CHAPTER ONE

INTRODUCTION TO ACCOUNTING AND BUSINESS

1.1 THE NATURE OF A BUSINESS

A business is an organization in which basic resources (inputs), such as materials and labor, are
assembled and processed to provide goods or services (outputs) to customers. The objective of
most businesses is to earn a profit. Profit is the difference between the amounts received from
customers for goods or services and the amounts paid for the inputs used to provide the goods or
services.

1.2 TYPES OF BUSINESS ORGANIZATIONS

Business organizations can be classified in various categories based on different criteria.

Based on the form of establishment

There are three basic forms of business organizations: sole proprietorships, partnerships, and
corporations.

1. Sole Proprietorship
A sole proprietorship is a business owned by one person and usually managed by the owner. No
special legal requirements must be met to start a sole proprietorship and usually only a limited
investment is required to begin operations.

A sole proprietorship is a separate entity for accounting purposes but it is not a separate legal entity
from the owner. That is, from the legal point of view, the owner and the business are treated as
one and the same. The owner will be held personally responsible for the debts and actions of the
business.

For instance, assume Flower Laundry is a sole proprietorship owned by Ato Alemu. Assume
also that the business has borrowed Birr 50,000 from the Commercial Bank of Ethiopia and failed
to pay its debts. In this case, if the Commercial Bank of Ethiopia can’t recover the amount it lent
from the properties of the company it can go to the extent of selling the owner’s personal
properties.

2. Partnership
A Partnership is like a sole proprietorship in most ways except that it has more than one owner. A
partnership is not a legal entity separate from the owners but an association that brings together

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the talents and resources of two or more people. The owners of a partnership are known as
partners.

The partners share the profits and losses of the partnership according to an agreed –on formula.
The personal resources of each partner can be called on to pay the obligations of the partnership.
That is, each partner is personally responsible for the debts of the partnership. From an accounting
standpoint, however, a partnership is a business entity separate from the personal activities of the
partners.

3. Corporations
A business organized as a separate legal entity with ownership divided into transferable units of
capital is called a corporation. The owners of a corporation are called stockholders or shareholders.
The corporation issues capital stock certificates to each stockholder showing the number of shares
(or stock) he or she owns. The stockholders are free to sell all or part of these shares to other
investors at any time. This ease of transfer of ownership adds to the attractiveness of investing in
a corporation. Since a corporation is a separate legal entity (an artificial person), the owners
(stockholders) are not personally liable for the debts of the corporation. Their risk of loss is limited
to the amount they paid (invested). Because of this limited liability in a corporation shareholders
are willing to invest in riskier, but potentially more profitable, activities.

Even though corporations are fewer in number than proprietorships and partnerships, they
contribute a lot to the economies of many countries in monetary terms.

Based on the types of activity engaged in (nature of business)

Three types of businesses operated for profit include service, merchandising, and manufacturing
businesses.
1. Service businesses: a business enterprise that provides service rather than products to
customers. E.g.: Ethiopian Air Lines (transportation services), The Walt Disney Company
(entertainment services).
2. Merchandising businesses: a business enterprise that sells products they purchase from other
businesses to customers. E.g.: Wal-Mart (general merchandise), Amazon.com (Internet books,
music, videos).
3. Manufacturing businesses: a business enterprise that changes basic inputs into products that
are sold to customers. E.g.: General Motors Corporation (cars, trucks, vans), Dell Inc. (personal
computers).

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Definition of accounting

As a financial information system, accounting is defined as a process of identifying, measuring,

recording and communicating economic events of an organization (business or non- business) to
interested users of the information.

