CHAPTER2

BASIC FINANCIAL
STATEMENTS
 Introduction to Financial Statements
 Financial statements are a structured representation of
the financial position (Balance Sheet), financial
performance (Income Statement) of an entity and the
inflow and outflow of cash (cash flow statement).

 The objective of financial statements is to provide

information about the financial position, financial
performance and cash lows of an entity that is useful to a
wide range of users in
making economic decisions.

 Financial statements is also help to assess the probability

that an enterprise will be able to make future cash.
 Three
Three primary
primary financial
financial statements
statements are
are
Describes where the
Balance Sheet enterprise stands at a
Depicts the specific date.
revenue and Income Statement
expenses for
a designated Statement of Cash Flows Depicts the ways
period of cash has changed
time. during a
designated period
of time.

 These financial statements are windows to a company's

performance and health.
The Balance Sheet: What is it?
• The balance sheet represents a record of a company's
assets, liabilities and equity at a particular point in time.
Balance sheet is named by the fact that a business’s
financial structure balances in the following manner:
 Assets = Liabilities + Shareholders' Equity
• Assets represent the resources that the business owns or
controls at a given point in time. This includes items such as
cash, inventory, machinery, buildings etc.
• The other side of the equation represents the total value of
the financing the company has used to acquire those assets.
Liabilities represent debt, while equity represents the total
value of money that the owners have contributed to the
business – including retained earnings, which is the profit
made in previous years.
 The Balance Sheet
ASSETS LIABILITIES EQUITY
Cash Accts Payable Pref Stock
Inventory Wages Payable Common Stk
Land/Bldgs = Taxes Payable + Retained
Earnings
Equipment Notes Payable
Accts Rcvbl Short term
Securities Long Term
 The Balance Sheet ~ Why do we care?
 The balance sheet provides investors with a snapshot
of a company's health as of the date provided on the
financial statement.
 If a company assets are large relative to liabilities, it's
in good shape. Conversely, if a company with a large
amount of liabilities relative to assets has risk to
creditors.
 The higher the debt ratio, the greater risk will be
associated with the firm's operation. In addition, high
debt to assets ratio may indicate low borrowing
capacity of a firm, which in turn will lower the firm's
financial flexibility.
 The Income Statement ~ What is it?
 The income statement measures a company's performance
over a specific time frame and presents information about
the revenues, expenses and profit that was generated as a
result of the business' operations for that period.
 Components of the Income Statement include:
 Revenue (how much the company earned)
 Expenses (how much the company has spent)
 Net Income before and after Tax (the profits of the
company)
 This statement contains the information that most of the
time mentioned in the press or in financial reports – figures
such as total revenue, net income, or earnings per share.
The Income Statement ~ Why do we care?
 The income statement answers the
question, "How well is the company's
business?
“Does it performing well?“
Basically, the question is "Is it making
money?"
 Firms with low expenses and high profits
relative to revenues are typically more
desirable for investment because it brings
more money directly to a shareholder.
 The Statement of Cash Flows ~ What is it?
• The statement of cash flows represents a record of
a business' cash inflows and outflows over a
period of time. It is the most sensitive of the
statements and focuses on the following cash-
related activities:
– Operating Cash Flow: Cash generated from
day-to-day business operations.
– Cash from Investing: Cash used for investing in
assets, as well as the proceeds from the sale of
other businesses, equipment or long-term
assets
– Cash from financing: Cash paid or received from
the issuing and borrowing of funds
The Statement of Cash Flows ~ Why do we care?
 The statement of cash flows is very important to investors
because it shows how much actual cash a company has
generated. The income statement includes non-cash
revenues or expenses, which the statement of cash flows
excludes.
 In addition it shows the ability of firms to generate cash.
Many companies have shown “profits” on the income
statement but struggled later because of insufficient cash
flows.
 It shows correct figures of firms, because cash flow
statement is very difficult for a business to manipulate its
cash situation. Earnings can be manipulated, but it's tough
to “fake” cash in the bank. For this reason some investors
use the cash flow statement as a more conservative
measure of a company's performance.
 Bringing It All Together
 The three financial statements we have discussed
are all related.
 The changes of assets and liabilities that is
indicated on the balance sheet are also reflected in
the revenues and expenses which are stated on
the income statement, which shows the company’s
gains or losses.
 Cash flows provide more information about cash
assets listed on a balance sheet and are related,
but not equivalent, to net income shown on the
income statement. Therefore, no one financial
statement tells the complete story of firms.
 A Starting Point: Statement of
Financial Position
Vagabond Travel Agency
Balance Sheet
January 1, 2007
Assets Liabilities & Owners' Equity
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
Accounting principles

certain accounting principles that are

important for an understanding of
financial statements and how
professional judgment by accountants
may affect the application of those
principles are shown in the next slides
The concept of business
entity

Vagabond Travel Agency

A business entity is separated from

the personal affairs of its owner.

