Accounting Fundamentals II: Lesson 9 Page 1 of 9

Accounting Fundamentals II: Lesson 9 (printer-friendly version)

Your Instructor: Charlene Messier

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Chapter 1

Introduction

Now that you've completed the worksheet in Lesson 8, you are well on your way to finishing the end-of-
fiscal-period work for Teammates, Inc.

The worksheet is used to prepare all of the financial reports required at the end of the year. The financial
reports prepared at the end of the fiscal period show not only the progress and condition of the
business, but also the changes in the owners' equity due to the activities of the business throughout the
year.

In this lesson, you will prepare an Income Statement, which shows the financial progress of the
corporation during the fiscal period.

Percentages of net sales are calculated for Sales, Gross Profit on Sales, Cost of Merchandise Sold,
Operating Expenses, Income from Operations, Other Expenses, and Net Income. The Board of
Directors of the corporation will use these figures and percentages to make important decisions
regarding the continued success and possible expansion of the corporation.

Businesses look for certain percentages to guide them in the success of the
business, and we will discuss these acceptable percentages as they
appear in the Income Statement Report.

You will also prepare a Statement of Stockholders' Equity report, which

shows the changes in Teammates, Inc. stockholders' equity, or net worth,
for the fiscal period.

Last, you will prepare a Balance Sheet, which is a report that shows the
balances in the Asset, Liability, and Stockholders' Equity accounts on
December 31. This report shows the condition of Teammates, Inc. on a
specific date, while the Income Statement shows the progress of the business from January 1 through
December 31.

Before we get started, let's spend some time learning the meaning of some common terms that will be
used in this lesson.

z Income Statement: A financial report that shows the progress of a business during a fiscal
period.

z Net purchases: The difference between purchases, purchases discounts, and purchases returns
and allowances.

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z Net sales: The difference between sales, sales discounts, and sales returns and allowances.

z Statement of Stockholders' Equity: A financial report that shows the changes in a corporation's
ownership for a fiscal period.

z Book value of assets: The difference between an asset's account balance and its related contra
account balance, such as Store Equipment and Depreciation Expense-Store Equipment.

z Long-term liabilities: Liabilities owed for more than one year.

z Short-term liabilities: Liabilities owed for one year or less.

z Working capital: The difference between total current assets and total current liabilities.

z Balance Sheet: A report that shows the value of assets, liabilities, and stockholders' equity on a
specific date.

z Component percentage: The percentage relationship between one financial statement and
another.

Okay, we've got a lot of work to do, so let's get going on some of these reports. You will need to print a
copy of the Income Statement form, the Statement of Stockholders' Equity form, and the Balance Sheet
form located in the Supplementary Material.

Chapter 2

The Income Statement

An Income Statement reports the financial progress of a business

from one date to another, from the beginning of the fiscal period to
the end. Teammates, Inc. prepares an Income Statement at the end
of its fiscal period, which is December 31.

All of the information you need to prepare the Income Statement

report is right there in the worksheet that you completed in the
previous lesson. Please be sure that you have a copy of that
worksheet readily available for easy reference as you complete the
reports in this lesson.

There is a sample Income Statement for Handy's Inc. in the

Supplementary Material section. This is the corporation that we used
as an example for the worksheet in Lesson 8. I suggest that you print
a copy to view as you complete Teammates' Income Statement for the year.

1. Notice that there is a three-line heading space at the top of the page. All financial reports have
this three-line heading space. On the first line, enter the corporation's name, Teammates, Inc. On
the second line, put the name of the report that you are preparing—in this case, Income
Statement. On the third line, enter the date, December 31, preceded by the words For the Year
Ended. By using these words, you are showing that the report covers the entire fiscal period and
not a single date.

Look at the headings and subheadings on the Income Statement example for Handy's Inc. The
main headings begin tight to the left margin, and the subheadings are indented slightly from the
left margin. The headings do not have figures on their lines, while the subheadings do.

2. On the first line, write Operating Revenue. On the next line, write Sales. Take the amount of

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Sales from column 6 of the worksheet and enter it into column 3 of the Income Statement.