Let’s take a closer look at the activities involved in the process:

1. The first part of the process – identifying – involves selecting those events that are
considered evidence of economic activity relevant to a particular organization. The sale of
goods by ABC Super Market, the rendering of service by Ethiopian Tele communications
Corporation, the payment of salary by the Commercial Bank of Ethiopia, and the purchase
of Building by Unity University College are examples of economic events.
2. Once identified and measured in Birr and cents, economic events are recorded to provide a
permanent history of the financial activities of the organization. Recording consists of
keeping a chronological diary of measured events in an orderly and systematic manner. In
recording, economic events are also classified and summarized. (This will be discussed in
detail in chapter-2)
3. This identifying and recording activity is of little use unless the information is
communicated to interested users. The information is communicated through the
preparation and distribution of accounting reports, the most common of which are called
financial statements.
A Vital element in communicating economic events is the accountant’s ability and responsibility
to analyze and interpret the reported information. Analysis involves the use of ratios, percentages,
graphs and charts to show the importance of financial trends and relationships. Interpretation
involves explaining to the user the meaning, and limitation of reported data.

As accounting plays an important role in the decision making process of business entities, it is
often called the language of business. As a result, whether you are an economist, a marketer,
investor, supplier or any other, to be successful, you should be able to “speak” and be familiar with
the basic terms used in the business environment.

Importance of accounting
The main purpose of accounting is to provide financial information to be used for decision-making.
For instance, Business executives and managers need the financial information provided by the
accounting system to help them plan and control the activities of the business. Outsiders such as
bankers, potential investors, and labor unions and others also need accounting information.

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In short the goal of the accounting system is to provide useful information to decision makers.
Thus, accounting is the connecting link between decision makers and business operations.

Book-keeping versus accounting

People often fail to understand the difference between accounting and bookkeeping. Bookkeeping
is the process of recording business activities, and keeping the records. It is the record- making
phase of accounting. The recording of transactions in Bookkeeping tends to be mechanical and
repetitive; it is only a small and probably the simplest but important part of accounting.

Accounting, on the other hand, includes the design of an information system that meets users’
needs. The major goals of accounting are the analysis, interpretation, and use of information.
Accounting includes system design, budgeting, cost analysis, auditing and tax planning and
preparation. A person might become a reasonably proficient bookkeeper in a few weeks or
months; however, to become a professional accountant requires several years of study and
experience.

Users of Accounting Information

Today’s accountants focus on the ultimate needs of those who use accounting information, whether
the users are inside or outside the business. Accounting is not an end by itself. The information
that accounting provides allows users to make “reasonable choices among alternative uses of
scarce resources in the conduct of business”

The people who use accounting information basically fall in to two categories:
1. External Users, and
2. Internal Users
1) External Users: External Users of accounting information are parties, which are not directly
involved in running the business enterprise. These include lenders, shareholders (stock
holders), suppliers, government (regulatory bodies) and others. External users rely (depend
on) accounting information to help them make better decisions in trying to achieve their goals.
- The area of accounting aimed at serving external users is called Financial Accounting. Its
main objective is to provide to external users information through financial statements.
Each external user has its own specified information-need depending up on the decisions to be
made. That is to say, all external users do not have the same intentions (objectives) when they use
the information.

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In the following paragraphs we will try to discuss how some external users use accounting
information.

a) Lenders / Creditors

Creditors lend money or other resources to an organization. Lenders include banks, mortgage and
finance companies. Lenders look for information to help them assess the ability of borrowers to
repay their debts.

b) Share- holders (Stockholders)

Shareholders have legal control over part or all of a corporation. When it comes to a corporation,
shareholders are not directly involved in the management of the corporation. However, as owners,
they have claims over the properties of the organization. Financial reports help to answer
shareholders’ questions such as:

- What is the income of the organization for the current and past periods?

- Are the properties adequate to meet business plan?

- Will the business continue to be profitable in the future?

c) Labor Unions

Labor unions are interested in judging the fairness of their wages and assessing future job
prospects. They also use accounting reports as evidence to ask for bonuses, when the organization
is successful.

d) Government

The Revenue Authority requires organizations to prepare financial reports, in order to compute
taxes.

e) Customers
They are particularly interested to evaluate whether or not their suppliers have strong financial
position. In many circumstances, customers want to acquire goods and services on credit bases.
This in turn makes them to prefer businesses with reliable financial status and those capable of
arranging credit facilities. To help them decide on picking their suppliers, customers need to be
supplied with accounting information.

