Chapter 2- Constructing Financial Statements Financial Statements: An In-depth Look A, Income Statement - Statement of Earnings 1, Components of an Income Statement: Operating Revenues — increase in assets or a decreat PL (in Gabitittes resolking from the t) ddiveny of a qood| produ of 3 pestorming wrvice & Operating Expenses ‘gecrease in assets or a inureast in UabiLities from on: goirg uations” wurved +o qunerate cevenves Other Items - - Gains or Losses = tndeen Seer OS Oo < result of ANE calf of as! 1 wt a. $0ld for $40,000 > $10,000 CO) She, Be an $0.0 sn 2. How the Components Can be Presented: (2) Formats: Single-Step Income Stmt. > Multi-Step Income Stmt. (Lamps togeter all sources of Revenues Gains, __—*Identying characteris: Gross Profi, Tes all expenses & losses) Income from Operations) Revenues Sx Interest Revenue * Revenues Sx “Gains from sale ofasers xx Cost of Goods Sold__ (x4) €ypence. ‘Total Revenues & Gains $ xx ., > Gross Profit Sx Las 2 Less Operating Exp: ‘Operating Expenses (ag Rent Expense (xx) ofassets (xx) 0 Wiae i.) . 2) insurance Exp (3x) + tncome From Operations Six EX: Co. Puys a Pool & IAG Liter renee for 48 evo our eee onntesaler s+ * oR Net Income as, co: ous ae Oo ais *bighlghts components of income sales war. SIS = coas Ls) ' exess Pret 473. _Uses of the Income Statement; analyze Profitability a, Gross Profit Ratio Ratio of gross profit to sats. Example; Sales Re¥* $175,000 Coss 125,00 Gross Pram 50,000 1 cross ProficRao: Gass Pot 850000 29.29% “THY Weed to Sales GN $175,000 porunas< tw For every $1 of sales, 29 cents is available to pases cover other expenses (other than COGS) and to earn a profit b.Profit Margin (Return on Sales)~ Ratio of Net Income to Sales. Shows profitability oF company. Example: Sales #4" $175,000 «coas) _(125,000) Gross Profit 50,000 ther Expenses 42,000) ‘NetIncome $8,000 IK Profit margin: Net Income = $8,000 = 05 or 5% Seles 2%" $175,000 For every $1 in sales, the company makes 5 cents in Net Income.Bal. Shek: SHE +s Me R. Statement of Retained Earnings or Statement of Stockholders’ Equity? Which to use? Statement of Retained Earnings — use this statement if there are (nos nges in a company’s stock during the period. BeginningRE $XX ‘fi +NetIncome XX for Yeax =Dividends__(XX)_ @ Meor EndingRE | $XX [7/31 “> Reports AM changs in PE at Statementof Stockholders’ Equity ~use this statement if there é (wed anges in @ company’s stock during the period. ot ee oo Remember: There are 2 parts an Equity vedate CS +Net Income edate PE = Dividends (xx ben 5 % Ending SHE 13) $Xx < End: CF nding 13) $XX <' nice > wmeports aU changs in HEClassified Balance Sheet - separates assets and liabilities into Seis Chora, tere) Assets: future economic benefits (resources) owned by or owed to the firm. 1 v A, Current Assets: converted into vast, sofd or used up during current period (within 12 mos.) oN cae Cosh okey i ve Lb 2. MES % marvetabwW equity securities Ke Cenort- term investments) 3. Accounts ceiver 4, Tnventory — goods etd for resale 5, Supplies 6. Prepaid Expenses * payments, made in advance for items sucn as advent) ronk, insovance, etc. = Prepaid Adverse, — prepaid Pant - prepaid Iysevanceterm) B. Non-Current Assets. > \yy> 1. Long-term Investments: inveseenenss Wn SeOeSA loonds oF et companies dink ert intends te held tor mon Ly. PPRAE 2. Plant, Property & Equipment (Fixed Assets): acquired for use in business rather than resale to customers. Relatively long useful lives. Land > aves NOT pave a United vsefol Ure 1234 64 CPM EF epindings op eoste computer po 5 fu) cath SRO : Limited U5 sue ute 3. Equiemant® ure BEE MII ere | AFHUES y Bal. sneet go degreciake + @ end Wl 5, venides $00. computer $50. = C1; oi Fiked assets PO “ree 6. Recurnlaked Degres reduces Peace Rook vole fo wok yale — (contra-asset) classi e eats 3. Intangible Assets (or Other Assets): lack physical substance, but help to generate revenue 1. Pakents © QLESIVE right 40 manufacture or seh a product z jue 2. qradermarts [Trade names: iPod, Big mac, Gare 3. Copyrights: exclusive right fo protect aucnstic mnaterial 4. Gramenise PightS? CKOWENE right to operate in i o Care ei emedwale> amount of purchase Enc paid in eLUeSs OF He market value of net assets (pssets- Wiab-) qintn a busivuss is puss2. Liabilities: debts A, Current Liabilities - requires the use of current assets to in the next 12 