3. On the next line, write Less: Sales Discount. Take the amount in the Sales Discount account from
column 5 of the worksheet and enter it into column 2 of the Income Statement.

4. Under that, write Sales Returns and Allowances. Take the amount in that account from column 5
of the worksheet and enter it into column 2 of the Income Statement.

5. Add these two amounts together and enter the sum into column 3 of the Income Statement on
the same line.

6. On the next available line, enter Net Sales. To calculate the Net Sales, take the total of Sales
Discount and Sales Returns and Allowances that you just entered in column 3 of the Income
Statement and subtract it from the Sales figure, which is two lines above it in column 3. Enter this
difference in column 4.

7. Write the heading Cost of Merchandise Sold on the next line. Below that, write the subheading
Merchandise Inventory, January 1. This is the Merchandise Inventory figure from column 1 in the
worksheet. Enter this amount into column 3 of the Income Statement.

8. Below that, write Purchases. Take the amount from column 5 of the worksheet and enter it into
column 2 of the Income Statement.

9. Next, write Less: Purchases Discount. Enter that amount from worksheet column 6 to Income
Statement column 1.

10. Then, write Purchases Returns and Allowances and enter that amount from worksheet column 6
to Income Statement column 1. Add these two amounts together and enter their sum on the same
line in column 2 of the Income Statement.

11. On the next line, write Net Purchases. Take the amount you just figured in column 2 and subtract
it from the Purchases balances in column 2, two lines above. Enter this difference in column 3.

Starting to get the hang of it?

12. On the next line, write Total Cost of Merchandise Available For Sale. Take the amount from
Merchandise Inventory, January 1 (column 3, five lines above), and add it to the sum you just
entered one line above. Enter the total in column 3. This total gives you the wholesale price of the
total merchandise that was available for sale to customers for the year.

13. On the next line, write Less: Merchandise Inventory, December 31. Enter the amount from
Merchandise Inventory, worksheet column 7, into column 3 of the Income Statement.

14. Below that, write Cost of Merchandise Sold. Figure the difference between the Total Cost of
Merchandise Available for Sale (column 3, two lines above) and Merchandise Inventory,
December 31 (column 3, one line above). Enter the difference in column 4. This number
represents the wholesale amount that Teammates, Inc. paid for the merchandise that it actually
sold to customers.

15. On the next line, write Gross Profit on Operations. Notice that you now have two figures in
column 4: Net Sales and Cost of Merchandise Sold. Figure the difference between those two
numbers and enter the difference into column 4. This is the gross profit that the corporation made
before deducting expenses and adding a few other miscellaneous income items.

16. On the next line, enter the heading Operating Expenses. Below that, take all of the expenses and
their balances from the worksheet column 5, beginning with Advertising Expense and continuing
through Utilities Expense. Enter all of these numbers into column 3 of the Income Statement.

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17. On the line below the last expense, write Total Operating Expenses. Add up all of the expenses
that appear in column 3 and enter the total in column 4.

18. Below that, write Income from Operations. Now subtract that Total Operating Expenses amount
(column 4) from the Gross Profit on Operations amount from 15 lines above, also in column 4.
The difference is the Income from Operations amount.

19. On the next line, write the heading Other Revenue, and below that write the subheading Gain on
Plant Assets. Find the amount in that account in worksheet column 6. Enter it into column 2 on
the Income Statement.

20. Below that, write Interest Income. Find that amount in worksheet column 6 and enter it into
Income Statement column 2.

21. On the next line, write Total Other Revenue. Figure the total of the Gain on Plant Assets and
Interest Income accounts (one and two lines above in column 2). Enter the total in column 3.

22. Now, on the next line, write the heading Other Expenses, and below it write Cash Short and Over.
Find the amount for this account in worksheet column 5, and enter it into column 2 of the Income
Statement.

23. Then write Interest Expense on the next line. Find the amount for this account in worksheet
column 5, and enter it into column 2 of the Income Statement.

24. On the next line, write Loss on Plant Assets. Take the balance in that account from worksheet
column 5 and enter it into column 2 of the Income Statement.

25. Below that, write Total Other Expenses. Add those last three column 2 numbers together and
enter their sum into column 3.

Almost done!