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f) Regulatory agencies
They need accounting information to know whether the company is operating with prescribed rule
or not. They make regulating decisions.
2) Internal Users: These are persons that are directly involved in managing and operating an
organization. They include managers and other important decision makers. The internal role
of accounting is to provide information to help improve the efficiency and effectiveness of an
organization.
The area of accounting aimed at serving the decision-making needs of internal users is called
Management Accounting. Internal users often have access to a lot of private and valuable
information. Internal reports aim to answer questions like:

➢ What are manufacturing costs per product?

➢ Which service activities are most profitable?
➢ What level of sales is necessary to break even?

1.3 THE ROLE OF ACCOUNTING IN BUSINESS

• To identify, record and communicate the economic events of an organization to interested
users.
• To prepare financial statements such as income statement, balance sheet, owner’s equity
statement and cash flow statement.
• To prepare necessary notes and disclosures to the users about the financial position of the
organization.
• To perform the managerial functions for the organization i.e.; business and non business
activities maintaining, budgeting, standard setting, controlling and decision making.
• To analyze and interpret financial activities for next improvements.

1.4 THE PROFESSION OF ACCOUNTING

Accountants are typically engaged in either
➢ Public Accounting or
➢ Private Accounting
i) Public Accounting

In Public Accounting accountants offer expert service to the general public on a fee basis. A major
portion of public accounting practice is involved with Auditing. In this area, a certified Public

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Accountant examines the financial statements of companies and expresses opinion as to the
fairness of presentation. When presentation is fair, users consider the statements to be reliable.

Management consulting is another area of public accounting. In this case, the accountant consults
the management generally about the growth and development of the business enterprise.

ii) Private Accounting

Instead of working in public accounting, an accountant may be an employee of a business

enterprise. In private accounting, they would be involved in one of the following activities:

1. Cost Accounting: Determining the cost of producing specific products.

2. Budgeting: Assisting management in quantifying goals concerning revenues, costs of
goods sold, and operating expenses.
3. General Accounting: recording daily transactions and preparing financial statements and
related information.
4. Accounting Information Systems: designing both manual and computerized data
processing systems.
5. Tax Accounting: preparing tax returns (forms to be filled by a company and returned to a
taxing authority) and engaging in tax planning for the company.
6. Internal Auditing: reviewing a company’s operations to determine compliance with
management policies and evaluating efficiency of operations.

1.5 OVERVIEW OF INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)

History of IFRS

IFRS originated in the European Union, with the intention of making business affairs and accounts
accessible across the continent. The idea quickly spread globally, as a common language allowed
greater communication worldwide. Although most companies in the United States follow
standards issued by FASB (financial accounting standards board), referred to as generally accepted
accounting principles (GAAP).
International Accounting Standards (IASs) were issued by the IASC (International accounting
standards committee) from 1973 to 2000. The IASB replaced the IASC in 2001. Since then, the
International Accounting Standard Board(IASB) has amended some IASs and has proposed to
amend others , has replaced some IASs with new IFRSs, and has adopted or proposed certain new
IFRSs on topics for which there was no previous IAS. Through committees, both the IASC and
the IASB also have issued interpretations of standards.

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In order to ensure high quality financial reporting, accountants present financial statements in
conformity with accounting standards that are issued by standard setting bodies.
❖ IFRS: a common set of standards that indicate how to report economic events.
❖ Financial accountants follow IFRS in preparing reports. These reports allow investors and
other users to compare one company to another.
❖ IASB has the primary responsibility for developing accounting principles.
❖ The objective of IFRS is to provide financial information about the reporting entity that is
useful to interested users.
Differences between IFRS and GAAP

