Back To CourseAccounting 101: Financial Accounting
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Rebekiah has taught college accounting and has a master's in both management and business.
Good day, everyone. I am Mrs. GAAP, and in the accounting industry, I am the boss. My name, GAAP, stands for generally accepted accounting principles. These are the principles that guide the creation of the financial statements. Since the discussion today is on two of the four financial reports that make up the financial statements, who would be better qualified to discuss them with you than me? Without further ado, let's begin our discussion of the balance sheet and the statement of cash flows.
Before we get into the discussion of what makes up the balance sheet, I think that we should discuss some of the basics of the balance sheet. The balance sheet is the financial report that lists all of the accounts of a company along with their balances. This report follows the formula: assets = liabilities + owner's equity. Assets are what a company owns. Liabilities are what a company owes. Owner's equity is how much money company owners have invested in the business.
All of the financial reports that make up the financial statements have a specific format as determined by GAAP. The title of the statement is always centered and takes three lines. The company name is on the first line. The financial report name is on the second line. And the third line tells the time period that the report covers. The balance sheet uses the last day of the accounting period as the date recorded on the report.
After the heading, the balance sheet is separated into two sides. The left side is to list company assets. The right side is to list both the company liabilities and owner's equity accounts. An easy way to remember this is to remember the balance sheet equation. The equals sign serves as the dividing line between the two sides.
Now it's time to create a basic balance sheet. Let's look at an example. Bill owns a pet shop named Bill's Pet Shop. He has the following accounts:
Cash in the bank = $4,500
Inventory = $23,000
Office Supplies = $2,500
Office Equipment = $5,000
Accounts Payable = $15,000
Notes Payable = $10,000
Bill Campbell - Capital = $10,000
Bill reports his financial information quarterly. The time period for this quarter is January 1 through March 31, 2013.
Following the format that we have listed above, the heading is the first item that needs to be entered. The first line will say 'Bill's Pet Shop.' The second line will say 'balance sheet.' The third line will say 'March 31, 2013.' After the heading is complete, it's time to divide the balance sheet into left and right sides. You don't have to actually draw a line down the center of the report, but you do need to be sure that there is a distinct separation between the asset side of the report and the liabilities and owner's equity side of the report.
Assets, recorded on the left side of the equation, are listed individually along with their balances. Using the information given for the pet shop, those assets will be the cash in the bank, inventory, office supplies, and office equipment. After all the assets are recorded, the total of the assets is calculated and written on the bottom line of the balance sheet. For Bill's Pet Shop, the entry to record total assets will be written as: Total Assets = $35,000.
The liabilities side of the balance sheet follows the same format as the assets. All liabilities are recorded first. For Bill's Pet Shop, the liabilities will be accounts payable and notes payable. Following the last entry for the liabilities, the total liabilities are recorded. For the pet shop, that entry will be written as: Total Liabilities = $25,000.
The owner's equity is reported under the liabilities section. It's important to leave a little space between the liabilities and owner's equity section so that the individual sections are separated. The total owner's equity for the company is reported on the line directly below the owner's equity heading. On the last line of the balance sheet, the total of liabilities and owner's equity is reported. The entry for the pet shop will say: Total Liabilities and Owner's Equity = $35,000. Once you verify that both sides of the balance sheet equal, the balance sheet is complete.
The statement of cash flows is the last financial report that is included in the financial statements. There are three parts to this financial report.
The first section is the operating activities section. Operating activities are the activities that describe cash that came in or went out of a company as a result of the normal, day-to-day operations of the company.
The second section of the cash flow statement is for listing investing activities. Investing activities describe income that came in or went out of a business as a result of transactions that involved the purchase or sale of items, such as plant, property, or equipment.
The final section of the cash flow statement is the financing activities section. Financing activities describe income that came in or went out of a business as a result of agreements with shareholders and/or investors.
