And in this video, we'll start exploring financial statements,

what they look like, and how they're interconnected.

We'll be using ASPE, Accounting Standards

for Private Enterprises, to produce our statements.

Why are financial statements necessary?

Remember that external stakeholders, mainly investors,

lenders, and other creditors, have

to make decisions about resource allocations--

where to put their money.

They use financial statements to answer questions

that they may have about a business.

From the video on business organization,

we know that corporations can be either public or private.

Public corporations must follow IFRS.

Private corporations can follow either IFRS or ASPE.

A private corporation that follows ASPE

will produce the following financial statements-- income

statement, statement if retained earnings,

balance sheet, and the statement of cash flows.

Corporations who follow IFRS, whether public or private,

must produce the following statements-- income statement,

statement of comprehensive income,

statement of changes in equity, statement

of financial position, and finally, the statement of cash

flows.

If you wish to learn more about these statements,

go to my video on IFRS financial statements.

In these videos, we'll only be covering ASPE.

Statements must be completed in a specific order

and we'll start with the income statement.

An income statement reports the results

of a businesses day-to-day operations-- the revenues,

less the expenses incurred to generate that revenue,

to obtain a profit figure called net income.

The income statement measures the business's performance

within a period of time either annually, quarterly,

or monthly.

To better understand the income statement,

we have to understand the two main elements-- revenues

and expenses.

Revenues are the income that a business earns.

There are only two ways to earn revenue.

Businesses either provide a service or a good.

The key to revenue is that it must be earned.

What does that mean?

It means that the business has done their job--

past tense.

For example, if a lawn care business

plans to mow a customer's lawn tomorrow,

it has not earned revenue today, because they have not

done their job as yet.

After they've finished mowing the customer's lawn,

they have earned their revenue.

If a retail store plans to sell a product to a customer

tomorrow, revenue is not earned because, again, the business

has not as yet done their job.

Revenues can only be recognized when the business has

finished the job, provided the service, or delivered the good.

Notice the past tense--

that's very important with regards to the element revenue.

To summarize, revenue is income earned

through the day-to-day activities of a business

when a service or good is provided.

Revenue-- earned by providing services or goods.

Expenses or the cost of the resources

that have been used, consumed, or incurred to help

generate revenue.

Expenses are best described through an example.

If you use gas in a lawnmower when you move a customer's

lawn, then the gas that was consumed during the moving

of the lawn is an expense--

a cost to earn the revenue.

Why?

Because the gas was consumed in order to help

generate service revenue.

Note that the concept of used, consumed, or incurred

is important, but so is the fact that these things must

have happened in order to earn revenue.

Costs or expenses must be matched to the revenue

they helped to generate.

Expenses-- cost of what is used, consumed, or incurred to help

generate revenue.

Now that you understand the elements

that make up the income statement,

let's look at the format.

The format of an income statement is important.

Note that the heading must always

include the company name, the title

of the financial statement, and the time period covered.

Then revenues are listed first.

If there are multiple revenues, you

must list each different type of revenue

individually, and then show a subtotal called total revenues.

Is there a correct order for revenues?

Generally, they're placed in the order of magnitude-- meaning

from the highest amount to the lowest.

Why?

Because remember the purpose of financial reporting--

provide information for external users

to make resource allocation decisions.

Therefore, highlighting the larger sources of revenue

first help to make the information more understandable

and increases clarity.

Expenses are listed next with the heading called

operating expenses.

The order of expenses, similar to revenues,

are from the largest to the smallest.

After listing all the expenses, this statement

provides a total of all the expenses,

excluding income tax expense.

Next is the subtotal-- income before income tax expense

calculated as total revenue minus total expenses.

Then, income tax expense is a separate expense item

before listing a final net income amount.

Often, textbooks show income tax expense in the same listing

as operating expenses.

However, this is incorrect.

Operating expenses are the costs of operating the business

and are controllable, for the most part, by the business.

Income tax expense is prescribed by this CRA--

Canada Revenue Agency-- and is not at all controllable.

As a consequence, income tax expense

must be listed separately.

What happens if expenses are greater than revenues?

Then a net loss amount is provided that the bottom

of the income statement.

The statement we have developed here

is called the single step income statement.

We'll be covering a multiple step income

statement in a future video.

Remember to pause the video to determine

your answer to this check your understanding

question about the uses of the income statement.

Investors are interested in a business's past performance

because it helps them.

The answer is not A--

determining the amount of debt a business currently

has is answered by reviewing the balance sheet.

The answer is not B either--

as the current value of a businesses property, plant,

and equipment is not available on any financial statement

that is produced under ASPE.

The answer is not D either.

Determining if a business is profitable enough

to repay its debt is what lenders and creditors

will use the income statement for, not investors.

The correct answer is C as investors

are interested in determining the future profitability

of the business.

Why is this?

Because it will help investors determine

if they will get the return on their investment

that they want in the future.

Investors also use the income statement

to determine if the business will be in a position

to pay dividends.

Lenders use the income statement to help them determine

if they want to fund a business with loans

and if the business will be in a position to repay the loan

plus interest in the future.

Other creditors use this statement

to figure out if the business will be profitable enough

to repay their debts as they come due.

The long-term survival of any business

depends on its ability to produce revenues that are

greater than their expenses.

Profit allows a business to fund their financing activities

by paying dividends to shareholders and interest

to lenders.

It also allows the business to pay for investing activities,

like buying new equipment.

Investors and creditors base their decisions

on their beliefs about a business's future performance.

Income statements, which show past performance,

give stakeholders information to help them make predictions

about future profitability.

The income statement is a statement

that is connected to two other financial statements.

The net income or net loss from the income statement

is used in both the statement of retained earnings

and the statement of cash flows under the indirect method.

Since the net income from the income statement

is used in other statements, it's

always the first financial statement completed.

The next statement produced is the statement

of retained earnings.

We'll be covering that statement in our next video.