Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 2 Basic Accounting Concepts 59

Transactions (b) and (c) have not improved the stockholders’ equity of Family Health

Care. They have simply changed the mix of assets and increased the liability, notes

payable. However, the objective of businesses is to improve stockholders’ equity

through operations.

Transaction d. During the first month of operations, Family Health Care earns pa-

tient fees of $5,500, receiving the amount in cash. The effect of this transaction is an in-

flow of cash flows from operating activities of $5,500. Thus, a positive $5,500 is entered

in the statement of cash flows column as an operating activity. Since cash has been

received, cash is increased by $5,500 under the balance sheet column for assets.

Fees earned of $5,500 is a revenue item that is entered in the income statement col-

umn as a positive amount. Since net income retained in the business increases stock-

holders’ equity (retained earnings) and since revenues contribute to net income,

$5,500 is also entered as an increase in retained earnings in the stockholders’ equity

column of the balance sheet. Entering the increases of $5,500 for cash and retained

earnings in the balance sheet columns retains the equality of the accounting equation.

The effect of this transaction on Family Health Care’s financial statements is summa-

rized below:

Balance Sheet

Assets  Liabilities  Stockholders’ Equity

Notes Capital Retained

Cash  Land  Payable  Stock  Earnings

4,000 12,000 10,000 6,000

5,500 5,500

9,500 12,000 10,000 6,000 5,500

Statement of Cash Flows

d. Operating 5,500

Statement of

Cash Flows

Income

Statement

d.

Income Statement

d. 5,500 Fees earned

Balances

d. Fees earned

Balances

Transaction e. For Family Health Care, the expenses paid during the month were

as follows: wages, $1,125; rent, $950; utilities, $450; interest, $100; and miscellaneous,

$275. Miscellaneous expenses include small amounts paid for such items as postage

due and newspaper and magazine purchases.

The effect of this transaction is an outflow of cash of $2,900 for operating activi-

ties. Thus, a negative $2,900 is entered in the statement of cash flows column as an op-

erating activity. Expenses have the opposite effect as revenues on net income and

retained earnings. As a result, each of the expenses is listed as a negative amount in

the income statement column. Finally, a negative $2,900 is also entered in the cash and

retained earnings columns of the balance sheet. The effect of this transaction on Family

Health Care’s financial statements is summarized on the next page.

Transaction f. At the end of the month, Family Health Care pays $1,500 to stock-

holders (Dr. Lee Landry) as dividends. Dividends are distributions of business earn-

ings to stockholders.