LESSON Preparing an Income Statement. CENTURY 21 ACCOUNTING Thomson/South-Western
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1 Preparing an Income Statement
2 2 Uses of Financial Statements Financial statements provide the source of information needed by owners and managers to make decisions on the future activity of a business The financial statements should provide: information about a business's financial condition changes in this financial condition the progress of operations (CONCEPT: Adequate Disclosure) Comparing financial condition and progress for more than one fiscal period also helps owners and managers make sound business decisions Financial information must be reported the same way from one fiscal period to the next. (CONCEPT: Consistent Reporting)
3 3 Uses of Financial Statements Hobby Shack prepares three (3) financial statements to report financial progress and condition: Income Statement Balance Sheet Statement of Stockholder s Equity
4 4 Income Statement An Income Statement is used to report a business s financial progress Merchandising businesses report: Revenue Cost of Merchandise Sold Gross Profit on Sales Expenses Net Income or Net Loss Current and previous income statements can be compared to determine the reasons for increases or decreases in net income This comparison is helpful in making management decisions about future operations
5 5 Income Statement Information from a completed work sheet is used to prepare an income statement Amounts in all revenue and expense accounts and Merchandising Inventory are reported on an income statement The income statement of a merchandising business has three (3) main sections: 1. Revenue 2. Cost of Merchandise Sold 3. Expenses
6 INCOME STATEMENT INFORMATION ON A WORK SHEET page 448 6
7 REVENUE SECTION OF AN INCOME STATEMENT FOR A MERCHANDISING BUSINESS 7 page Heading 6. Contra account amounts 2. Revenue section 7. Contra account total 3. Title of revenue account (Sales) 8. Net Sales 4. Sales amount 9. Net sales amount 5. Less contra accounts (Sales Discount & Sales Ret. and Allow)
8 COST OF MERCHANDISE SOLD SECTION OF AN INCOME STATEMENT FOR A MERCHANDISING BUSINESS 8 page Cost of Merchandise Sold section Beginning inventory (Trial Balance) 3. Purchases section 4. Total cost of merchandise available for sale Ending inventory (Balance Sheet) 6. Cost of merchandise sold
9 COMPLETING AN INCOME STATEMENT FOR A MERCHANDISING BUSINESS 9 page Gross Profit on Sales (Net Sales - Cost of Merchandise Sold) 2. Expenses section 3. Net Income before Federal Income Tax (Gross Profit on Sales Expenses) 2 4. Less Federal Income Tax Expense (Income Statement) 5. Net Income after Federal Income Tax Double lines 6 7. Component percentage (divided by Net Sales)
10 LESSON 15-2 Analyzing an Income Statement
11 11 Using Component Percentages A percentage relationship between one financial statement item and the total that includes that item is known as a component percentage Every sales dollar reported on the income statement includes four components: 1. Cost of Merchandise Sold 2. Gross Profit on Sales 3. Total Expenses 4. Net Income before income tax To help make decisions about future operations, Hobby Shack analyzes relationships between these four income statement components and sales, which is shown in a separate column on the income statement
12 ANALYZING AN INCOME STATEMENT SHOWING A NET LOSS page
13 13 Acceptable Component Percentages For a component percentage to be useful, a business must know acceptable percentages This information is determined by making comparisons with prior fiscal periods as well as with industry standards published by industry organizations Based on these sources, Hobby Shack determines acceptable component percentages for the current fiscal period Each percentage represents the amount of each sales dollar that is considered acceptable Unacceptable component percentages serve as a warning that management action is necessary
14 14 Acceptable Component Percentages (pg. 455) Acceptable Industry Standards Hobby Shack Component Percentages Sales 100% 100% Cost of Merchandise Sold Not more than 46.0% 44.9% Gross Profit on Sales Not less than 54.0% 55.1% Total Expenses Nor more than 35.0% 33.9% Net Income before Federal Income Tax Not less than 19.0% 21.2% For example: Hobby Shack determines that the cost of merchandise sold should be no more than 46.0%, or 46 cents of each sales dollar.
