Financial Statements for a Sole Proprietorship

Chapter 9

Exploring the World of Business New England Aquarium funds its operations in

several different ways. Sources of funds includes Memberships sold to the public Admissions fees Sale of Aquarium-sponsored books and films Grants from corporate sponsors

What do you think? Why is it important for New England Aquarium to prepare

financial statements even though their purpose is not to earn a profit.

The Income Statement

Section 1

What You’ll Learn

Why financial statements are important for business decisions.

The purpose of the income statement.

How to prepare an income statement.

Key Terms

Financial Statement

Income Statement

Financial Statements

The primary statements prepared for a sole proprietorship is Income statement Balance Sheet Statement of changes in Owner Equity

Income Statement

The income statement contained the following section: The heading The revenue for the period The expenses for the period The net income or net loss for the period

The Heading

1. The name of the business (Who?)

2. The name of the report (What?)

3. The period covered (When?)

The Heading (Cont.)

Reporting Period Wording of Date Line

One month For the Month Ended October 31, 20--

One quarter For the Quarter Ended March 30, 20--

One year For the Year Ended June 30, 20--

The Revenue Section

1. Write “Revenue” on the first line at the left side of the form

2. Enter the revenue account names beginning on the second line, indented about half an inch from the left edge of the form.

3. Enter the balance of the revenue account** If the business has more than one revenue account

the balances are entered in the first column. Total revenues is then written in the second amount column.

** The words “Total Revenue is indented approx 1 inch from the left edge of the form

The Expenses Section

1. On the line following the revenue section write “Expenses” at the left side of the form.

2. On the following line, write the names of the expense accounts, indented half an inch, in order that they appear on the work sheet.

1. Since there are several expense accounts enter the individual balances in the first amount column.

Expense Section (Cont)

3. Draw a single rule under the last expense account balance.

4. Write the words “Total Expenses” on the line following the last expense account name, indent 1 inch

5. Add the balances for all the expense accounts write the total in the second amount column, one line below the last expense account balance.

The Net Income Section

1. Draw a single rule under the total expenses amount

2. Subtract the total expenses from total revenue to find net income. Enter the net income in the second amount column under the total expense amount.

3. On the same line write the words ”Net Income” at the left side of the form.

4. If the amount of net income matches the amount shown on the work sheet, draw a double rule under the net income amount.

Showing a Net Loss

If total expenses are greater than total revenue, there is a net loss.

Enter the net loss amount in the second amount column under the total expenses

Write the words “Net Loss” on the same line at the left side of the form.

Section 1 Check your Understanding Thinking Critically

Communicating Accounting

Problem 9-1 Analyzing a Source Document

The Statement of Changes in Owner’s Equity

Section 2

What You’ll Learn

The purpose of the statement of changes in owner’s equity

How to prepare the statement of changes in owner’s equity.

Key Terms

Statement of changes in owner’s equity

The Heading of the Statement of Changes The first line consists of the name of the

business (Who?) The second line indicates the name of the

statement (What?) The third line indicates the period covered

(When?)

Completing the Statement of Changes in Owner’s Equity1. On the first line, write “Beginning Capital” followed

by a comma and then by the first day of the period.2. In the second amount column, enter the balance of

the capital account at the beginning of the period. The source of the information is the capital account

3. Next enter the increases to the capital account. Investments made by the owner during the period. On the next line write the words “Net Income” indent so the word line up with Investment by Owner”. Enter the amount in the first amount column, enter the net income amount.

Completing the Statement of Changes (cont.)4. Write the words “Total Increase in Capital” on the

next line at the left side of the form. Add the investments by owner and net income amount and enter total in the second amount column. Draw a single rule under the amount.

5. Write “Subtotal” on the next line, at the left side of the form. Add the amounts for beginning capital and total increase in capital. Enter the result in the second amount column.

Completing the Statement of Changes (cont.)6. The next section of the statement lists the

decreases to the capital account: withdrawals and net loss. Write the words “Less: Withdrawals by Owner” at the left side of the form. Find the withdrawal amount on the worksheet. Enter the amount in the second amount column. Draw a single rule under the withdrawal amount.

