CAPITAL

A Typical balance sheet

Marjorie Breck, CPA

Income Statement

Year Ended December 31, 1976

An Operations Statement for a service business

Pappas Gift Shop

Income Statement

Year Ended December 31, 1976

Two basic financial statements are the balance sheet and the operations statement. The balance sheet shows the firm’s condition on the last day of the accounting period. It shows what the business owns and what it owes to its creditors or its owners. A business is always in a state of equilibrium. In other words, what it owns is equal what is owes. This is expressed in the following accounting formula:

Assets = Liabilities + Owner’s Equity

A statement of owners’ equity shows what changes have occurred in regard to equity since the previous balance sheet was compiled. It shows, for example, the money the owners have put in (investment) or taken out (disinvestment) of the business, as well as profits and losses from its operations.

The operations statements is also referred to as a profit and loss statement or an income and expense statement. It shows how much profit or loss was generated by the operations of the company during the accounting period. In this case operations may be considered as sales of goods or services. The profit from sales after the direct cost for producing the goods or services have been deducted is called gross income or gross profit. While income is produced, however, the business has certain other expenses – indirect cost related to the production of that income, such as general or selling expenses. The balance that is left when these further expenses are deducted is called net income or net profit.

A third basic financial statement is the statement of changes in financial position, which shows an increase or decrease in working capital for the year and how this change arose. In some cases, this statement will show the change in the cash position rather than the change in working capital.

The three basic types of business in terms of operations are service, merchandising and manufacturing. A service business gives advice or service exclusively. An accounting firm, for example, offers services, as does a television repair shop. The giant travel and tourist industry, one of the largest industries in the world, sells services rather than goods. A merchandising business aco… goods for sale to its customers. A…chborhood grocery store may be considered a merchandising enterprise, and so may a huge mail-order and retail-outlet company like Sears-Roebuck. A manufacturing business changes the form of goods by analysis, as in an oil or sugar refinery; by synthesis, as in a steel mill; or by assembly, as in an automobile assembly plant or an electronics factory that assembles consumer products like television sets.

Copies of the various statements described above, together with the financial and operating data in the accounting records, are sent to owners, management personnel, labor unions, appropriate government bureaus, creditors, and the general public. Reports intended only for use and distribution within the company on parts or phases of the business are also prepared periodically from the financial records. A cash report, for example, may be required daily by some companies, but only weekly or monthly by others.

A body of principles and concepts underlies the practice of accounting. These concepts together form a general guide to the accounting profession. First, an accounting system must provide consistency in the accumulation and recording of financial data. A mixture of different systems does not give a true picture of financial affairs of an organization. Second, an accounting system must make it possible to compare the data issued to management, government and the public. This concept is called comparability, and without it there would be no firm basis on which to tax a company, to invest in it or even to manage it. Each of the groups interested in a company would otherwise receive a different picture of its financial affairs. Third, an accounting system must provide the basis for arriving at decisions and solutions in handling the operational and financial problems of the organization. Without this decision-making base, most companies would be unmanageable. There would, for instance, be no way of pinpointing trouble areas within the company.

Certain assumptions underlie all accounting activity. Although accountants may disagree over the value of many rules of practice and procedure in their field, there are some assumptions on there they almost universally agree. One of them is the idea of the business as an accounting entity, independent of its owners for accounting purpose. This is similar to the concept of a legal entity that is embodied in incorporation. A corporation has some of the legal rights and obligations of a single individual. Another common assumption is that money serves as the unit of measure to be used for recording and reporting transactions. This provides a common denominator for past, present and future transactions. The concept is similar to the one that makes mathematics the common language of science. Still another commonly held assumption is that there is a basic accounting period, that is, an interval of time for which an income statement is prepared. Without using specific intervals, there would be no base for illustrating the rate of hange in the company. The accounting period is, in other words, a kind of business calendar.

Another standard that is generally accepted in the profession is that of objective evidence. Accountants need verifiable evidence just as scientists do. In the case of accountants, the evidence consists of business papers or other records for any transaction. This standard cannot always be universally applied, however, because there are situations in the practice of accounting when objective evidence is not available. Accounting for depreciation, for example, must be compiled on the basis of the accountant’s judgement, but within the guidelines specified in applicable tax codes.

Date: 2014-12-29; view: 978