26. On the next line, write the subheading Net Deduction. Figure the difference between the Total
Other Revenue amount (six lines above in column 3) and the Total Other Expenses amount (one
line above in column 3). Enter the difference in column 4.

27. Okay, now on the line below, write Net Income before Federal Income Tax. Subtract the Net
Deductions figure (one line above in column 4) from the Income From Operations figure (11 lines
above in column 4). Enter that difference in column 4.

28. Below that, write the subheading Less: Federal Income Tax Expense. Find the amount from that
account, worksheet column 5, and enter it into Income Statement column 4.

29. Last, but certainly not least, go to the next line and write Net Income After Federal Income Tax.
Figure the difference between the Net Income Before Federal Income Tax (two lines above) and
the Federal Income Tax Expense (one line above). Enter the difference into column 4 also.

Whew! There's the final net income for Teammates, Inc. for the year. This number should be the same
net income figure that appears on the worksheet: $105,741.33.

The Income Statement is now complete except for figuring the component percentages for each number
in column 4. To determine these percentages, divide each number by the number that appears in Sales
column 4. The component percentage for Sales will be 100%. Carry out the divisions to two places past
the decimal point and round to the nearest tenth of a percent (one place after the decimal point).

Note that the percentages for the Cost of Merchandise Sold and the Gross Profit on Operations will add
back up to 100%. Each component percentage shows how much of each dollar was applied to each

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separate category. For example, if the component for expenses is 21%, that means that, for each $1.00
in sales, $ .21 went toward expenses.

There are some commonly acceptable component percentages that businesses look for on the Income
Statement to determine if the business is operating successfully. They are:

Income Statement Item Acceptable Component Percentage

Net Sales 100%
Cost of Merchandise Sold Not more than 71.0%
Gross Profit on Operations Not less than 29.0%
Total Operating Expenses Not more than 22.4%
Income from Operations Not less than 6.6%
Net Deductions Not more than 0.1%
Net Income before Federal Not less than 6.5%
Income Tax

You'll notice that some of Teammates' component percentages are off by a little. The Cost of
Merchandise Sold is .3% high, and the Gross Profit on Operations is .3% low. However, the Net Income
before Federal Income Tax is .7% high. Although these differences are minimal, they should be
addressed so that they don't continue to decrease.

There are various reasons why the Cost of Merchandise Sold and the Gross Profit on Operations might
be out of line with acceptable component percentages. A fairly young business likely needs to make
adjustments during its first few years of operation to meet or exceed these minimum component
percentages.

Perhaps Teammates, Inc. needs to negotiate with its vendors for a slightly better wholesale price for
their merchandise. Or, if they aren't already taking advantage of all purchase discounts, they should
probably begin doing so. In addition, they might want to look at the percentage of markup on their
merchandise. A very small increase in their prices could easily make up for the difference of .3%.

This is the very reason why these financial reports are so valuable to businesses. A few percentage
points here and there can add up over a period of time and could make the difference between the
success or failure of a business. By looking carefully at the Income Statement, a business can make the
necessary adjustments to become even more profitable.

Chapter 3

Statement of Stockholders' Equity

You are now ready to prepare a Statement of Stockholders' Equity

for Teammates, Inc. for the year. Once again, there is an example
of this report for Handy's Inc. in the Supplementary Material section.
You might want to print a copy of this example to view as you
complete the report for Teammates.

Fill in the three-line heading with the following information. On line

1, put the corporation's name, Teammates, Inc. On line 2, write
Statement of Stockholders' Equity, which is the name of the
financial report that you will prepare. On the third line of the
heading, write For the Year Ended December 31.

This report also has headings that begin tight at the left margin, and

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subheadings that are slightly indented. The first heading is Capital Stock. On the line below that
heading, write $100.00 Per Share, slightly indented.

On the next line, write January 1 — 1,500 Shares Issued. Find the amount in the Capital Stock account
from the Worksheet, column 2 ($150,000.00), and enter it into column 2 of the Statement of
Stockholders' Equity report.

Below that, write Issued During Current Year — None, and enter 0 under the Capital Stock figure in
column 2. On the next line, write Balance, December 31 — 1,500 Shares Issued, and enter $150,000.00
in column 3.

