Chapter 4 1

Cash, Short-term Investments

and Accounts Receivable

Chapter 4

Chapter 9The Corporate Income Statement and

Financial Statement Analysis

Chapter 9 33

Chapter 9Learning Objectives

• Account for investments in stocks and bonds.

• Identify the key elements of the corporate income statement.

• Compute earnings per share.

• Account for corporate income taxes.

• Discuss the objectives of, and sources for, information for financial statement analysis for different types of decision makers.

• Prepare trend analyses of financial statement data and common-sized financial statements.

• Compute key financial ratios including liquidity, leverage, activity, profitability, and market strength ratios.

• Assess earnings quality.

Chapter 9 4

The Income Statement

Income From Operations = Revenue – COGS- General Expenses

Other Items include:Interest Income/ExpenseEarnings (or losses) from stock or bond investments Discontinued operations

Extraordinary itemsCumulative effects of accounting changesDeferred income taxes

Chapter 9 5

Avon Consolidated Statement of Income Example

Chapter 9 6

Investments in Stocks

•Cost Method

•Equity Method

Chapter 9 7

Equity Terms

•Parent•Subsidiary•Consolidation•Minority Interest

Chapter 9 8

Visual Recap 9.1Accounting Methods for Long-term Stock Investments

 

  Method Cost Equity  

  Ownership < 20% 20%–80% >80%  

  Initial Investment

InvestmentCash

 

InvestmentCash

InvestmentCash

 

  Receipt of Dividends

CashDividend Revenue

 

CashInvestment

CashInvestment

 

  Year-End Procedures

Debit or credit the Investment account to adjust it to FMV. The other debit or credit will be to Stockholders’ Equity

InvestmentIncome from

Unconsolidated Affiliates

Consolidate the financial statements of both companies; remove the effects of transactions between the two companies. Subtract minority interest.

 

           

Chapter 9 9

Investments in BondsEXHIBIT 9.2Journal Entries for a Bond Investment Purchased at a Discount  Date Description Debit Credit 2009Apr.1 Investment in Bonds 93,641

Cash 93,641Recorded purchase of $100,000, 10%, 5-year bonds at a market rate of 12%.

Sept.30 Cash 5,000Investment in Bonds 636 Interest Revenue 5,636Received semiannual interest & amortized discount to the investment account.

Chapter 9 10

Dec. 31 Interest Receivable 2,500Investment in Bonds 318

Interest Revenue 2,818Accrued semiannual interest & amortized discount to the investment account.

2010 Mar.31 Cash 5,000

Investment in Bonds 318Interest Revenue 2,818Interest Receivable 2,500

Received semiannual interest & amortized discount to the investment account.

Investment in Bonds Continued

Chapter 9 1111

Gilbert Company purchases $100,000 face value 10% bonds from Garbo Company for $95,300. To record the purchase of the bonds, Gilbert will debit

a. Bonds Payable for $95,300.

b. Investment in Bonds for $95,300.

c. Investment in Bonds for $100,000.

d. Bonds Payable for $100,000.

Chapter 9 1212

Gilbert Company purchases $100,000 face value 10% bonds from Garbo Company for $95,300. To record the purchase of the bonds, Gilbert will debit

a. Bonds Payable for $95,300.

b. Investment in Bonds for $95,300.

c. Investment in Bonds for $100,000.

d. Bonds Payable for $100,000.

Chapter 9 1313

Gilbert Company purchases $100,000 face value 10% bonds from Garbo Company for $103,900. As Gilbert amortizes the premium, the Investment in Bonds account will

a. increase one period and decrease the next period.

b. decrease each period.

c. increase each period.

d. impossible to determine with the given data.

Chapter 9 1414

Gilbert Company purchases $100,000 face value 10% bonds from Garbo Company for $103,900. As Gilbert amortizes the premium, the Investment in Bonds account will

a. increase one period and decrease the next period.

b. decrease each period.

c. increase each period.

d. impossible to determine with the given data.

Chapter 9 15

Corporate Income Taxes

Taxable income over Not over Tax rate  $ 0 50,000 15% 50,000 75,000 25% 75,000 100,000 34% 100,000 335,000 39% 335,000 10,000,000 34% 10,000,000 15,000,000 35% 15,000,000 18,333,333 38% 18,000,000 35%

Chapter 9 16

Two Sets of Books?

•Temporary Differences• Permanent Differences

•Deferred Tax Liability•Deferred Tax Asset

Chapter 9 17

Income From Noncontinuing Items

• Discontinued Operations

• Extraordinary Items

• Cumulative Effect of a change in Accounting Principle

Chapter 9 18

Discontinued Operations

Income Statement will contain:(1) the operating income (or loss) for that business segment (2) the gain (or loss) resulting from the disposal of the segment.