The stable-dollar assumption
tells us that we will only record
accounting information that can
be expressed in monetary units,
usually dollars in the United
States.
Stable-Dollar
Assumption
for asset valuation.
The cost principle tells us that
Assets accounting information is based
upon actual cost incurred.
We refer to this as historical cost.
Cost Principle The going-concern assumption states
that in the absence of information to
the contrary, the business entity is
assumed to continue operations into
the future.
These accounting
principles support Going-Concern
cost as the basis Assumption
The objectivity principle states that
Objectivity accounting information must be
unbiased and based upon
Principle independent evidence.
 Assets
Vagabond Travel Agency
Balance Sheet
January 1, 2007
Assets Liabilities & Owners' Equity
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
 Liabilities
Vagabond Travel Agency
Balance Sheet
January 1, 2007
Assets Liabilities & Owners' Equity
Liabilities are
Cash $ 22,500 Liabilities:
debts that
Notes receivable
Accounts receivable
10,000
60,500
Notes payable
Accounts payable
$ 41,000
36,000
represent negative
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
future cash flows
Building 90,000 Owners' Equity:
for the enterprise.
Office equipment 15,000 Capital stock
Retained earnings
150,000
70,000
Total $ 300,000 Total $ 300,000
 Owners’ Equity
Vagabond Travel Agency
Balance Sheet
January 1, 2007
Assets Liabilities & Owners' Equity
Owners’ equity
Cash $ 22,500 Liabilities:
represents the
Notes receivable
Accounts receivable
10,000
60,500
Notes payable
Accounts payable
$ 41,000
36,000
owners’ claims on
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
the assets of the
Building 90,000 Owners' Equity:
business.
Office equipment 15,000 Capital stock
Retained earnings
150,000
70,000
Total $ 300,000 Total $ 300,000
 Owners’ Equity
Changes in Owners’
Equity

•Owners’ •Payments
Investments to Owners
•Business •Business
Earnings Losses
 Vagabond Travel Agency
Balance Sheet
January 1, 2007
Assets Liabilities & Owners' Equity
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
Building 90,000 Owners' Equity
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000

Assets
Assets == Liabilities
Liabilities ++ Owners’
Owners’ Equity
Equity
$300,000
$300,000 == $80,000
$80,000 ++ $220,000
$220,000
Business transactions affect the
elements of the accounting equation:

Assets = Liabilities + Owners’ Equity

In the next slides will demonstrate how certain

business transactions affect the elements of the
accounting equation
 Business transactions
 On May 1, Jill Jones and her family invested $8,000 in JJ’s Lawn Care
Service and received 800 shares of stock.
 On May 2, JJ’s purchased a riding lawn mower for $2,500 cash.
 On May 8, JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in
cash and issued a note payable for the remaining $13,000.
 On May 11, JJ’s purchased some repair parts for $300 on account.
 On May 18, JJ’s was able to sell half of the repair parts to ABC Lawns
for $150, a price equal to JJ’s cost. JJ’s will receive the cash
within 30 days.
 On May 25, ABC Lawns pays JJ’s $75 as a partial settlement of its
accounts receivable.
 On May 28, JJ’s pays $150 of its accounts payable.
 On May 29, JJ’s recorded lawn care services (revenue) provided
during May of $750. All clients were paid in cash.
 On May 31, JJ’s purchased gasoline (expense) for the lawn mower and
the truck for $50 cash.
 Let’s analyze some transactions for JJ’s Lawn Care Service.

On May 1, Jill Jones and her family invested $8,000 in JJ’s Lawn
Care Service and received 800 shares of stock.

JJ's Lawn Care Service

Balance Sheet
May 1, 2007
Assets Owners' Equity
Cash $ 8,000 Capital Stock $ 8,000

Total $ 8,000 Total $ 8,000

 On May 2, JJ’s purchased a riding lawn
mower for $2,500 cash.
JJ's Lawn Care Service
Balance Sheet
May 2, 2007
Assets Owners' Equity
Cash $ 5,500 Capital Stock $ 8,000
Tools & Equipment 2,500

Total $ 8,000 Total $ 8,000

 On May 8, JJ’s purchased a $15,000 truck.
JJ’s paid $2,000 down in cash and issued a note payable
for the remaining $13,000.