The next heading is Retained Earnings, so enter that on the next available line. Below that, write the
subheading Balance, January 1, and enter the amount of Retained Earnings from worksheet column 2
into column 2 of the Statement of Stockholders' Equity report.

Next, write Net Income After Federal Income Tax for the Year. This is the amount on the last line of the
Income Statement that we completed in the previous chapter. Enter that number into column 1 of the
Statement of Stockholders' Equity report.

Below that, write Less Dividends Declared During the Year, and enter the amount in column 1 of the
Dividends account on the worksheet ($90,000.00).

On the next line of the report, write Net Increase During the Year, and enter the difference between the
Net Income and the Dividends figures in column 2. On the line below that, enter Balance — December
31 and enter this amount in column 3.

Last, write Total Stockholders' Equity — December 31 and enter the sum of the Capital Stock and the
balance in Retained Earnings in column 3. This is the total stockholders' equity in Teammates, Inc. as of
December 31. Double rule all three columns to show that the report is complete and correct.

Chapter 4

Balance Sheet

You are now ready to complete the Balance Sheet for

Teammates, Inc. at the end of the year. This report shows the
balances in assets, liabilities, and stockholders' equity at the
end of the fiscal period.

With the exception of the Total Stockholders' Equity figure, all

of the amounts you'll need for this report are in columns 7 and
8 of the worksheet, which are the Balance Sheet columns.

Let's begin! You'll find a copy of the Balance Sheet for

Handy's in the Supplementary Material if you would like to
print a copy for reference.

Once again, fill in the three-line heading on the Balance Sheet

report form. Write Teammates, Inc. on line 1, Balance Sheet
on line 2, and December 31 on line three. You won't write For the Year Ended this time because a
Balance Sheet shows the condition of the business on a specific date rather than its progression over
the year.

On the first line, center the word Assets in the first column. Below that, write Current Assets at the left
margin.

On the next line, write Cash and enter its worksheet balance into column 2. List the next three current

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assets showing on Teammates, Inc.'s worksheet (Petty Cash, Notes Receivable, and Interest
Receivable), then enter their worksheet balances in Balance Sheet column 2.

Below that line, write Accounts Receivable and list the worksheet balance for that account in Balance
Sheet column 1. On the next line, write Less: Allowance for Uncollectible Accounts, and enter that
amount in column 1.

Find the difference between the Accounts Receivable amount and the Allowance for Uncollectible
Accounts amount and enter that difference on the same line in column 2.

Next, write Merchandise Inventory and the worksheet balance for that account. Remember, all of these
amounts should come from the Balance Sheet columns (7 and 8) of the worksheet. Continue listing the
assets with Supplies and Prepaid Insurance, entering their amounts in column 2.

On the next line, write Total Current Assets and figure the total for all of the amounts in column 2, from
Cash to Prepaid Insurance. Put the total in column 3.

Below that, write Plant Assets at the left margin and put Office Equipment on the next line. Then enter
the worksheet amount for that account in column 1. Then, write Less: Accumulated Depreciation—Office
Equipment and enter the amount of office equipment depreciation in column 1. Figure the difference
between these two accounts and enter it on the same line in column 2.

Now do the same for the Store Equipment account, listing its balance first, then writing Less:
Accumulated Depreciation—Store Equipment and entering that amount. Again, figure the difference and
enter it in column 2 on the same line.

Now, write Total Plant Assets on the next line. Add the two amounts in column 2 for Store and Office
Equipment and put the sum in column 3. Add this figure to the Total Current Assets figure above. Write
Total Assets on the next line and the sum in column 3.

Center Liabilities on the next line. Below that, enter the heading Current Liabilities at the left margin. List
all of the current liabilities showing in column 8 of the worksheet, beginning with Notes Payable and
continuing down through Dividends Payable. Enter these account balances in column 2 of the Balance
Sheet.

On the next available line, write Total Liabilities at the margin and enter the total of all of the liabilities in
column 3.

Now, center Stockholders' Equity on the next line. Below that, write Capital Stock and enter the
worksheet amount for that account in column 2.