We're still going to use Bill's Pet Shop as our example. On January 1, the company had $5,000 in cash. The following activities occurred:
Cash received from customers was $27,000.
Cash paid for salaries was $6,000.
Cash paid for rent was $3,000.
Cash paid for other items was $12,000.
Purchase of equipment was $5,000.
Additional owner's equity was $5,000.
Now that we have all the information that we need, let's put together the statement of cash flows. As in the other financial reports, the heading of this statement is centered on the page and will take up three lines. The first line is for the company name. In this case, you'd put Bill's Pet Shop. The second line names the financial report. In this case, it'll read: Statement of Cash Flows. The third line lists the time period that the statement covers. For this statement, it will read: For the Quarter ending March 31, 2013.
After the heading section is complete, it's time to enter the correct activities under each section. The first section is the operating section. For Bill's Pet Shop, which of the activities are operating activities? They are cash received from customers, cash paid for salaries, rent, and other items. The cash received from customers is listed first, followed by each of the three cash paid categories. Each item is recorded on a separate line.
After all operating activities are entered, the total income received from operations is calculated. To do this, simply subtract all cash paid from cash received and enter the amount on the next line of the cash flow statement. Bill's Pet Shop has a total cash provided by operating activities of $6,000.
The second section of the statement of cash flows is the investing section. For this time period, Bill's Pet Shop only had one item that'll appear here. Bill purchased $5,000 of equipment for the pet shop. This activity meets the criteria for an investment activity. On the statement, the heading investing activities is written below the completed operating activities section. Underneath the heading, the purchase of equipment and the dollar amount is recorded.
The third section, the financing section, immediately follows the investing section. Looking back on the activities for Bill's Pet Shop in this quarter, we can see that Bill made another $5,000 deposit into the company account. This was an addition to the owner's equity account and is classified as a financing activity. Just as in the other two sections of the statement of cash flows, the heading of this section is placed under the last completed section. The activities that fall into this category are then listed. For Bill's Pet Shop, the additional investment he made in the company will be reported here.
Once all the information is complete, there are just a few more things that need to be done. The increase or decrease in cash is recorded. The pet shop had a $6,000 increase in cash for the quarter. The cash that was on hand January 1 is recorded as: Cash January 1 = $5,000. The next line adds the increase or subtracts the decrease in cash from the cash on hand at the beginning of the period and records it. For the pet shop, the entry would be: Cash March 31 = $11,000. The statement of cash flows is now complete.
The balance sheet and the statement of cash flows are two of the four financial reports that make up the financial statements. The format of these reports and the information reported on the report are defined by generally accepted accounting principles, also known as GAAP. The purpose of the balance sheet is to report all accounts that a company has and the account balances.
Accounts are broken down into three categories: assets, liabilities, and owner's equity. Assets are things that a company owns. Liabilities are things that a company owes. Owner's equity is the amount of money that an owner has invested in his business. The balance sheet follows the formula: assets = liabilities + owner's equity. In order for the balance sheet to be complete and accurate, the total of all the assets must be equal to the sum of the total of liabilities and owner's equity.
The statement of cash flows is the last report generated for the financial statements. Its purpose is to show how cash flowed in and out of a company for a given time period. The statement of cash flows is broken down into three sections: operating activities, investing activities, and financing activities. Operating activities are those that are directly related to the day-to-day operations of the company. Investing activities are those that involve the purchase or sale of items such as plant, property, or equipment. Financing activities are activities that are a result of agreements with shareholders and/or investors.
In order to complete the statement of cash flows, you must know the amount of cash from the beginning of the accounting period and determine the amount of cash in the current accounting period. These two dollar amounts added together result in the cash available at the end of the accounting period. Once these last two financial reports are completed, then the company has their complete set of financial statements. It certainly is a great deal of work to get to that point!
When this lesson is complete, you should be able to:
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Back To CourseAccounting 101: Financial Accounting
14 chapters | 137 lessons | 13 flashcard sets