JJ's Lawn Care Service

Balance Sheet
May 8, 2007
Assets Liabilities and Owners' Equity
Cash $ 3,500 Liabilities:
Tools & Equipment 2,500 Notes Payable $ 13,000
Truck 15,000 Owners' Equity:
Capital Stock 8,000

Total $ 21,000 Total $ 21,000

 On May 11, JJ’s purchased some repair
parts for $300 on account.

JJ's Lawn Care Service

Balance Sheet
May 11, 2007
Assets Liabilities and Owners' Equity
Cash $ 3,500 Liabilities:
Tools & Equipment 2,800 Notes Payable $ 13,000
Truck 15,000 Accounts Payable 300
Total Liabilities $ 13,300
Owners' Equity:
Capital Stock 8,000

Total $ 21,300 Total $ 21,300

 Jill realized she had purchased more repair parts than needed.
On May 18, JJ’s was able to sell half of the repair parts to ABC Lawns for
$150, a price equal to JJ’s cost. JJ’s will receive the cash within 30 days.

JJ's Lawn Care Service

Balance Sheet
May 18, 2007
Assets Liabilities and Owners' Equity
Cash $ 3,500 Liabilities:
Accounts Receivable 150 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 300
Truck 15,000 Total Liabilities $ 13,300
Owners' Equity:
Capital Stock 8,000

Total $ 21,300 Total $ 21,300

 On May 25, ABC Lawns pays JJ’s $75 as a partial
settlement of its accounts receivable.

JJ's Lawn Care Service

Balance Sheet
May 25, 2007
Assets Liabilities and Owners' Equity
Cash $ 3,575 Liabilities:
Accounts Receivable 75 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 300
Truck 15,000 Total Liabilities $ 13,300
Owners' Equity:
Capital Stock 8,000

Total $ 21,300 Total $ 21,300

 On May 28, JJ’s pays $150 of its accounts
payable.
JJ's Lawn Care Service
Balance Sheet
May 28, 2007
Assets Liabilities and Owners' Equity
Cash $ 3,425 Liabilities:
Accounts Receivable 75 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities 13,150
Owners' Equity:
Capital Stock 8,000

Total $ 21,150 Total $ 21,150

 On May 29, JJ’s recorded lawn care services
(revenue) provided during May of $750. All clients
were paid in cash.
JJ's Lawn Care Service
Balance Sheet
May 29, 2007
Assets Liabilities and Owners' Equity
Cash $ 4,175 Liabilities:
Accounts Receivable 75 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities 13,150
Owners' Equity:
Capital Stock 8,000
Retained Earnings 750
Total $ 21,900 Total $ 21,900
On May 31, JJ’s purchased gasoline (expense) for the lawn mower
and the truck for $50 cash.

JJ's Lawn Care Service

Balance Sheet
May 31, 2007
Assets Liabilities and Owners' Equity
Cash $ 4,125 Liabilities:
Accounts Receivable 75 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities 13,150
Owners' Equity:
Capital Stock 8,000
Retained Earnings 700
Total $ 21,850 Total $ 21,850

Now, let’s review how JJ’s transactions

affected the accounting equation.
 To explain how the statement of financial position, often referred to as the
balance sheet, is an expansion of the basic accounting equation.

Assets = Liabilities + Owners' Equity

Accts. Tools & Notes Accts. Capital Retained
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + Earnings
May 1 $ 8,000 $ 8,000
Balances $ 8,000 $ 8,000
May 2 (2,500) $ 2,500
Balances $ 5,500 $ 2,500 $ 8,000
May 8 (2,000) $ 15,000 $ 13,000
Balances $ 3,500 $ 2,500 $ 15,000 $ 13,000 $ 8,000
May 11 300 $ 300
Balances $ 3,500 $ 2,800 $ 15,000 $ 13,000 $ 300 $ 8,000
May 18 $ 150 (150)
Balances $ 3,500 $ 150 $ 2,650 $ 15,000 $ 13,000 $ 300 $ 8,000
May 25 75 (75)
Balances $ 3,575 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 300 $ 8,000
May 28 (150) (150)
Balances $ 3,425 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000
May 29 750 750
Balances $ 4,175 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 $ 750
May 31 (50) (50)
Balances $ 4,125 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 $ 700
 Let’s prepare the Income Statement and Statement of Cash Flows
for JJ’s Lawn Care Service for the month ending May 31, 2007.