7. On the next line, at the left side of the form, write the words “Ending Capital” followed by a comma and the last day of the period.

8. Subtract the withdrawal amount to determine the ending balance of the capital account. Draw a double rule below the ending amount.

Statement of Changes in the Owner’s Equity for an Ongoing Business To prepare the statement of changes in

owners equity for an ongoing business you would need to go to the account ledger to obtain the beginning balance for the period.

Statement of Changes in Owners Equity Showing a Net Loss Since there are two items that decrease

capital, withdrawal and net loss, the amounts of the individual items are entered in the first amount column.

The total decrease in capital is entered in the second amount column

Key Points

Owner Investments and Withdrawals Investments by the owner and net income

increase capital. Withdrawals by the owner and net loss decrease

capital.

A Matter of Ethics

Financial Report or Repair?Your favorite uncle, who owns a restaurant, has asked you to help with this bookkeeping. He desperately needs a bank loan and wants you to prepare the financial statements. After going over his accounting records, you don’t believe a bank will give him a loan; but you notice that by leaving out an expense or two, your uncle’s business could look more promising. After all, he does have some good ideas for improving the business.

Ethical Decision Making: What are the ethical issues? What are the alternatives? Who are the effected

people? How do the alternative effect

the parties? What would you do?

Section 2 Check Your Understanding Thinking Critically

Analyzing Accounting

Problem 9-2 Determining the Ending Capital Balances

The Balance Sheet

Section 3

What You’ll Learn

The purpose of the balance sheet

How to prepare a balance sheet

How to analyze information on financial reports

Key Terms

Balance sheet

Report form

Ratio analysis

Sales profitability ratio

Return on sales

Liquidity ratio

Current ratio

Current assets

Current liabilities

Quick ratio

Sections of the Balance Sheet The heading The assets section The liability and owners equity section

The Heading

The name of the business (Who?)

The name of the financial statement (What?)

The date of the balance sheet (When?)

The Asset Section

1. Write the word “Assets” on the first line in the center of the column containing the account names.

2. On the following line, enter asset account names and their balances. List them in the same order as they appear in the balance sheet section of the work sheet. Enter the account balances in the first amount column. Draw a single rule under the last account balance

3. On the next line write the words “Total Assets” indented about half an inch. Add the asset balances and enter total in the second amount column.

The Liabilities and Owner’s Equity Sections1. On the line after “Total Assets” enter the

heading :Liabilities” in the column containing the account names.

2. List the liability account names and their balances in the same order as the work sheet. Draw a single rule under the last account balance.

3. On the next

Ratio Analysis

Ratio analysis The comparison of two amounts on a financial

statement The evaluation of the relationship between those

amounts Profitability ratios

Used to evaluate the earning performance of business during the accounting period

Measure of its ability to grow and continue to earn revenue

Return on Sales

Sales is a revenue account representing the sale of merchandise.

Return on sales examine the portion of each sales dollar that represent profit To calculate this ratio:

Divide net income by sales

Liquidity Ratios

A liquidity ratio measures the ability of a business to pay its current debts.

Two common ratios are Current ratio

Quick ratio

Section 3 Check Your Understanding Thinking Critically

Communicating Accounting

Problem 9-3 Calculating Return on Sales

Key Concepts

Preparing financial reports is the seventh step in the accounting cycle. The primary reports are the income statement and the balance sheet. The statement of changes in owner’s equity is often prepared.

The income statement reports the net income or net loss for the period

The statement of changes in owner’s equity summarizes the impact the periods business had on the capital account

The balance sheet reports the balances of assets, liability and owner’s equity at the end of the period.

Key Concepts (cont.)

Financial reports may be handwritten, typewritten, or prepared using a computer.

The chart on page 223 list the source of information for each financial report.

Ratio analysis is used to determine the financial strength, activity, or debt-paying ability of a business.

Liquidity ratios measure the ability of a business to pay its current debts as they become due.

Chapter 9 Review and Activities Conducting an Audit with Alex

Problem 9-6

Project: Case Study 3