- GAAP tends to be more rules based, while IFRS tends to be more principles based. Under
GAAP, companies may have industry specific rules and guidelines to follow, while IFRS
has principles that require judgment and interpretation to determine how they are to be
applied in a given situation.
- The way a balance sheet is formatted is different in the US than in other countries. Under
GAAP, current assets are listed first, while a balance sheet prepared under IFRS begins
with non- current assets.
- The two standards also state different approaches to ordering categories on the balance
sheet. GAAP calls for accounts to be listed in the order of liquidity or how quickly and
easily they can be converted to cash. The items are arranged in descending order (most
liquid to least liquid); current asset, non-current assets, current liabilities, non-current
liabilities, and owner’s equity. Under IFRS, the order is reversed (least liquid to most
liquid):non-current assets, current assets, owner’s equity, non-current liabilities, and
current liabilities.
Measurement principles
IFRS generally uses one of two measurement principles, the historical cost principle or the fair
value principle. Selection of which principle to follow generally relates to trade-offs between
relevance and faithful representation.
Relevance means that financial information is capable of making a difference in a decision.
Faithful representation means that the numbers and descriptions match what really existed or
happened they are factual.
➢ Historical cost principle
The cost principle dictates that companies record assets at their cost. This is true not only
at the time the asset is purchased, but also over the time the asset is held. For example if a
company purchases land for $500,000, the company initially reports it in its accounting

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 records at $500,000. But what does the company do if, by the end of the next year, the fair
value of the land has increased to $600,000? Under the historical cost principle; it continues
to report the land at $500,000.
➢ Fair value principle
It states that assets and liabilities should be reported at fair value (the price received to sell
an asset or settle a liability). Fair value information may be more useful than historical cost
for certain types of assets and liabilities. For example certain investment securities are
reported at fair value because market value information is usually readily available for
these types of assets. In determining which measurement principle to use, companies weigh
the factual nature of cost figures versus the relevance of fair value. In general, even though
IFRS allows companies to revalue property, plant, and equipment and other long lived
assets to fair value, most companies choose to use cost. Only in situation where assets are
actively traded, such as investment securities, do companies apply the fair value principle
extensively.

Assumptions

Assumptions provide a foundation for the accounting process. Two main assumptions are the
monetary unit assumption and the economic entity assumption.
✓ Monetary unit assumption
It requires that companies include in the accounting records only transaction data that can be
expressed in money terms. This assumption enables accounting to quantify (measure) economic
events. The monetary unit assumption is vital to applying the historical cost principle.

This assumption prevents the inclusion of some relevant information in the accounting records For
example, the health of a company's owner, the quality of service, and the morale of employees are
not included. The reason: Companies cannot quantify this information in money terms. Though
this information is important, companies record only events that can be measured in money.

✓ Economic Entity Assumption

An entity is an organization or a section of an organization that stands apart as a separate economic

unit. According to this concept, any business is considered as a separate entity, distinct from the
persons who own it. In other words, business is treated as a unit or entity apart from its owner,
creditors and other business. This concept is also known as 'separate entity concept’.

Separate entity concept already exists, legally, in a joint stock company. Even in the sole proprietor
and partnership firms, this concept of 'separate entity', though does not legally exist, is presumed

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to exist for accounting treatment. The entity concept applies to any economic unit that needs to be
evaluated separately.

1.6 THE ACCOUNTING AND AUDITING BOARD OF ETHIOPIA (AABE)

The board shall be accountable to the Ministry of Finance and Economic Development (Art.3/2/
of Regulation 332/2014). According to the Article 5 of the 332/2014, the board shall have the
following objectives:

➢ Promoting high quality reporting of financial and related information by reporting entities;
➢ Promoting the highest professional standards among auditors and accountants,
➢ Promoting the quality of accounting and auditing services,
➢ Ensuring that the accounting profession is used in the public interest; and
➢ Protect the professional independence of accountants and auditors.
According to Article 4(2) of the proclamation No.847/2014, the Accounting and Auditing Board
of Ethiopia (AABE) shall have the following powers and duties to:

• Issue Standards and directives relating to financial reporting and auditing and ensure
compliance therewith;
• Conduct inquiry or investigation and impose administrative sanction in accordance with
the provisions of the proclamation where appropriate on public interest entities and public
auditors to enforce compliance with financial reporting and auditing standards; and
• Cooperate with, or become a member or an affiliate of, any international body, the
objectives or functions of which are similar to or concerned with those of Board.

1.7 THE ACCOUNTING EQUATION AND ELEMENTS OF THE EQUATION

Under GAAP, assets are resources owned by a business and provide future benefits. Under IFRS,
assets are resources controlled by a business and provide future benefits. Examples of assets
include cash, receivables, land, buildings, and equipment etc. The rights or claims to the assets are
divided into two types: (1) the rights of creditors and (2) the rights of owners. The rights of
creditors are the debts of the business and are called liabilities. The rights of the owners are called
owner's equity.

