• 6. Adjusted Trial Balance
• 7. Financial Statements
• 8. Closing Entries
• 9. Post closing to ledger
• 10. after post closing trial balance
1. Identifying and Analyzing Business
Transactions
• The accounting process starts with identifying
and analyzing business transactions and
events. Not all transactions and events are
entered into the accounting system. Only
those that are related to the business entity
are included in the process.
2. Recording in the Journals
• Simple you can say journal entries or general
journal
Debit and Credit Rules
Debits
Debits and
and credits
credits affect
affect accounts
accounts as
as
follows:
follows:
A = L + OE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase
2.The Journal entries
In
In an
an actual
actual accounting
accounting system,
system, transactions
transactions
are
are initially
initially recorded
recorded in
in the
the journal.
journal.
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2003
May 1 Cash 8,000
Capital Stock 8,000
Ownersinvest cash in the business.
3. Posting Journal Entries to the Ledger
Accounts
Posting
involves
copying
information
from the
journal to the
ledger
accounts.
Posting Journal Entries to the Ledger Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2003
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest cash Ledger
in the business.
Cash
Date Debit Credit Balance
2003
May 1 8,000 8,000
3 trail balance
rd
• a statement of all debits and credits in a
double-entry account book
Unadjusted Trial Balance
Recording Adjusting Entries
• Required by the accrual basis of accounting
• Prepared at the end of the fiscal period
• Records (recognizes) for the current period
– Expenses incurred
– Revenues earned
• Recorded in the general journal
• Posted to the general ledger
Adjusting Entries
Adjusting Every
entries are adjusting
needed whenever entry involves a
revenue or expenses change in either a
affect more than one revenue or expense
accounting and an asset
period. or liability.
Types of Adjusting Entries
Converting
Converting
Converting
Converting
assets
assets to
to liabilities
liabilities to
to
expenses
expenses revenue
revenue
Accruing
Accruing
Accruing
Accruing
unpaid
unpaid uncollected
uncollected
expenses
expenses revenue
revenue
Converting assets to expenses
• Some cash expenditures are made to obtain benefits for more
than one accounting period. Examples of such expenditures
include advance payment of rent or insurance, purchase of
office supplies, purchase of an office equipment or any other
fixed asset. These are recorded by debiting an appropriate asset
(such as prepaid rent, prepaid insurance, office supplies, office
equipment etc.) and crediting cash account. This procedure is
known as postponement or deferral of expenses and prepaid
expenses. An adjusting entry is made at the end of accounting
period for converting an appropriate portion of the asset into
expense.
2.
•
Converting Liabilities to Revenue
Sometime companies collect cash for which the
goods or services are to be provided in some
future period. Such receipt of cash is recorded
by debiting cash and crediting a liability
account known as unearned revenue account.
This procedure is known as postponement or
deferral of revenue. At the end of accounting
period the unearned revenue is converted into
earned revenue by making an adjusting entry
for the value of goods or services provided
during the period.
3. Accruing Unpaid Expenses
• Unpaid expenses are expenses which are
incurred but no cash payment is made during
the period. Such expenses are recorded by
making an adjusting entry at the end of
accounting period. It is known as accruing the
unpaid expenses.
4. Accruing Uncollected Revenue
• Uncollected revenue is the revenue that is
earned but not collected during the period.
Such revenue is recorded by making an
adjusting entry at the end of accounting
period. It is known as accruing the uncollected
revenue.
Adjusted Trial Balance
JJ's Lawn Care Service
Adjusted Trial Balance All balances
31 May 2009
Cash $ 3,925
are taken from
Accounts receivable 75 the ledger
Tools & equipment 2,650 accounts on
Accum. depreciation: tools & eq. $ 50
Truck 15,000
31 May after
Accum. depreciation: truck 250 preparing the
Notes payable 13,000 two
Accounts payable 150
Share capital 8,000 depreciation
Dividends 200 adjusting
Sales revenue 750
Gasoline expense 50
entries.
Depreciation exp.: tools & eq. 50
Depreciation exp.: truck 250
Total $ 22,200 $ 22,200
Closing Entries
• A closing entry is a journal entry that is
made at the end of an accounting period to
transfer balances from a temporary
account to a permanent account.
Accounting System Components
Permanent Temporary
Account Assets Revenues, Gains
types Liabilities Expenses, Losses
Equity Dividends
Balances Carry forward to Closed to retained
the next fiscal earnings at year-end
period
Represent the
accounting
equation
Preparing the Financial
Statements
• The output of the accounting system
• Based on the adjusted general ledger
account balances
• Directly from the general ledger
– Income statement
– Balance sheet
• From analysis of general ledger accounts
– Statement of cash flows
Auditor’s Opinion
• Audit is conducted by CPAs
• The audit report is the formal statement of
audit opinion
– Unqualified opinion
– Qualified opinion
– Adverse opinion
– Disclaimer of opinion
Classification of Auditor’s Report
1. Unqualified opinion. Often called a clean
opinion, an unqualified opinion is an audit
report that is issued when an auditor determines
that each of the financial records provided by
the business are free of any misrepresentations.
In addition, an unqualified opinion indicates
that the financial records have been maintained
in accordance with the standards known as
Generally Accepted Accounting Principles
(GAAP)
Classification of Auditor’s Report Cont.
2. Qualified opinion. In situations when a
company’s financial records have not been
maintained in accordance with GAAP but no
misrepresentations are identified, an auditor
will issue a qualified opinion. The writing of
a qualified opinion is extremely similar to
that of an unqualified opinion. A qualified
opinion, however, will include an additional
paragraph that highlights the reason why the
audit report is not unqualified.
Classification of Auditor’s Report Cont.
3. Adverse opinion. This indicates that the firm’s
financial records do not conform to GAAP. In
addition, the financial records provided by the
business have been grossly misrepresented.
Although this may occur by error, it is often an
indication of fraud. When this type of report is
issued, a company must correct its financial
statement and have it re-audited, as investors,
lenders and other requesting parties will
generally not accept it.
Classification of Auditor’s Report Cont.
4. Disclaimer of opinion. On some
occasions, an auditor is unable to complete an
accurate audit report. This may occur for a
variety of reasons, such as an absence of
appropriate financial records. When this
happens, the auditor issues a disclaimer of
opinion, stating that an opinion of the firm’s
financial status could not be determined.
Management’s Responsibility
• Management is responsible for
– The preparation of the financial statements
– The integrity of the financial statements
• Management’s Statement of Responsibility
– May be included in the annual report
