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Lecture 6

COMMERCE 1AA3 Lecture Notes - Lecture 6: Financial Statement, Retained Earnings, Income Statement

Course Code
Aadil Merali Juma

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Saturday, September 9, 2017
Areej Raza
Chapter 1- The Financial Statements
Chapter 2- Recording Business Transactions
The Basic Objective of Accounting:
The basic objective of accounting is to identify and measure the activities of a business entity in order
to evaluate its performance and to assess its financial health; then communicate the results to
stakeholders through a set of accounting reports that contain useful information so as to help them
make rational economic decisions.
Why Accounting is the Language of Business:
Accounting is an information system that measures and records business activities, process data into
reports, and reports results to decision makers. Accounting is “the language of business.”
Users of Accounting Information
External to Business:
Non-profit organizations
Employees and Employee unions
Internal to Business:
Financial Statements
Financial Statements are the business documents that companies use to report the results of their
activities to various user groups. The system of accounting produces the following statements:
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flow

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Saturday, September 9, 2017
Areej Raza
Financial Statements are the reports that companies use to convey the financial results of their
business actitivites to various user groups, which can include managers, investors, creditors, and
regulatory agencies.
1. The Income Statement
Also called the Statement of Operations or Statement of Earnings
Reports two main categories
o Revenues and gains
o Expenses and losses
Shows the “bottom line”
o Net income or net loss for the period
Net income is the most important item in the financial statements
Revenues and expenses are required to run a business
Gain or loss is accidental and happens without control or prediction
2. Statement of Retained Earnings
Retained earnings is portion of net income company has kept over a period of years
In other words, retained earnings represent the equity accumulated through operations that
generate net income.
Positive balance indicates revenues exceeded expenses
The statement of retained earnings reports the changes in a company’s retained earnings
during the same period covered by the income statement.
Accumulated deficit indicates expenses have exceeded revenues
Net income (or net loss) flows from the Income Statement or the Statement of Retained
o Opens with beginning retained earnings balance
o Adds net income (or subtracts net loss)
Flows from the Income Statement
o Subtracts dividends
o Reports ending retained earnings balance.
ENDING RE= BEGINNING RE + Net Income (-Net Loss) Dividends

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Saturday, September 9, 2017
Areej Raza
3. The Balance Sheet
Also called the Statement of Financial Position
o Assets
o Liabilities
o Stockholder’s Equity
Shows that assets equal sum of liabilities and stockholder’s equity
Reports retained earnings which comes from the Statement of Retained Earnings
Current assets are listed in order of their liquidity
Owner’s equity is the owner’s remaining interest in the assets of the company after deducting
all its liabilities. Owner’s Equity= Assets Liabilities
Assets = Liabilities + Owner’s Equity
Statement of Financial Position
1. Recognition (Identification)
2. Measurement (Valuation)
3. Disclosure (Classification)
Assets: Recognition
Future benefits will the asset benefit you in the future?
o R&D expensing- research and development expenses. R&D is a liability to accountants
b/c it’s an expense and a high uncertainty if it’s going to work or not,
Right to future benefits for something to be an asset you have to own them therefore why
you don’t put employees on the balance sheet as an asset
o Human Capital
o Intangibles
Assets: Measurement
Historical Cost- an asset will always be noted as how much you originally bought it for. As a
general rule, assets are recognized at historical/acquisition cost. Some assets might be reported
under a different basis.
Market Value- can you measure the asset? Reputation is an asset and it isn’t measureable.
o Replacement Cost (Entry Value)
o Net Realizable Value (Exit Value)
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