Chapter 9 19

Extraordinary ItemsUnusual in nature: The event should be highly abnormal, taking into account the environment in which the entity operates

ANDInfrequent in occurrence: The event should not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates.

Chapter 9 20

Corporate Income Statement Format

Chapter 9 2121

An item that is both unusual in nature and infrequent in occurrence is shown on the income statement

a. as an extraordinary item before tax.

b. as an extraordinary item net of tax.

c. with discontinued operations net of tax.

d. with discontinued operations before tax.

Chapter 9 2222

An item that is both unusual in nature and infrequent in occurrence is shown on the income statement

a. as an extraordinary item before tax.

b. as an extraordinary item net of tax.

c. with discontinued operations net of tax.

d. with discontinued operations before tax.

Chapter 9 23

Analytical Techniques• Trend Analysis• Common-sized Financial Statements• Ratio Analysis

Trend Analysis: Shows percentage changes from year to year.

Common Size Financials: each line item is expressed as a percentage of a major financial statement component within the year.

Ratio Analysis: study of relationships between two financial statement items.

Chapter 9 24

Avon Trend Analysis of Income Statements

Chapter 9 25

Avon Common-Sized Income Statements

Chapter 9 2626

Browning Company reports total assets of $1,200,000 on its December 31, 2010 balance sheet. Accounts receivable is reported at $120,000 and inventory is reported at $230,000. A common-sized balance sheet will report inventory at

a. 10%.

b. 29.17%.

c. 19.17%.

d. 52.17%.

Chapter 9 2727

Browning Company reports total assets of $1,200,000 on its December 31, 2010 balance sheet. Accounts receivable is reported at $120,000 and inventory is reported at $230,000. A common-sized balance sheet will report inventory at

a. 10%.

b. 29.17%.

c. 19.17%.

d. 52.17%.

Chapter 9 28

Ratio Analysis

Current Ratio Quick Ratio

Liquidity

D eb t to To ta l A sse ts L on g -te rm D eb t to E q u ity T im es In te res t E arn ed

L everag e

Age of Rec. AR Turnover Age of Inventory Inventory Turnover Asset Turnover

Activity

Chapter 9 29

Ratio Analysis

G ross M arg in % P ro fit M arg in % R etu rn on A sse ts R etu rn on E q u ity

P ro fitab ility

Price - Earnings Market to Book

Market Strength

Chapter 9 30

Key Financial Liquidity Ratios for Avon

Chapter 9 31

Key Financial Leverage Ratios for Avon

Chapter 9 32

Key Financial Leverage Ratios for Avon Continued

Chapter 9 33

Key Activity Ratios for Avon

Chapter 9 34

Key Activity Ratios for Avon Continued

Chapter 9 35

Key Profitability Ratios for Avon

Chapter 9 36

Key Profitability Ratios for Avon Continued

Chapter 9 37

Key Market Strength Ratios for Avon

Chapter 9 3838

Current assets and current liabilities for Strong Company are $400,000 and $250,000, respectively. Inventory and prepaid expenses amount to $150,000. The quick ratio is

a. .625.

b. .375.

c. 1.00.

d. 1.60.

Chapter 9 3939

Current assets and current liabilities for Strong Company are $400,000 and $250,000, respectively. Inventory and prepaid expenses amount to $150,000. The quick ratio is

a. .625.

b. .375.

c. 1.00.

d. 1.60.

Chapter 9 4040

Current assets and current liabilities for Strong Company are $400,000 and $250,000, respectively. Inventory and prepaid expenses amount to $150,000. The current ratio ratio is

a. .625.

b. .375.

c. 1.00.

d. 1.60.

Chapter 9 4141

Current assets and current liabilities for Strong Company are $400,000 and $250,000, respectively. Inventory and prepaid expenses amount to $150,000. The current ratio ratio is

a. .625.

b. .375.

c. 1.00.

d. 1.60.

Chapter 9 4242

Gray Company reports net sales of $500,000, gross profit of $350,000, income from operations of $100,000, and net income of $50,000. Gray’s profit margin percentage is

a. 30%.

b. 20%.

c. 70%.

d. 10%.

Chapter 9 4343

Gray Company reports net sales of $500,000, gross profit of $350,000, income from operations of $100,000, and net income of $50,000. Gray’s profit margin percentage is

a. 30%.

b. 20%.

c. 70%.

d. 10%.

Chapter 9 44

Ways to Assess the Quality of a Firm’s Reported Earnings

Chapter 9 4545

THE END!