Financial Statements for a Sole Proprietorship

The Seventh Step in the Accounting Cycle: Financial Statements

The primary financial statements prepared for a sole proprietorship are the income statement and the balance sheet. A third statement, the statement of changes in owner’s equity, is also often prepared.

The Income StatementThe income statement reports the

net income or net loss for the period.

It contains the following sections:• The heading• The revenue for the period• The expenses for the period• The net income or net loss for the

period

The Income Statement

Where are we getting the numbers for the Income Statement?From the work sheet!

The Revenue Section:for More Than One Revenue Account

A) Write “Revenue:” on the first line at the left side of the form.

B) Enter the revenue account names beginning on the second line, indented about half an inch.

C) Draw a single rule under the last revenue account.

D) Write the words “Total Revenue” indented about one inch.

E) Enter the balance of the revenue account(s) in the second column (total column).

AB

CD E

The Revenue Section:For One Revenue Account

A) Write “Revenue:” on the first line at the left side of the form.

B) Enter the revenue account name beginning on the second line, indented about half an inch.

C) Write the total of the account in the second column.

The Expense Section

D) On the line following the revenue section, write “Expenses:” at the left side of the form.

E) On the following lines, write the names of the expense accounts, indented half an inch, in the order that they appear on the work sheet. Enter their individual balances in the first amount column.

The Expense Section

F) Draw a single rule under the last expense account balance.

G) Write the words “Total Expenses” on the line following the last expense account name, indented about one inch.

H) Add the balances for all the expense accounts. Write the total expenses amount in the second amount column.

The Net Income Section

I) Draw a single rule under the total expenses amount.J) Subtract the total expenses from the total revenue to

find net income.K) On the same line, write the words “Net Income” at the

left side of the form.L) If the amount of net income matches the amount

shown on the work sheet, draw a double rule under the net income amount.

Chapter Nine, Section 2:

The Statement of Changes in Owner’s Equity

The statement of changes in owner’s

equity summarizes changes in the

owner’s capital account as a result of

business transactions during the period.

The Statement of Changes in Owner’s Equity

The information to prepare this statement is found in three places:

the work sheet the income statement the owner’s capital account in the

general ledger

BC

A) Write the words “Beginning Capital” followed by a comma and then by the first day of the period.

B) In the second amount column, enter the balance of the capital account at the beginning of the period.

C) Enter the increases to the capital account, investments made by the owner. Write “Add: Investments by Owner.”

D) Enter the total investment in the first amount column.

E) Write the words “Net Income.” In the first amount column, enter the net income amount from the income statement. Draw a single rule under the net income amount.

F) 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 amounts and enter the total in the second amount column. Draw a single rule under the amount.

G) 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.

FG

H) The next section of the statement lists the decreases to the capital account: withdrawals and net loss. When there is no net loss, write the words “Less: Withdrawals by Owner” at the left side of the form. Enter the withdrawals amount in the second amount column. Draw a single rule under that amount.

H

I) 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.

J) Subtract the withdrawals amount from the subtotal to determine the ending balance of the capital account. Finally, draw a double rule below the ending capital amount.

J

Remember:

Beginning Capital

+ Investments

+ Net Income or – Net Loss

- Withdrawals

Ending Capital

Section 3 The Balance Sheet

What You’ll Learn

The purpose of a balance sheet.

How to prepare a balance sheet.

Why It’s ImportantThe balance sheet reports the

financial position of a business at a specific point in time.

The Balance Sheet

The balance sheet is a report of

the balances in all asset, liability,

and owner’s equity accounts at the

end of the period.

The Balance Sheet

The balance sheet represents the

basic accounting equation; thus, the

assets section total must equal the

total of the liabilities and owner’s

equity sections.

Assets = Liabilities + Owner’s Equity

The Balance Sheet

The Asset Section

B

A

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

B) On the following lines, enter the 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.

The Asset Section

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

C

The Liabilities Section

D) On the line after “Total Assets” enter the heading “Liabilities” in the column containing the account names.

E) On the following lines, list the liability account names and their balances in the same order as on 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.

D

E

The Liabilities Section

F) On the next line, write the words “Total Liabilities,” indented about half an inch. Add the individual liability balances and enter the total in the second amount column.

F

The Owner’s Equity Section

G) On the next line enter the heading “Owner’s Equity” in the center of the column containing the account names.

H) On the next line, write the name of the capital account. In the second amount column, enter the ending balance of the capital account as shown on the statement of changes in owner’s equity.

GH

Proving the Equality of the Balance Sheet

I) Draw a single rule under the balance of the capital account. On the next line, write the words “Total Liabilities and Owner’s Equity,” indented about half an inch.

J) Add the total liabilities amount and the ending capital balance. Enter the total in the second amount column. If the totals are not equal, there is an error.

J

I J

Proving the Equality of the Balance Sheet

*Most errors occur when transferring amounts from the work sheet or from the statement of changes in owner’s equity. Verify that each account balance has been transferred properly.

K) When total assets equal total liabilities and owner’s equity, draw a double rule under the total assets amount and under the total liabilities and owner’s equity amount.

J

K

K

Ratio Analysis Ratio analysis involves the

comparison of two amounts on a financial statement and the evaluation of the relationship between these amounts.

Used to determine the financial strength, activity, or debt-paying ability of a business.

Return on Sales Allows business owners to examine

the portion of each sales dollar that represents profit.

*This means that every dollar of sales produced 43.4 cents of profit.

Net Income $1,150 net income= = .434 or 43.4%

Sales $2,650 sales

Liquidity Ratios A measure of the ability of a business

to pay its current debts as they become due and to provide for unexpected needs of cash.

Examples:

Current Ratio

Quick Ratio

Liquidity: the ease with which an asset can be converted to cash.

Current Ratio

Relationship between current assets and current liabilities.

Current Assets $22,575Current Liabilities $11,725

= Current Ratio = 1.92 or 1.9:1

Current Ratio

A ratio of 2:1 or higher is considered favorable by creditors.

This indicates that a business is able to pay its debts. (2 current dollars for every 1 current dollar of debt).

OR their assets are two times their current liabilities.

Quick Ratio

The relationship between short- term liquid assets (cash and receivables) and current liabilities.

Cash and Receivables $ 22,575Current Liabilities $11,725= Quick Ratio = 1.92:1

Quick Ratio A quick ratio of 1:1 is considered

adequate.

This indicates that a business can pay its current debts with cash and incoming receivables.

1 dollar of liquid assets for each 1 dollar of current liabilities

Vertical Analysis

Each dollar amount reported on a financial statement is also reported as a percentage of another amount, called a base amount, appearing on that same statement.

Vertical Analysis

For Example: The net sales amount for each year is assigned a percentage of 100. Every other amount on the income statement is stated as a percentage of the net sales amount.

Horizontal Analysis

The comparison of the same items on financial statements for two or more accounting periods or dates and the determination of changes from one period or date to the next.

Each amount from the current statement is compared with its corresponding amount on the previous statement.