For example, XYZ has total assets of approximately $11 million. Liabilities and equity are the
rights or claims against these resources, Thus, XYZ has $11 million of claims against its $11
million of assets. Claims of those to whom the company owes money (creditors) are called
liabilities. Claims of owners are called shareholders equity. XYZ has liabilities of S6 million and
shareholders' equity of $5 million. The following equation shows the relationship among assets,
liabilities, and owner's equity:

Assets= Liabilities + Equity

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 Liabilities usually are shown before owner's equity in the accounting equation because creditors
have first rights to the assets. However, owners have residual right over the assets of an entity. It
provides the underlying framework for recording and summarizing economic events, and it
applies to all economic entities regardless of size.

The accounting equation serves as the basic foundation for the accounting systems of all
companies.

The expanded Accounting Equation is as follows:

Assets=Liabilities + Share Capital + Retained Earnings (For Corporate business)

Assets=Liabilities + Share Capital + revenue - expense - dividend (For Corporate business)

Assets =Liabilities + Owner's investment + Revenue - Expense - Owner's withdrawal (For

non-corporate business)

According to IFRS

Assets: are defined as resources controlled by an entity as a result of past events and from which
future economic benefits are expected to flow to the entity.

Liability: is a present obligation of an entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.

Equity: The ownership claim on a company's total assets is equity. It equals to total assets minus
total liabilities. Here is why: The assets of a business are claimed by either creditors or
shareholders. To find out what belongs to shareholders, we subtract creditors' claims (the
liabilities) from the total assets. The remainder is the shareholders' claim on the assets. It is often
referred to as residual equity that is, the equity "left over" after creditors’ claims are satisfied.

Equity generally consists of

(1) Share capital-ordinary and

(2) Retained earnings.

Share Capital - Ordinary:

A corporation may obtain funds by selling ordinary shares to investors. Share capital - ordinary is
the term used to describe the amounts paid in by shareholders for the ordinary shares they purchase.

Retained Earnings:

Retained earnings- is determined by three items: revenues, expenses, and dividends.

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Revenue: is the gross increase in owner's equity resulting from business activities entered into for
earning profit such as sales revenue, fees revenue, interest revenue etc

Expense: is the cost of assets consumed or services used in the process of earning revenue such
as cost of goods sold, wages expense, supplies expense, utility expense etc. It decreases owner’s
equity.

Dividends: net income represents-an increase in net assets which is then available to distribute to
shareholders. The distribution of cash or other assets to shareholders is called a dividend.
Dividends reduce retained earnings. However, dividends are not expenses. A corporation first
determines its revenue and expense and then computes net income or net loss. If it has net income,
and decides it has no better use for that income, a corporation may decide to distribute a dividend
to its owners (the shareholders).

In summary, the principal sources (increases) of equity are investments by shareholders and
revenues from business operations. In contrast, reductions (decreases) in equity result from
expenses and dividends.

1.8 BUSINESS TRANSACTIONS AND FINANCIAL STATEMENTS

Transactions (business transactions) are a business's economic events recorded by accountants.

Transactions may be external or internal. External transactions involve economic events between
the company and some outside enterprise. For example, RST Company purchases of equipment
from a supplier, payment of monthly rent to the landlord, and sale of goods to customers are
external Transactions. Internal transactions are economic events that occur entirely within one
company. The use of equipment and cleaning supplies are internal transactions for RST Company.

Companies carry on, many activities that do not represent business transactions. Examples are
hiring employees, answering the telephone, talking with customers, and placing merchandise
orders. Some of these activities may lead to business transactions: Employees will earn wages, and
suppliers will deliver ordered merchandise. The company must analyze each event to find out if it
affects the components of the accounting equation. If it does, the company will record the
transaction.

Double entry system: - This system was developed by Venetian merchants in 1494. And Lucas
Pacioli, he is known as the father of Accounting, published about double entry system. This system
says that each financial transaction affects at least two accounts.

