ACC 100- Chapter 4- Financial Statements

Income Statement
● Definition: Shows the business’s profitability, whether the revenues are higher than the
expenses and by how much.
● Reports results of operations:
○ Revenues: Income earned
■ Service: Already provided
■ Good: Already delivered
○ Expenses: Used, consumed, or incurred to help generate revenue.
■ Costs which have been used, consumed, incurred
■ To help generate revenue
○ Profit or loss
● Measures performance over a period of time = Past performance
● Uses of the income statement:
○ Owners:
■ How profitable is the business?
■ Will dividends be paid?
○ Lenders:
■ Loan money or not
■ Will the business repay the loan plus interest
○ Other Creditors:
■ Will the business repay outstanding obligations?
● It answers the following questions:
○ Was the business profitable in the current year?
○ Was the profit high enough in comparison to the revenues earned?
○ If the business has loans or wants to borrow money from the bank, is there enough
profit to repay the loan, plus interest, both now and in the future?
○ Is the business generating enough profit to continue into the future (going concern
assumption from Chapter 1)?

Statement of Retained Earnings

● Definition: Shows how much of the profit is kept in the business and how much is paid
out to the owners.
● Reports how:
○ Profit (or net loss)
○ Dividends
■ Changes equity
● Because changes in equity are mainly due to generations and
distribution of profit

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 ● Stakeholders:
○ Asssess use of profit
○ Amount retained vs. distributed to owners
● Equity: Wealth due to owners
○ Owners capital: Invest $20,000
○ Profit retained: Profit $10,000 increase, paid will increase, dividends decrease
■ Dividends: Profit paid out to owners
● Uses of retained earnings:
○ Owners:
■ Use past dividends payouts to predict future dividends
■ Is the business reinvesting enough profit to support future growth?
○ Lenders:
■ Are dividend payouts reasonable, leaving enough cash to repay debts?
○ Other creditors:
■ Is the business reinvesting enough profit to ensure future growth?
● It answers the following questions:
○ Did the business pay dividends to the owners?
○ Given the profit, were the dividend payments high enough? Or were they too
high?
○ How much of the profit was retained (kept) in the business for future growth and
expansion?
○ Could the business pay out additional dividends in the future? (This can be
assessed by reviewing how high the retained earnings from the past was).

Balance Sheet
● Definition: Shows a business’s financial position, the details of its assets (owned), the
liabilities (owed to third parties) and the equity (owed to the owners). It is used to assess
the business’s financial position.
● Elements:
○ Assets:
■ Owed
■ Benefit the business in the future
■ Happened in the past

Current Long term

● Converted into cash, sold, ● Not a current asset

used, or consumed ● Benefits realized over more than one year
● One year ● Subcategories:

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 ● Examples: ○ Property, plant, and equipment: All the
○ Cash lands the business owns.
○ Accounts receivable ○ Intangible assets: Not physical, can’t
○ Supples touch, legal rights such as trade marks
○ Other assets: Any assets that last than
one year and don’t belong to the other
two.

○ Liabilities:
■ Owed to third parties
■ Repaid in the future
■ Happened in the past

Current Long-Term

● Outflow of cash, goods, or services ● Outflow of cash, goods, or services

● One year ● Beyond one year
● Examples: ● Examples:
● Accounts payable ● Mortgage payable
● Salaries payable ● Loan payable
● Interest payable ● Note payable
● Unearned revenue

○ Equity: Wealth due to owners, owed to owners by the business

■ Owners capital and retained earnings
● It answers the following questions:
○ What is the breakdown of the assets?
○ Are the assets liquid enough (can be converted into cash) so that the liabilities
(debts) can be paid when they come due?
○ If the business closed now, would there be enough liquid assets to pay off the
debts?
○ What is the breakdown of the liabilities?
○ When are debts owed (short term or long term) and how much debt is there in
relation to the assets?
○ How much of the business is funded through debt (liabilities) and how much is
funded through owner's contributions (equity)?

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Statement of Cash Flows
● Shows the cash inflows and outflows over the period as well as the cash position at the
end of the period.
● Shows:
○ Management of cash
○ Inflows of cash
○ Outflows of cash
● Uses the cash basis of accounting
● Activities:
○ Financing: Getting and repaying funding (debt or equity)
○ Investing: Buying and selling long-lived assets
○ Operating: Revenue and expenses from the day-to-day operations.
● Uses:
○ Owners:
■ Is there enough cah to pay dividends?
○ Lenders and other creditors:
■ Is there enough inflows of cash to pay debts?
■ Will the business need additional financing in the future?
○ Owners, lenders, and other creditors:
■ Assess the business’s ability to produce future cash inflows
● It answers the following question:
○ Was the business able to generate cash from its day to day operations?
○ Is there enough cash to pay dividends?
○ Is there cash available to pay the business's debts as they come due?
○ Will the business be able to fund future purchases from its own cash or will it
have to borrow from creditors (the bank)?
○ Given the cash flows in the past what can be said (predicted) about future cash
flows?
● While the income statement focuses on profitability (which, as noted, does not mean
cash) the statement of cash flows focuses only on cash transactions, how much cash
flowed in and out of the business and from where.