HI5001

TOPIC 2
Financial Statements & Decision
Making

1
 Introduction
A. Types of business structures
B. Basic Financial Statements
C. Assumptions made and characteristics of
information
D. Basic effects of transactions
 Types of Business Entities
Single proprietorship or sole trader
Owned by one person
Partnership
Owned by two or more partners
Company of corporation
Owned by shareholders
Separate legal entity
 Sole Trader
A. One person who IS the business.
B. Easiest of all business structures to set
up.
C. Limited access to capital.
D. Business ceases when owner dies or
decides to get out.
E. Tax system- treated as PAYG same as an
employee.
F. Limited level of expertise available.
 Partnership
Similar to Sole trader (where not incorporated)
except obviously greater access to capital by
virtue of more owners (normally up to 20) though
is different for accounting and for legal
partnerships.

Again treated as PAYG per partner.

Partnership ceases when one partner leaves

Incorporated partnership means that the
business is a separate legal entity and as such is
treated like a company.
 Companies
These are separate legal entities that can:
A. Trade in their own name
B. Sue and be sued.
C. Have continuity regardless of change of
shareholders
D. Access to far greater capital and or
financial resources such as bonds and
debentures as well as through capital
raising (through a prospectus normally
unless restricted)
 Management Functions

PLANNING
What to do
How to do it

CONTROLLING ORGANISING
Evaluating actual vs DECISION Developing the
planned performance MAKING organisational structure

DIRECTING
Performing
according to plan
 Basic Financial Statements
Financial performance (Income Statement)
Operating efficiency
Financial position (Balance Sheet)
Economic condition
Cash flows
Operating activities
Investing activities
Financing activities
 The Income Statement
DONS AUTO REPAIRS
Income Statement
For the year ended 30 June 2015
REVENUE:
Repair revenue $442,500
EXPENSES:
Advertising expense $ 20,250
Repair supplies expense 91,710
Salaries and wages expense 127,800
Rent expense 40,260
Telephone expense 20,190
Light and Power expense 47,940 348,150
PROFIT $ 94,350
 The Income Statement (cont.)
Income
Inflows of or savings in outflows of economic
benefits that result in an increase in equity during
the reporting period. Recognises the event
generally, not the receival (e.g. recognises
revenue when earned)
Expenses
Decreases in equity representing the consumption
or loss of economic benefits in the form of
reductions in assets or increases in liabilities
other than distributions to owners (again
recognises when expensed, not always when
paid)
Most larger businesses apply the accrual method
 The Statement of Changes in Equity

DONS AUTO REPAIRS

Statement of Changes in Equity
For the year ended 30 June 2015
Don Brady, Capital , 1 July 2014 $ 237,330
Net profit for the year 94,350
$ 331,680
Less: Drawings 45,000
Don Brady, Capital , 30 June 2015 $ 286,680
 The Statement of Changes in Equity (cont.)

Balance sheet Income statement Balance sheet

as at beginning of year for the period as at end of year
A1 L1 = E1 I E = Profit A2 L2 = E2

2
1
4
Statement of owners equity
for the period
E1 + Profit Drawings = E2
3
 The Balance Sheet
DONS AUTO REPAIRS
Balance Sheet
as at 30 June 2015
ASSETS LIABILITIES
Cash at Bank $ 50,340 Accounts payable $ 20,760
Accounts receivable 17,790 Mortgage payable 201,000
Repair supplies 14,610 221,760
Repair equipment 110,700
Land 60,000 EQUITY
Building 255,000 Don Brady, Capital 286,680
$508,440 $508,440

ASSETS = LIABILITIES + EQUITY

 The Balance Sheet (cont.)
ASSETS
Cash at Bank $ 50,340
Accounts receivable 17,790
Repair supplies 14,610
Repair equipment 110,700
Land 60,000
Building 255,000
$508,440 ASSETS
Less: LIABILITIES
LIABILITIES
Accounts payable $ 20,760
Mortgage payable 201,000
= EQUITY
221,760
NET ASSETS $286,680
EQUITY
Don Brady, Capital 286,680
$286,680
 The Balance Sheet (cont.)
Assets
Resources controlled by the entity as a result of
past transactions or events from which future
economic benefits are expected to flow to the
entity
Liabilities
Present obligations of an entity arising from
past transactions or events, the settlement of
which is expected to result in an outflow of
resources from the entity
 The Balance Sheet (cont.)
Equity
The residual interest of the owner/s in the assets
(less liabilities) of the entity

ASSETS = LIABILITIES + EQUITY

or

ASSETS LIABILITIES = EQUITY

 Exercise
Jill Jordans Events Management Services
31/3/2015
Accounts payable 64,000 Accounts receivable 72,000
Building 600,000 Cash at bank 66,000
Land 240,000 Mortgage payable 580,000
Office equipment 120,000 Office supplies 18,000
Required:
a) Use the above to prepare a balance sheet in account (T) format.
b) Then prepare balance sheet in narrative (columnar) format.
 Balance Sheet (T format)
Balance Sheet as at 31/3/2015
Assets Liabilities
Cash at bank $ 66,000 Accounts payable $ 64,000
Accounts receivable 72,000 Mortgage payable 580,000
Office supplies 18,000
Land 240,000 Total Liabilities 644,000
Buildings 600,000
Office equipment 120,000 Equity
Capital 472,000