After that, write Retained Earnings and enter the amount of Retained Earnings that you just calculated in
the Stockholders' Equity report. Do not use the balance in the Retained Earnings account from the
worksheet. You need to use the newly figured and updated Retained Earnings balance as of December
31.

On the next line, write Total Stockholders' Equity and add the Capital Stock and the Retained Earnings
balances together, putting the total in column 3.

Finally, on the next line, write Total Liabilities and Stockholders' Equity, and add the Total Liabilities in
column 3 and the Total Stockholders' Equity in column 3. This total should equal the amount you
entered for Total Assets above. If it is, double rule all three columns to show that the assets = liabilities +
stockholders' equity, and everything is in balance.

Whew! That's it for the end-of-fiscal-period financial reports, except for one more after the adjusting and
closing entries are entered in the General Ledger, which we'll do in the next lesson.

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Chapter 5

Conclusion

You have learned a great deal of information in this lesson—all very

important to any business. The Income Statement is used to make
vital financial decisions that could increase the profitability of the
business.

The Stockholders' Equity Statement is important to show the steady

increase of equity in the business, and the Balance Sheet shows the
current balances in the General Ledger.

Although it takes a fair amount of time to complete these reports,

they're all necessary to the overall well-being of the business as it
enters a new fiscal period.

You should now be able to see the general overall picture of double-
entry accounting and how it all comes together at the end of a fiscal
period.

A company has to maintain accurate, complete records at all times in order to get a true picture of how
the business is progressing. Some companies require that these financial reports be done more
frequently than once a year, especially new businesses that want to know the status of the business
during the first year or two.

As usual, when you feel ready, please take the Lesson 9 Quiz. Good luck!

Supplementary Material

Handy's Hardware Examples

/crs/pix/af2/L09-Hardware_Forms.pdf
The forms you'll be creating for Teammates, Inc. in this lesson can
be pretty complicated. To help you understand where everything
goes and why, take a look at these example we created for a
different company. You can print them out and keep them handy as
you go through the Teammates year-end forms.

Teammates Forms
/crs/pix/af2/L09-Teammates_Forms.pdf
Here are the year-end report forms that you'll need to print out for
this lesson's work: the Income Statement, the Statement of
Stockholders' Equity, and the Balance Sheet.

Lesson 9 Solutions
/crs/pix/af2/L09-Solutions.pdf
All finished? Click here to check your work against this lesson's
solution forms. You can either print them or check the amounts
online. Unfortunately, some of the wider forms can only appear
sideways, so printing may be your better option. If you don't mind
tilting your head, you'll be able to see what you need to see on the
screen while saving some printer ink and paper! Note: Only those
forms and accounts with new entries in them will appear in each
lesson's solutions. If you're curious about a transaction in a
previous lesson, you'll have to go back to that lesson's Solution
link.

Financial Report Descriptions

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http://www.mapnp.org/library/finance/fp_fnce/fp_basic.htm
This link provides brief explanations of various financial reports
pertaining to for-profit businesses.

FAQs

Q: How do you figure the component percentages on the Income Statement?

A: By dividing the category total by the net sales figure and rounding to nearest tenth of a
percent. For example, to find the component percentage for expenses, divide the total
expense figure by the net sales figure, then round the answer to the nearest tenth of a
percent.

Q: What does cost of merchandise sold mean?

A: It's the wholesale price of the merchandise that the corporation actually sold during the
fiscal period.

Q: Why are component percentages important to a corporation?

A: Component percentages are important to the board of directors of a corporation

because board members use these figures to determine the well-being of the corporation.
They also use these numbers to determine expansion plans, overhead costs, and
dividends to be paid to the stockholders.

Q: What is the difference between current assets and plant assets?

A: A current asset is an asset that the corporation now has or expects to receive within a
year. A plant asset is an asset that should last more than one year, like equipment and
furniture.

Q: Why is a Balance Sheet necessary?

A: A Balance Sheet is necessary to show the account balances in the Asset, Liability, and
Stockholders' equity accounts at the end of the fiscal period.

Course content © 1997-2007 by Charlene Messier. All rights reserved. Reproduction or redistribution
of any course material without prior written permission is prohibited.

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