Assets = Liabilities + Owners' Equity

Accts. Tools & Notes Accts. Capital Retained
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + Earnings
May 1
Balances
$
$
8,000
8,000
These
These transactions
transactions $
$
8,000
8,000
May 2 (2,500) $ 2,500 impact
impact the
the
Balances $ 5,500 $ 2,500 $ 8,000
May 8 (2,000) Statement
Statement
$ 15,000 $ of
of Cash
Cash
13,000
Balances $ 3,500 $ 2,500 $ 15,000 $ 13,000 $ 8,000
May 11 300 Flows.
Flows. $ 300
Balances $ 3,500 $ 2,800 $ 15,000 $ 13,000 $ 300 $ 8,000
May 18 $ 150 (150)
Balances $ 3,500 $ 150 $ 2,650 $ 15,000 $ 13,000 $ 300 $ 8,000
May 25 75 (75)
Balances $ 3,575 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 300 $ 8,000
May 28 (150) (150)
Balances $ 3,425 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000
May 29 750 These
These transactions
transactions 750
Balances $ 4,175 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 $ 750
May 31 (50) impact
impact the the Income
Income (50)
Balances $ 4,125 $ 75 $ 2,650 $
Statement.
15,000 $ 13,000
Statement.
$ 150 $ 8,000 $ 700
To explain how the income statement reports an enterprise’s financial
performance for a period of time in terms of the relationship of
revenues and expenses.

JJ's Lawn Care Service

Income Statement
For the Month Ended May 31, 2007

Sales Revenue $ 750

Operating Expense:
Gasoline Expense 50
Net Income $ 700

Investments
Investments by by and
and payments
payments to to the
the owners
owners
are
are not
not included
included on
on the
the Income
Income Statement.
Statement.
To explain how the statement of cash flows presents the change in cash
for a period of time in terms of the company’s operating, investing, and
financing activities.

JJ's Lawn Care Service

Statement of Cash Flows
For the Month Ended May 31, 2007
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Purchase of lawn mower $ (2,500)
Purchase of truck (2,000)
Collection for sale of repair parts 75
Payment for repair parts (150)
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month $ 4,125
Cash balance, May 1, 2007 -
Cash balance, May 31, 2007 $ 4,125
 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2007
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Operating
Operating activities
Purchase of lawn mower activities include
include
$ (2,500)
Purchase of truck (2,000)
the
the cash
cash effects
effects of
Collection for sale of repair parts of revenue
revenue 75
and
and expense
Payment for repair parts
expense transactions.
Net cash used by investing activities
(150)
transactions. (4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month $ 4,125
Cash balance, May 1, 2007 -
Cash balance, May 31, 2007 $ 4,125
 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2007
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Purchase of lawn mower $ (2,500)
Purchase of truck (2,000)
Collection for sale of repair parts 75
Payment for repair parts (150)
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investing
Investing activities
activities include
Investment by owners include the
the 8,000

cash
cash effects
effects of
of purchasing
purchasing and
Increase in cash for month
Cash balance, May 1, 2007 and
$ 4,125
-
selling
selling assets.
assets.
Cash balance, May 31, 2007 $ 4,125
 JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2007
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Financing
Financing activities
activities include
Purchase of lawn mower include the
the cash
cash $ (2,500)
effects
effects of
of transactions
transactions with
Purchase of truck
with the
the owners
Collection for sale of repair parts owners
(2,000)
75
and
and creditors.
creditors.
Payment for repair parts (150)
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month $ 4,125
Cash balance, May 1, 2007 -
Cash balance, May 31, 2007 $ 4,125
 Now, let’s prepare the Balance Sheet for JJ’s
Lawn Care Service for May 31, 2007.
Assets = Liabilities + Owners' Equity
Accts. Tools & Notes Accts. Capital Retaine
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + Earning
May 1 $ 8,000 $ 8,000
Balances $ 8,000 $ 8,000
May 2 (2,500) $ 2,500
Balances $ 5,500 $ 2,500 $ 8,000
May 8 (2,000) $ 15,000 $ 13,000
Balances $ 3,500 $ 2,500 $ 15,000 $ 13,000 $ 8,000
May 11 300 $ 300
Balances $ 3,500 $ 2,800 $ 15,000 $ 13,000 $ 300 $ 8,000
May 18
Balances $ 3,500
$ 150
$ 150
These
(150)
These
$ 2,650
balances
balances
$ 15,000
will$ 300
$ 13,000 will $ 8,000
May 25 75 (75) appear
appear on
on the
the $ 300
Balances $ 3,575 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 8,000
May 28 (150) Balance
Balance Sheet.
Sheet. (150)
Balances $ 3,425 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000
May 29 750 75
Balances $ 4,175 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 $ 75
May 31 (50) (5
Balances $ 4,125 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 $ 70
 JJ's Lawn Care Service
Balance Sheet
May 31, 2007
Assets Liabilities
Cash $ 4,125 Notes payable $ 13,000
Accounts receivable 75 Accounts payable 150
Tools & equipment 2,650 Owners' Equity
Truck 15,000 Capital stock 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850

