Financial Statements

Financial statements are reports that summarize and communicate information obtained from day-to-day bookkeeping activities. After all of the income and expenses of the business have been recorded, financial accountants prepare financial statements in the following order:

1. Income Statement
2. Statement of Retained Earnings—also called Statement of Owner’s Equity
3. The Balance Sheet
4. The Statement of Cash Flows

Understand Financial Statements

In order to get a better understanding of financial statements, what they communicate to the users of accounting information, and how the statements are connected, we will use the final balances as of January 31, 20XX for a fictitious delivery-service company, Metro Courier Inc. Just as a financial accountant would do, we will use these figures to prepare the company’s financial statements required by GAAP. Let’s look at Metro Courier’s financial information and prepare some financial statements.

Balance of Accounts for Metro Courier Inc. as of January 31, 20XX
Item	Item Type	Dollar Amount
Cash	Asset	[latex]$ 66,800[/latex]
Accounts Receivable	Asset	[latex]$ 5,000[/latex]
Supplies	Asset	[latex]$ 500[/latex]
Prepaid rent	Asset	[latex]$ 1,800[/latex]
Equipment	Asset	[latex]$ 5,500[/latex]
Truck	Asset	[latex]$ 8,500[/latex]
Accounts Payable	Liability	[latex]$ 200[/latex]
Common Stock	Equity	[latex]$ 30,000[/latex]
Retained Earnings (beginning balance)	Equity	[latex]$ 0[/latex]
Service Revenue	Revenue	[latex]$ 60,000[/latex]
Salary Expense	Expense	[latex]$ 900[/latex]
Utilities Expense	Expense	[latex]$ 1,200[/latex]

Income Statement

The income statement, sometimes called an earnings statement or profit and loss statement, reports the profitability of a business organization for a stated period of time. In accounting, we measure profitability for a period, such as a month or year, by comparing the revenues earned with the expenses incurred to produce these revenues. The income statement contains the following:

• Revenues are the inflows of cash resulting from the sale of products or providing services to customers. We measure revenues by the prices agreed on between the business and customer.
• Expenses are the costs incurred to produce revenues. In other words, expenses are costs of doing business (typically identified as accounts with the word “expense”).
• Net Income = Revenues − Expenses.  Net income is often called the earnings of the company. When expenses exceed revenues, the business has a net loss. 

Metro Courier Inc.
Income Statement
Month Ended January 31, 20XX
Revenue:
Service Revenue		[latex]$ 60,000[/latex]
Total Revenues		[latex]$ 60,000[/latex]
Expenses:
Salary Expense		[latex]$ 900[/latex]
Utility Expense		[latex]$ 1,200[/latex]
Total Expenses		[latex]$ 2,100[/latex]
Net Income ([latex]$60,000 - 2,100[/latex])		$ 57,900

The net income from the income statement will be used in the statement of owner’s equity, also called statement of retained earnings.

Statement of Retained Earnings

The statement of owner’s equity or statement of retained earnings, explains the changes in retained earnings between two balance sheet dates. We start with beginning retained earnings (in our example, the business began in January, so we start with a zero balance) and add any net income (or subtract net loss) from the income statement. Next, we subtract any dividends declared (or any owner withdrawals in a partnership or sole-proprietor) to get the ending balance in retained earnings (or capital for non-corporations).

Metro Courier Inc.
Statement of Retained Earnings
Month Ended January 31, 20XX
Beginning Retained Earnings, Jan 1		[latex]$   0[/latex]
Net income from month (from income statement)		[latex]$ 57,900[/latex]
Total increase		[latex]$ 57,900[/latex]
Dividends (or withdrawals for non-corporations)		[latex] – $0[/latex]
Ending Retained Earnings, January 31		$ 57,900

The ending balance we calculated for retained earnings (or capital) is then reported on the balance sheet.