Total Assets $1,116,000 Total Liabilities & Equity $1,116,000

 The Statement of Cash Flows
Income and expenses do not necessarily
represent cash
Statement of cash flows reports
Cash in
Cash out
By activity type
 The Statement of Cash Flows (cont.)
DONS AUTO REPAIRS
Cash Flow Statement
For the year ended 30 June 2015
CASH FLOWS FROM OPERATING ACTIVITIES
Cash received from customers $424,710
Cash paid to suppliers and employees (342,000)
Net cash from operating activities $ 82,710
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of land and buildings (315,000)
Purchase of repair equipment (110,700)
Net cash used in investing activities (425,700)
CASH FLOWS FROM FINANCING ACTIVITIES
Amount borrowed under mortgage 201,000
Investment by owner 237,330
Drawings by owner (45,000)
Net cash from financing activities 393,330
Net increase (decrease) in cash held 50,340
Cash at beginning of year 0
Cash at end of year $ 50,340
 Assumptions made & Characteristics of Information

Assumptions
Accounting entity assumption
Need to identify boundaries
Accrual basis assumption
Transactions and events recorded when they
occur
Going concern assumption
Entity will continue indefinitely
Period assumption
Profit determined for a period of time
 Assumptions made & Characteristics of Information (cont.)

Characteristics
Relevance
Reliability
Comparability and consistency
Understandability
Materiality
Benefits and costs
Income is costly to produce
 Effects of Transactions on the Accounting Equation &
Financial Statements

Transactions result in changes in assets,

liabilities and equity
Every transaction affects at least
2 components of the accounting equation
After each transaction is recorded the equation
is still in balance

ASSETS = LIABILITIES + EQUITY

 In-class Example
1.Darren Jones deposits $35,000 in a
business bank account.

Assets = Liabilities + Equity

Cash at Darren Jones,
Bank Capital
(1) $35,000 = $35,000
 In-class Example (cont.)
2. Darren purchases a vehicle and some lawn
mowing & gardening equipment.

Assets = Liabilities + Equity

Cash at bank Equipment Vehicle Darren Jones, Capital
(1) $35,000 = $35,000
(2) -30,000 + 9,000 + 21,000
5,000 + 9,000 + 21,000 =
$35,000

$35,000
 Example (cont.)
3. Darren purchases fuel supplies for $2,500
on credit.
Assets = Liabilities + Equity
Cash at bank Equipment Vehicle Fuel supplies Accounts payable Darren Jones, Capital
(1) $35,000 = $35,000
(2) -30,000 + 9,000 + 21,000
5,000 + 9,000 + 21,000 = 35,000
(3) +2,500 +2,500
5,000 + 9,000 + 21,000 + 2,500 = 2,500 + 35,000

$37,500 = $37,500
 In-class Exercise
The Party Shop commenced on 1/1/2014
Owner, Claire Damico invested $150,000 for YE 31/12/14.
Received $420,000 cash for party-hire services.
Paid cash expenses $300,000 (wages & office supplies)
Purchased vehicle ($48,000) & computer system ($75,000)
Paid Rent in the amount of $49,500
Purchased land ($120,000) to build an office in new year.
Business borrowed $45,000 on land from bank.
Required.
1. Prepare Income Statement for YE 31/12/2014
2. Prepare Statement of Cash Flow for YE 31/12/2014
3. Can the business operate profitably & still have net
cash outflow for the year? Better indicator-profit/cash-
flow?
 Solution Income Statement
The Party Shop
Income Statement
for YE 31/12/2014
Income
Revenue $420,000

Expenses
Wages & Office supplies $300,000
Rent 49,500 349,500

Profit/Loss $ 70,500
 Solution Statement of Cash Flow
The Party Shop
Statement of Cash Flows
for YE 31/12/2014
Cash-flows from operating activities
Cash received from customers 420,000
Cash paid to suppliers and employees (300,000)
Rent (49,500)
Net cash from Operating 70,500
Cash-flows from investing activities
Purchase of land (120,000)
Purchase of vehicle (48,000)
Purchase of computer system (75,000)
Net cash from Investing (243,000)
Cash-flows from financing activities
Investment by owner 150,000
Mortgage (Land) (45,000)
Net cash from Financing 105,000
Net Cash-flow at end of year (67,500)
 Tutorial

Questions:
Hoggett & Edwards Discussion Question 5
Exercises 2.10
Problems 2.5, 2.9 & 2.12
Decision Case
Communication/Group Activity
Ethical Issues: Ethical practices among friends
The END

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