months. + ae ts Pouyable 1. Recouns oy. ae a cost 2. wages Poyabl a ) 3. Ynearned Revenve a debt owed to a custonuy cepaid for goods of services : mas passes) uescrightons, gift cards, season Hicleuts 4, pokes Payaele (due within 12 months) “gnort- term” B. Long-term Liabilities: debt not satisfied within next 12 months Notes RUYBHL (not Payal within (2 rons) [org> ker” 2. mortgrat PasptoU 3. Bonds Payal 3. Stockholders Equity: claims of owners against the net assets of the firm. (Assets - Liabilities = SHE) 2) iu @) Paris: net assets 1. Common Stock (Capital Stock) ~ this is Contributed Capital aa investments YY owners 2, Retained Lamings this is Earned Capital nek income over we LIFE of HL Company) 55 any dividendscrossitied ‘Balaie Sheet Assets Liabites: ye Current Assets: Current Liabilities: aK Gi 5 Accounts Payable Sx oe hee ele prea a se Imentory m Wages Payable = & Supplies i a” s Pripald Expenses x —S$Total Current Lives Sxx 000 ——Sotal Carrent Assets Sex 2000 Long-Term Deb: Long Term imestments x ‘Notes Payable Sax Fis Assets Bonds Pavable = land Se Total Long-Term Delt Sat Building ax (cet Tord LIABILITIES Sex ¥ Equipment a ‘Stockholders Equity: Rete Dare comneasseh Common Sock $m Total Fixed Assets, NOT xx BV Retained Earnings cs Patents ae Total SHE. Sax ¥ vce BE (otitis Uses & Limitations of a Balance Sheet- Use the balance sheet to analyze liquidity: Se Ligudiy ite ety of co PDO em Ss 1, Working Capital > cuvvent pscets COA) = Curvent Liaki = 2000 = \900 = $1000 2. Current Ratios CA SAL we ay ce ~ 00d Limitations of the Ralance Sheet 1. Historical Cost vs. FMV Omissions * = inter prepared Hademar¥s, qatents, ot. = stokt of economy, - work force = Uke crag. of product ’Problem: “These financial statement items are for Batra Corporation at year-end, December 31,2012: Salaries expense 820,000 Utilities expense 14,900 ‘Equipment 15,900 ‘Accounts Payable 6220 Sales Revenue 69,600 Uneamed rent revenue 1,800 Common stock 20,000 Cost of Goods Sold (COGS) 38,700 Cash oso Accounts receivable 8,780 ‘Accumulated depreciation 400 Dividends 14,000 Depreciation expense 4,000 Retained earings (lan, 1,2012) 25,200 Prepaid Expenses 1500 Required: ‘a. Prepare e multi-step income statement and a Retained Earnings Statement forthe year Batra Corp. did not issue any new stock during the year. i, Prepare a classified balance sheet at December 31, 2012.Problem: Given the following information, answer the questions below: Revenue, 2012 $ 24,000 Liabilities ~ Dee. 31, 2012 25,000 Issuance of Common Stock 4,000 Dividends, 2012 12,000 Stockholder Equity ~ Jan 1, 2012 27,000 Stockholder Equity ~Dec.31,2012 35,000 a, What are the total assets on December 31, 2012? b. What is net income for the year? c. What is total expense for 2012?D. Statement of Cash Flows Identifies the sources and uses of cash. (3) Sections: Same as our 3 Business Activities 1. Operating - inflow or outflow of cash resulting from the ‘purchase or sale of a product or service Changs in cA A CL Il. Investing — inflow or outflow of cash resulting from the sale or purchase of long-term assets, such as Plant, Property, and Equipment and Intangible Assets cranes in LT assets C lorg- term) IIL. Financing ~inflow or outflow of cash resulting from issuance or retirement of long-term debt and capital stock and payment of cash dividends Changs in LT debt & Equity, Liianiuities )Elements of an Annual Report: 1. Letter from the President, Chairman of the Board of Directors 2. Description of Products and Markets 3. Financial Section A. Management’s Report B. Financial Statements: 1. Balance Sheet 2. Statement of Earnings (Income Statement) 3. Statement of Stockholders’ Equity or Statement of Retained Earnings 4, Statement of Cash Flows C. Notes to the Financial Statements - Footnotes Footnote #1: Summary of Significant Accounting Policies D, Independent Auditor's Report ”The primary objective of financial reporting isto provide useful economic information t0 permit users of the information to make informed decisions. Should I buy/sell stock, ‘Should ITend the company money? What makes accounting information useful? Qualitative Characteristics: A. Understandability — information should be comprehensible to those who are willing to spend time to understand it. B. Relevance ~ capacity of information to make a difference in a decision C. Faithful Representation — is