Income Statement
A summary of an entity's results of operation for a specified period of time is revealed in the income statement, as it provides information about revenues generated and expenses incurred. The difference between the revenues and expenses is identified as the net income or net loss. The income statement can be prepared using a single-step or a multiple-step approach, and might be further modified to include a number of special disclosures relating to unique items. These topics will be amplified in a number of subsequent chapters. For now, take careful note that the income statement relates to activities of a specified time period (e.g., year, quarter, month), as is clearly noted in its title:
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QUARTZ CORPORATION Income Statement For the Year Ending December 31, 20X9 |
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Revenues |
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Services to customers Interest revenue |
$750,000 15,000 |
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Total revenues |
$765,000 |
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Expenses |
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Salaries Rent Other operating expenses |
$235,000 115,000 300,000 |
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Total expenses |
650,000 |
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Net income |
1115000 |
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The Statement of Retained Earnings
The example balance sheets for Edelweiss revealed how retained earnings increased and decreased in response to events that impacted income. You also know that retained earnings are reduced by dividends paid to shareholders.
The statement of retained earnings provides a succinct reporting of these changes in retained earnings from one period to the next. In essence, the statement is nothing more than a reconciliation or "bird's-eye view" of the bridge between the retained earnings amounts appearing on two successive balance sheets.
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QUARTZ CORPORATION Statement of Retained Earnings For the Year Ending December 31, 20X9 |
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Retained earnings - January 1, 20X9 |
$400,000 |
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Plus: Net income |
115,000 |
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$515,000 |
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Less: Dividends |
35,000 |
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Retained earnings - December 31, 20X9 |
$480,000 |
If you examine very many sets of financial statements, you will soon discover that many companies provide an expanded statement of stockholders' equity in lieu of the required statement of retained earnings. The statement of stockholders' equity portrays not only the changes in retained earnings, but also changes in other equity accounts such as capital stock. The expanded statement of stockholders' equity is presented in a subsequent chapter.
Balance Sheet
The balance sheet focuses on the accounting equation by revealing the economic resources owned by an entity and the claims against those resources (liabilities and owners' equity). The balance sheet is prepared as of a specific date, whereas the income statement and statement of retained earnings cover a period of time. Accordingly, it is sometimes said that balance sheets portray financial position (or condition) while other statements reflect results of operations. Quartz's balance sheet is as follows:
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QUARTZ CORPORATION Balance Sheet December 31, 20X9 |
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Assets |
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Cash Accounts receivable Land Other assets |
$192,000 248,000 450,000 10,000 |
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Total assets |
$900 000 |
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Liabilities |
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Salaries payable Accounts payable Total liabilities Stockholders' equity Capital stock Retained earnings Total stockholders' equity Total liabilities and equity |
$ 34,000 166,000 $220,000 480,000 |
$200,000 700,000 $900,000 |
Statement of Cash Flows
The statement of cash flows details the enterprise's cash flows. This operating statement reveals how cash is generated and expended during a specific period of time. It consists of three unique sections that isolate the cash inflows and outflows attributable to (a) operating activities, (b) investing activities, and (c) financing activities. Notice that the cash provided by operations is not the same thing as net income found in the income statement. This result occurs because some items hit income and cash flows in different periods. For instance, remember how Edelweiss (from the earlier illustration) generated income from a service provided on account. That transaction increased income without a similar effect on cash. These differences tend to even out over time.
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QUARTZ CORPORATION Statement of Cash Flows For the Year Ending December 31, 20X9 |
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Operating activities |
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Cash received from customers Cash received for interest Cash paid for salaries Cash paid for rent Cash paid for other items |
$ 720,000 15,000 (240,000) (115,000) (300,000) |
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Cash provided by operating activities |
$ 80,000 |
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Investing activities |
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Purchase of land |
(250,000) |
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Financing activities |
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Payment of dividends |
(35,000) |
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Decrease in cash |
$(205,000) |
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Cash, January 1 |
397,000 |
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Cash, December 31 |
$ 192,000 |
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Suffice it to say that the underpinnings of the statement cash flows require a fairly complete knowledge of basic accounting. Do not be concerned if you feel like you lack a complete comprehension at this juncture. A future chapter is devoted to the statement.
Articulation
It is important for you to take note of the fact that the income statement, statement of retained earnings, and balance sheet articulate. This means they mesh together in a self-balancing fashion. The income for the period ties into to the statement of retained earnings, and the ending retained earnings ties into the balance sheet. This final tie-in causes the balance sheet to balance. These relationships are illustrated in the following diagram.
Unlocking the Mystery of Articulation
It seems almost magical that the final tie-in of retained earnings will exactly cause the balance sheet to balance. This is reflective of the brilliance of Pacioli's model, and is indicative of why it has survived for centuries.
