Chapter 2

Basis of Financial Statements

Business transactions and events are the starting points offinancial statements. The process from transactions to financialstatements is as follows:

• Identify transaction and event from source documents.

• Analyze transaction and event using the accounting equation.

• Record relevant transactions and events in a journal.

• Post journal information to ledger accounts.

• Prepare and analyze trial balance and financial statement

Source Documents

Source documents identify and describe transactionsentering the accounting system.

Examples:

• Bills from suppliers

• Sales receipts

• Checks

• Purchase orders

• Payroll records

• Bank statement


Ledger and Chart of Accounts

The ledger is a collection of all accounts and their balancesfor an accounting system. A company’s size and diversity ofoperations affect the number of accounts needed.


Double-Entry Accounting T

Assets: increases debit+ and credits decrease-

Liabilities: decrease debits- and increase credits+

Equity: decrease debits- and increase credit+

Common stock: decreases debits- and increases credits+

Dividends: increase debit+ and decrease credit-

Revenues: decrease debits- and increase credits+

Expenses: increase debtis+ and decrease credits-

Double Entry Accounting: Account balance

An accounting balance is the difference between the increases and decreases in an account.

Preparing a Trial Balance

  1. Preparing a trial balance has three steps: List each accounting tittle and its amount ( from ledger) in the trial balance.

  2. Computer the total of debit balance and the total of credit balances.

  3. Verify (prove) total debit balance euqal total credit balances.


Financial Statements prepared from Trial Balance

Both the Beginning Balance Sheet and the Ending Balance Sheet are both a point in time.

Statement of cash flows, statements of retained earnings, and Income statement are a period of time

Financial Statements

The four financial statements and their purposes are:

1. Income statement—reports revenues less expenses incurred by a business over a period of time.

2. Statement of retained earnings—reports changes in equity over there porting period from net income (or loss) and from any dividends over a period of time.

3. Balance sheet—reports the financial position (types and amounts of assets, liabilities, and equity) at a point in time.

4. Statement of Cash Flows—lists the cash inflows and cash outflows for the period.

**For simplicity, we do not show the statement of cash flows for FastForward in this chapter, but we do return to this statement in the next chapter**

Presentation Issues

1. Dollar signs are not used in journals and ledgers.

2. Dollar signs appear in financial statements and otherreports such as trial balances.

3. Put dollar signs beside only the first and last numbersin a column

Debt Ratio - Computation

Debt Ratio = Total liabilities/ Total assets