Maryanne M. Rouse
University of South Florida
Financial statements serve as both milestones and signposts. As milestones, financial statements help the reader assess the past financial performance and current financial condition of a proprietorship, partnership, or corporation. As signposts, financial statements provide information about the past and present that is useful in predicting future financial performance and condition.
The three most frequently encountered and most widely used financial statements are the Balance Sheet, the Income Statement, and the Statement of Cash Flows. These three general-purpose financial statements are intended to provide information to shareholders, creditors, and other stakeholders about the financial position, operating results, and investing/financing activities of an organization.
Financial statements reflect only past transactions and events. A transaction typically involves an exchange of resources between the business and other parties. Purchase of goods held for resale, either on open account or for cash, is an example of a transaction.
BASES OF ACCOUNTING
Although there are hybrid systems that combine elements of both, the two most widely used bases of accounting are the cash basis and the accrual basis.
Cash Basis. Under the cash basis of accounting, revenue is recognized when cash is received and expenses are recognized when cash is disbursed. Many small businesses and most individuals use the cash basis of accounting when preparing financial statements and tax returns. A key reason for its popularity is that it is simple: any cash coming in is treated as revenue while any cash going out is treated as expense. The cash basis also allows individuals to shift (legally!) receipts and payments from one period to another to reduce taxable income. Because the timing of receipts and disbursements will influence reported profit (or taxable income), the... [continues]
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