Therefore, each transaction must have a dual effect on the accounting equation. For example, if an
asset is increased, there must be a corresponding

(1) Decrease in another asset,

(2) Increase in a specific liability, or

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(3) Increase in equity.

Illustration: Transactions Analysis

To demonstrate how to analyze transactions in terms of the accounting equation, we will review
the business activities of Softbyte.

Transaction 1: Investment by shareholders: Ray and Barbara Neal decided to start a smart
phone app development company that they incorporate as Softbyte. On September 1, 2020, they
invest $15,000 cash in the business in exchange for $15,000 of ordinary shares.

Transaction 2: Purchase of equipment for cash; Softbyte purchases computer equipment for
$7,000 cash. This transaction results in an equal increase and decrease in total assets, though the
composition of assets changes.

Transaction 3: Purchase of supplies on credit; Softbyte purchases for $1,600 from Mobile
Solutions Company headsets and other computer accessories expected to last several months.
Mobile Solutions agrees to allow Softbyte to pay this bill in October.

Transaction 4: Services performed for cash; Softbyte receives $1,200 cash from customers for
app development services it has performed.

Transaction 5: Purchase of advertising on credit: Softbyte receives a bill for $250 from
Programming News for advertising on its website but postpones payment until a later date.

Transaction 6: Services performed for cash and credit: Softbyte performs $3,500 of app
development services for customers. The company receives cash of $1,500 from customers, and it
bills the balance of $2,000 on account.

Transaction 7: Payment of expenses: Softbyte pays the following expenses in cash for
September: office rent $600, salaries and wages of employees $900, and utilities $200.

Transaction 8: Payment of accounts payable: Softbyte pays its $250 Programming News bill in
cash. The company previously (in Transaction 5) recorded the bill as an increase in Accounts
Payable and a decrease in equity.

Transaction 9: Receipt of cash on account: Softbyte receives $600 in cash from customers who
had been billed for services (in Transaction 6).

Transaction 10: Dividends: The Corporation pays a dividend of $1,300 in cash to Ray and
Barbara Neal, the shareholders of Softbyte.

Assets = Liabilities + Equity

Cash + A/R + Supplies + Equipment A/P Share Capital

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1, $15, 000 +$15,000 Issued Share
2, -$7.000 +$7.000

$8,000 $7,000 $15,000

3. +$1,600 + $1,600

$8,000 $1,600 $7,000 $1,600 $15,000

4. +$1,200 +1,200(service revenue)

$9,200 $1,600 $7,000 $1,600 $16,200

5. +$250 -$250(adv. exp)

$16,200 $1,600 $7,000 $1,850 $15,950

6. +$1,500 +$2,000 +3,500(Ser. revenue)

$10,700 $2,000 $1,600 $7,000 $1,850 $19,450

7.-$1,700 -600 rent expense

-900 sal/wage exp.

-200 utility expenses

$9,000 $2,000 $1,600 $7,000 $1,850 $17,750

8. -$250 -$250 _______________

$8,750 $2,000 $1,600 $7,000 $1,600 $17,750

9. +$600 -$600 ________ ________ _________ ______________

$9,350 $1,400 $1,600 $7,000 $1,600 $17,750

10.-$1,300 -$1,300(dividend)

$8,050 $1,400 $1,600 $7,000 $1,600 $16,450

$18,050 $18,050

Note that the dividend reduces retained earnings, which is part of equity. Dividends are not
expenses. Like shareholders' investments, dividends are excluded in determining net income. You
should note the following in the above business transaction summary:

1. The effect of every transaction is an increase or a decrease in one or more of the accounting
equation elements.

2. Both sides of the accounting equation are always equal.

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3. The owner's equity is increased by amounts invested by the owner and is decreased by
withdrawals by the owner. In addition, the owner's equity is increased by revenues and is decreased
by expenses.