complete, neutral, and free from TOF serntul ree trom bias Ons with ola ies D. Comparability ~ andes 0S2%6 analyze tap ormoke Companies. nd look for similarities or differences 7 similar account methods have bun applied acrass compani¢s — 1 industry aweragy” E. Consistency ~ allows comparisons within a company from ‘one accounting period to thenext jy, | > Yy-2 > 4v.3 > once yoo Steck an accounting ethod > stick with it! FR Materiality — the dollar magnitude of the transaction makes a difference in how it is recorded. Does an error in any way affect the judgment of someone relying on the information. “ivosn con asset costs 410 or expen? Conservatism — don’t overstate assets or revenues, don’t, ‘understate liabilities or expenses, Use least optimistic estimate when two estimates OTamounts are about equally likely. eosonallTRANSACTION ANALYSIS - Using the “Aecounting Equation” Economic event are the bass for recording transactions in the accounting system. For ‘every transaction, itis essential to analyze its effect on the accounting equation. Example - Keeping the Accounting Equation in balance. ‘Owner invests $1,000 cash ‘Obtains loan from bank for $5,000. Purchased supplies for $2,000, paid cash. Received $3,000 cash from customer for 3 jobs to be performed in future, (Fee for each job is $1,000) Dividend of $500 was pai. Performed a job for a fee of $700. Customer paid in cash. Performed job for customer for a fee of $900. Customer will pay next month. 8. Paid employees wages of $1,500. 9. Completed one job for customer in #4 above. 10, Supplies on hand at the end of the month are $800. beNe nae “Assets =| Liabilities +” ] Stockholder it Aacounie Tate] Unsure] Common | Ravens Receivable | Supplies Payable | Revense | Sided | (Expense) Retsned EarTHE RECORDING PROCESS Double-Entry System: standardized method of recording increases and decreases in accounts. The Accounting Equation: A(@)L + SHE b. The Rul 1. Debits on the Jeff, Credits on the right *{ocakional terms” 2. Por each individual transaction, debit{2credits. |! c, T-Accounts: Summarizes in one place all transactions that affect an individual account. cosy ale EAE ot |e gunk Exe- pe fe al? pe | cs seeeeteeeeee vt | & *a debit Sugoes, 2a 1a oe Asset ‘Stockholder's Equity debit cosh 40,000 oe debit le 5 ot A credit < 300 mc Recording Transactions Using Debits & Credits: resets: Cash, ALL, purniture & Fixtures sepPeS, Equipmunt, Boirding, land, “Paventory mes ercod vl increase ait asse7 with a debit Decrease an asset with a credit Ex. Purchase a viding for $20,000 paying cash guildiva, T cach tS Udk® FIP, nickes Paryaiolsy vnearned @ev., woos Increase a liability with a eredit Decrease a liability with a debit EX. Porchaxt £2000 of supplicS on account suppies wie + SHE: CS, CE Increase equity with a credit Decrease equity with a debit Ex. Owner invests Slope Inte Hu co- cas os t Ex: company pays a 4600 dividend we he oeekHadirs” Caan piv. t cash DW: pividends ~~ reaver Equity Increase revenue with a credit Decrease revenue with a debit Ex: Performed a. pe for a fee of f1300, we Commer will Gay nett month ale * KWNENUE ew. + increas FaurteyEre! URUHES Exe., Punt Gre.) Woop ExP., COGS, Sugotits Exe., Peprecietion Exp. Increase an expense with a debit + 2 Decrease an expense with a credit debit credit ey of Yt $2000 in gueetiesy _5xg0eS” supplies 4500 axe on hand @ veay- ‘. 7 Nowe] somes 4 eee isomer sopplies Exe TA end. S00 equity {on Ending Balance in a T-Avcount: Endirg Balance = Total Pebits - Total ovedits of Total Credits - Total Devits e. Summarize Rules of Debits & Credits assets, Exe-) Dive _pesets, 40+) DIV Liab. SHE, Par eee + ~ peoit exedit $XX end Sho ree Vv wormnah Glance = Debit Balance Normal Balance A Normal Balance > side used fo increay 1 account PEAD = pevits incean Expengs, Assets, gs piviclends weTHE ACCOUNTING CYCLE STEP 1: RECORD GENERAL JOURNAL ENTRIES A. General Journal: a chronological listing of transactions Example: Sept.1 Owner invests $2,000 into company Sept.3 Borrows $5,000 from local bank Sept. 5 Purchase $1,000 of supplies on account Sept.7 Received $700 cash from customer for services rendered. Sept. 12 Purchased land for $3,000; paid $800 down and borrowed the balance by issuing a $2,200, one-year note. Sept.15 Paid employee wages of $500 B. To Record: V. STEP2: POST TO GENFRAT.TFDGFR (contains all individual t-accounts)