Assets
Assets == Liabilities
Liabilities ++ Owners’
Owners’ Equity
Equity

$21,850
$21,850 == $13,150
$13,150 ++ $8,700
$8,700
 To explain the important relationships among the statement of financial
position, income statement, and statement of cash flows, and how
these statements relate to each other.

Relationships Among Financial

Statements
Date at Date at
beginning end of
of period Time period

Balance Balance
Sheet Sheet

Income Statement
Statement of Cash Flows
 Financial Statement Articulation
JJ's Lawn Care Service
Statement of Cash Flows
JJ's Lawn Care Service
For the Month Ended May 31, 2007
Cash flows from operating activities: Income Statement
Cash received from revenue transactions $ 750 For the Month Ended May 31, 2007
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Sales Revenue $ 750
Purchase of lawn mower $ (2,500) Operating Expense:
Purchase of truck (2,000) Gasoline Expense 50
Collection for sale of repair parts 75
Net Income $ 700
Payment for repair parts (150)
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month $ 4,125 JJ's Lawn Care Service
Cash balance, May 1, 2007 -
Balance Sheet
Cash balance, May 31, 2007 $ 4,125
May 31, 2007
Assets Liabilities
Cash $ 4,125 Notes payable $ 13,000
Accounts receivable 75 Accounts payable 150
Tools & equipment 2,650 Owners' Equity
Truck 15,000 Capital stock 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850
 Forms of Business Organization

Sole
Sole Partnerships
Partnerships Corporations
Corporations
Proprietorships
Proprietorships
 Forms of Business Organization

Most business organizations are organized as a sole

proprietorship, a partnership or a corporation. GAAP can be
applied to the financial statements of all three forms of
organization.
Sole proprietorship:- is unincorporated business owned by a
single person. It is separated from the other affairs of its owner.
It is common for small retailer stores, farms, service business
and professional practices, like in law, medicine and
accounting.
Partnership: is unincorporated business owned by two or more
persons agree to act as partners(co-owners). It is widely used
for small business.
Corporation: is a type of business organization that is
recognized under the law as an entity separate from its owners.
 Characteristics of Business organizations
Sole proprietorship
Owner Proprietor—only
one owner
Life of organization Limited by the owner’s
choice, or death
Legal viewpoint Owner and business entity
are not regarded as separate
Accounting viewpoint Business entity is separated
from other affairs of owner
Separate taxable No
entity from owner
Ease of formation Very easy
Management Owner
Personal liability Proprietor is
of the owner(s) for personally liable
the business’s debts
Transferability of Only by sale of entire
ownership business or creation of
different entity
Partnership Corporation
Partners—two or Stockholders—
more owners generally many owners
Limited by the owner’s Indefinite
choice, or death
Owners and business Separate entity from
entity are not owners
regarded as separate
Business entity is Business entity is
separated from other separated from other
affairs of owners affairs of owners
No Yes
Partnership Articles of corporation
agreement is helpful generally requires
May be divided Board of directors
among partners
Partners are Stockholders are not
personally liable personally liable
Can sell all or a Can easily
portion of partnership transfer(sell) all or a
interest portion of stock
 Reporting Ownership Equity in the
Statement of Financial Position

Sole Ow ner's equity:

Sole
Proprietorships
Proprietorships Jill Jones, capital $ 8,000

Partners' equity
Jill Jones, capital $ 4,000
Partnerships
Partnerships Bill Jones, capital 4,000
Total partners' equity $ 8,000

Owners' equity
Capital stock $ 7,000
Corporations
Corporations Retained earnings 1,000
Total stockholders' equity $ 8,000
 END OF
CHAPTER 2