Financial Statements
After transactions have been recorded and summarized, reports are prepared for users. The
accounting report providing this information is called financial statements. Companies prepare
four financial statements from the summarized accounting data:

1. Income Statement

The income statement reports the success or profitability of the company's operations over a
specific period of time. For example, Softbyte’s income statement is dated "For the Month Ended
September 30, 2020." It is prepared from the data appearing in the revenue and expense columns
of the equation. The heading of the statement identifies the company name, the type of statement,
and the time period covered by the statement. The income statement lists revenues first, followed
by expenses. Then, the statement shows net income (or net loss).When revenues exceed expenses,
net income results. When expenses exceed revenues, a net loss results.

SOFTBYTE
Income Statement

For the Month Ended September 30, 2020

Revenues;

Service revenue------------------------------------------------------------------ $ 4,700

Expenses;

Salaries and wages expense----------------------- $900

Rent expense----------------------------------------$600

Advertising expense--------------------------------$250

Utilities expense-------------------------------------$200

Total expenses-------------------------------------------------------------------- (1950)

Net income----------------------------------------------------------------------------------$2,750

2. Retained Earnings Statement

Softbyte retained earnings statement reports the changes in retained earnings for a specific period
of time. The time period is the same as that covered by the income statement ("For the Month

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ended September 30, 2020"). The information provided by this statement indicates the reasons
why earnings increased or decreased during the period. If there is a net loss, it is deducted with
dividends in the retained earnings statement.

SOFTBYTE

Retained Earnings Statement

For the Month Ended September 30, 2020
Retained earnings, September 1----------------------------------------$0

Add: Net income -------------------------------------------------2,750

Less: Dividends --------------------------------------------------1,300

Retained earnings, September 30-------------------------------------$1450

3. Statement of Financial Position (BALANCE SHEET)

Softbyte statement of financial position reports the assets, liabilities, and equity at a specific date
(September 30, 2020). Observe that the statement of financial position lists assets at the top,
followed by equity and then liabilities. Total assets must equal total equity and liabilities. Softbyte
reports only one liability, Accounts Payable, on its statement of financial position. In most cases,
there will be more than one liability such as Notes payable, Accounts payable, Salaries and wages
payable.

SOFTBYTE
Statement of Financial Position

September 30, 2020

Assets:

Equipment------------------------------------------------------------------------------ $ 7,000

Supplies------------------------------------------------------------------------------------ 1,600

Accounts receivable---------------------------------------------------------------------- 1,400

Cash------------------------------------------------------------------------------------- --- 8,050

Total asset----------------------------------------------------------------------------------------- $18,050

Equity and Liabilities:

Equity

Share capital- ordinary-------------------------------------- $15,000

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Retained earnings---------------------------------------------- 1,450

Total stockholder's equity -------------------------------------------------------------------$16,450

Liability

Account payable-------------------------------------------------------------------------------$1,600

Total equity and liabilities-------------------------------------------------------------------$18,050

4. Statement of Cash Flows

It is a summary of cash receipts and cash payments of a business entity for a specific period time.
This statement has three sections i.e. operating activities, investing activities, and financing
activities.

a. Operating activities
This section includes cash transactions that enter in to the determination of net income or net loss.

b. Investing Activities

This section includes the cash transaction for the acquisition and sale of relatively long term or
permanent type of assets.

c. Financing Activities

This section includes the cash transaction related to cash investment by the owner's and borrowing
and withdrawals by the owner.

NB: the cash balance at the beginning of the period is added to the increase (or decrease) in
cash for the period to obtain the cash balance at the end of the period.

SOFTBYTE
Statement of Cash Flows
For the Month Ended September 30, 2020

Cash flows from operating activities:

Cash receipts from revenues---------------------------------------- $3,300

Cash payments for expenses----------------------------------------- (1950)

Net cash provided by operating activities-------------------------------------------------1,350

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Cash flows from investing activities:

Purchase of equipment--------------------------------------------------------------------- (7,000)

Cash flows from financing activities:

Sale of ordinary shares -----------------------------------------------$15,000

Payment of cash dividends-------------------------------------------- (1.300)

Net cash provided by financing activities------------------------------------------------ 13,700

Net increase in cash -------------------------------------------------------------------------8,050

Cash at the beginning of the period-----------------------------------------------------------0

Cash at the end of the period---------------------------------------------------------------$8050

18