15 15 Analysis of Component Percentages Cost of Merchandise Sold Is a major cost and must be kept as low as possible Gross Profit on Sales Gross profit must be large enough to cover total expenses and the desired amount of net income Total Expenses Must be less than gross profit on sales to provide a desirable net income Net Income before Federal Income Tax Shows the progress being made by a business
16 Analyzing an Income Statement Showing a Net Loss 16 When a business s expenses are greater that the gross profit on sales, the difference is know as a net loss An amount written in parentheses on a financial statement indicates a negative number Actions to Correct Unacceptable Component Percentages: Increase sales revenue Decrease cost of merchandise sold Increase sales revenue and also decrease cost of merchandise sold Reduce expenses
17 17 Financial Ratios Individual amounts reported on an income statement have little meaning without being compared to another amount Comparisons between other financial items can provide valuable information about the financial performance of a business A comparison between two items of financial information is called a financial ratio Earnings per Share: the amount of net income after federal income tax belonging to a single share of stock Dividing Net Income after Federal Income taxes by the number of shares outstanding Price-Earnings Ratio: the relationship between the market value per share and earnings per share of a stock (P-E Ratio) Market price per share divided by the earnings per share as determined by the stock market
18 18 FINANCIAL RATIOS page 459 Earnings per Share Net Income after Federal Income Tax Number of Shares Outstanding = Earnings per Share $80, ,500 = $32.13 Price-Earnings Ratio Market Price per Share Earnings per Share = Price-Earnings Ratio $ $32.13 = 10.7
19 LESSON 15-3 Preparing a Statement of Stockholder s Equity
20 20 TERMS REVIEW page 463 statement of stockholders equity a financial statement that shows changes in a corporation s ownership for a fiscal period par value a value assigned to a share of stock and printed on the stock certificate
21 21 CAPITAL STOCK SECTION OF THE STATEMENT OF STOCKHOLDERS EQUITY page Heading 2. Capital Stock and Par Value 3. Stock at the beginning of the year (2,000 shares x $50) 4. Stock issued during the year (500 shares x $50) 5. Total stock issued at the end of the year
22 RETAINED EARNINGS SECTION OF THE STATEMENT OF STOCKHOLDERS EQUITY 22 page Retained Earnings 2. Beginning balance (Balance Sheet credit col.) 3. Net income after federal income tax (Income Statement debit col.) Dividends declared (Balance Sheet debit col.) 5. Increase in retained earnings 6. Ending balance 7. Total stockholders equity 7
23 LESSON 15-4 Preparing a Balance Sheet
24 24 TERMS REVIEW page 471 current liabilities liabilities due within a short time, usually within a year long-term liabilities liabilities owed for more than a year supporting schedule a report prepared to give details about an item on a principle financial statement
25 BALANCE SHEET INFORMATION ON A WORK SHEET page
26 BALANCE SHEET INFORMATION ON A WORK SHEET 26 The information used to prepare a balance sheet is obtained from two sources: (1) the Balance Sheet columns of a work sheet (2) the owner s equity statement The difference between an asset s account balance and its related contra account balance is known as book value An asset s book value is reported on a balance sheet by listing three amounts: (1) the balance of the asset account (2) the balance of the asset s contra account (3) the book value
27 CURRENT ASSETS SECTION OF A BALANCE SHEET 27 page Heading 3. Book value of 4. Asset accounts 2. Begin assets section accounts receivable 5. Current assets
28 PLANT ASSETS SECTION OF A BALANCE SHEET 28 page Write the heading Plant Assets. 2. Calculate the book value of office equipment Use the same procedure to calculate the book value of store equipment. 4. Calculate total plant assets. 5. Calculate total assets.
29 LIABILITIES SECTION OF A BALANCE SHEET 29 page Heading 2. Account title and amount of each current liability 3. Total liabilities 2 3
30 STOCKHOLDERS EQUITY SECTION OF A BALANCE SHEET 30 page Stockholders Equity 2. Capital stock 3. Retained earnings 4. Total stockholders equity 5. Total liabilities and stockholders equity 6. Double rules 6
31 31 COMPLETED BALANCE SHEET page 469 (continued on next slide)
32 32 COMPLETED BALANCE SHEET page 469 (continued from previous slide)
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