Session 2
Overview of Financial Statements
Lecture objectives
1. Purpose of financial statements
2. Simple formats of financial statements
3. Major accounting concepts
4. Major accounting principles
Purpose of financial statements
• What cash • How much wealth • What is the
movemenets took was generated? accumulated wealth
place? of the business at
the end of the
period and what
form does it take?
Statement of
Statement of Income
financial
cash flows statement
position
Purpose of statement of cash flows
How does a
company
obtain its Where does
cash? a company
spend its
cash?
What explains
the change in
the cash
balance?
Statement of cash flows
Opening balance of cash xxx
Add: Cash inflows xxx
Less: Cash outflows (xxx)
Closing balance of cash xxx
Example 1
Paul was unemployed and unable to
find a job. He therefore decided to
embark on a business venture. With
Christmas approaching, he decided to
buy gift wrapping paper from a local
supplier and to sell it on the corner of
his local high street. He felt that the
price of wrapping paper in the high
street shops was unreasonably high.
This provided him with a useful (Cost of purchase)
business opportunity.
He began the venture with £40 of his
own money, in cash. In July, Paul’s
first day of trading, he bought
wrapping paper for £40 and sold
three-quarters of it for £45 cash.
Example 1
He began the venture Statement of cash flows for July
with £40 of his own
money, in cash. In July, Opening balance of cash
Paul’s first day of (Cash introduced (by Paul) £ 40
trading, he bought Add: Cash from sales of wrapping paper 45
wrapping paper for £40 Less: Cash paid to buy wrapping paper (40)
and sold three-quarters
Closing balance of cash £ 45
of it for £45 cash.
(Cost of purchase)
Purpose of income statement
❖Reflects the results of a company’s activities for
a specific period of time.
❖The important factor to determine the degree of
“better-offness” of a business.
Income statement
Sales revenue xxx
Less: Expenses (xxx)
Profit (Loss) xxx
Example 2
He began the venture
with £40 of his own Income Statement for July
money, in cash. In July,
Paul’s first day of Sales Revenue $ 45
trading, he bought Less: Cost of goods sold (3/4 of £40) (30)
wrapping paper for £40
and sold three-quarters Profit $ 15
of it for £45 cash.
Revenue
❖The price of goods sold & services rendered
during a given accounting period.
❖Represents actual or expected cash inflows.
❖Causes owner’s wealth to increase.
Expenses
❖The cost of the goods & services used in the
process of earning revenue.
❖Represents actual or expected cash outflows.
❖Causes a decrease in owner’s wealth.
All expenses
incurred in All costs involved
acquiring stock in getting stock
and getting it from store to the
ready for sale. customer.
Supplier Business Customer
Cost of goods sold Other expenses
Business expenses
Salaries
Rent
Telephone &
Internet Expneses
Travelling & Conveyance Printing & Stationary
Purpose of statement of financial position
❖Helps users see if company has enough
assets to pay debts.
❖Assists users to determine the underlying
value of a company.
Statement of financial position
Assets
(itemized) xxx
Total assets $A
Liabilities
(itemized) xxx
Total liabilities xxx
Owner's equity xxx
Total liabilities & onwers' equity $A
Example 3
He began the venture with £40 of his own money, in cash.
In July, Paul’s first day of trading, he bought wrapping
paper for £40 and sold three-quarters of it for £45 cash.
Statement of financial position as at July 31
Assets
Cash (closing balance) 45
Inventories of goods for resales (1/4 of £40) 10
Total assets £ 55
Liabilities 0
Owner's equity £ 55
Total liabilities & onwers' equity £ 55
What are assets ?
❖Assets are resources a business owns.
❖They have the capacity to provide future services
or benefits.
What are liabilities?
Liabilities are claims against assets—that is,
existing debts and obligations.
What is owner’s equity?
“The residual interest in the assets of the entity
after deducting all its liabilities.”
The relationship between the
major financial statements
Income statement
Statement
for the period Statement
of financial
of financial
position
position
as at
as at the
beginning
end of the
of the
period
period
Statement of cash flows
for the period
Historical cost principle
❖Assets should be recorded at acquisition cost.
❖Is it relevant?
$1,000,000 $1,200,000
2016 2021
Fair value principle
❖Assets & liabilities should be recorded at fair value.
❖Is it representationally faithful?
$1,000,000 $1,200,000
2016 2021
Disclosure principle
❖ An entity must disclose all facts important enough
to make a difference to financial statement users.
➢ Accounting reports must include any additional
information needed to make sure that the financial
statements are not misleading.
Revenue recognition principle
❖Revenue should be recognized in the accounting
period in which the performance is satisfied.
▪ At the time goods are sold or services are
rendered.
Expense recognition principle
(Matching principle)
Match expenses with revenues in the period when the
company makes efforts to generate those revenues.
Acquisition cost Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
$12,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000
ALLOCATION
Expenses Revenues
MATCHING
Prudence principle
❖ Prudence is the exercise of caution when making
judgements under conditions of uncertainty.
❖ The exercise of prudence means that assets and income
are not overstated and liabilities and expenses are not
understated.
Example 4
❖ A business owns winter coat that was bought for $12,000 in
November 2020. It has gone down in value and is worth just
$9,000 in March 2021.
❖ Should it recognize this loss and value the inventory at $9,000?
Statement of financial position
ASSETS
Inventory $ 12,000
Statement of financial position
ASSETS
Inventory $ 9,000
Income statement
Expenses
Stock write down $ 3,000
References
❖Atrill & McLaney (2017), Accounting and Finance
for Non-specialists, Chapter 1 & 2.
❖Weetman (2019), Financial and Management
Accounting: An introduction, Chapter 4.
