Income StatementIncome Statement

Chapter 4Chapter 4

What is Income Statement?What is Income Statement?

What is the major difference between What is the major difference between Income Statement and Balance Sheet?Income Statement and Balance Sheet?

Income StatementIncome Statement Balance Sheet Balance Sheet

Presents the revenues Presents the revenues And expenses and And expenses and resulting net incomeresulting net income

Or net lossOr net lossFor a specificFor a specificPeriod of timePeriod of time

Reports the assets, Reports the assets, liabilities, and liabilities, and owner’s equity owner’s equity

At a specific dateAt a specific date

Usefulness of the income StatementUsefulness of the income Statement

Evaluate the past performance of the enterpriseEvaluate the past performance of the enterprise

Predict future performancePredict future performance

Assess the risk of achieving future cash flowsAssess the risk of achieving future cash flows

Limitations of the Income StatementLimitations of the Income Statement

Items that might be relevant but cannot be reliably Items that might be relevant but cannot be reliably measured are not reportedmeasured are not reported

Some numbers depend on accounting methods Some numbers depend on accounting methods used used

Some numbers depend on judgments and estimates Some numbers depend on judgments and estimates

Format of the Income Format of the Income StatementStatement

Gross ProfitGross Profit is the excess of net sales over the cost of goods sold. is the excess of net sales over the cost of goods sold. Net IncomeNet Income is the amount by which revenues exceed expenses. is the amount by which revenues exceed expenses. Net LossNet Loss is the amount by which expenses exceed revenues. is the amount by which expenses exceed revenues. RevenueRevenue is the gross increase in owner’s equity resulting from is the gross increase in owner’s equity resulting from

business activities entered into for the purpose of earning income.business activities entered into for the purpose of earning income. ExpenseExpense is the cost of assets consumed or services used in the is the cost of assets consumed or services used in the

process of earning revenue.process of earning revenue. Net salesNet sales “sales “sales lessless sales returns and allowance and sales sales returns and allowance and sales

discount”discount” Cost of goods soldCost of goods sold is the total cost of merchandise sold during the is the total cost of merchandise sold during the

period. period.

Elements of income statementElements of income statement

RevenuesRevenues ExpensesExpenses GainsGains LossesLosses

Single-Step Income StatementSingle-Step Income Statement

Two groups exist Two groups exist

Expenses are Expenses are deducteddeducted from revenues to arrive at net income or from revenues to arrive at net income or net lossnet loss

Income tax is reported separately as the last item before net income Income tax is reported separately as the last item before net income to indicate its relationship to income before income taxto indicate its relationship to income before income tax

Revenues Expenses

Dan Deines CompanyDan Deines Company

Income StatementIncome Statement

For the year ended Dec 31, 2004For the year ended Dec 31, 2004

RevenuesRevenues

Net Sales 2,972,413Net Sales 2,972,413

Dividend Revenue 98,500Dividend Revenue 98,500

Rental Revenue Rental Revenue 72,91072,910

Total Revenues Total Revenues 3,143,8233,143,823

ExpensesExpenses

Cost of Goods Sold 1,982,542Cost of Goods Sold 1,982,542

Selling Expenses 453,028Selling Expenses 453,028

Administrative Expenses 350,771Administrative Expenses 350,771

Interest Expense 126,060Interest Expense 126,060

Income Tax Expense Income Tax Expense 66,93466,934

Total Expenses Total Expenses 2,979,4892,979,489

Net Income Net Income 164,489164,489

Earning per common share 1.74Earning per common share 1.74

Multiple-Step Income StatementMultiple-Step Income Statement

It provides more useful information because:It provides more useful information because:

1.1. It separates operating and non-operating activities.It separates operating and non-operating activities.

2.2. It classifies expenses by function.It classifies expenses by function. 3.3. It allows instant comparisons and ratio computations It allows instant comparisons and ratio computations

which evaluate performance of the companywhich evaluate performance of the company

Dan Deines CompanyDan Deines Company

Income StatementIncome Statement

For the year ended Dec 31, 2004For the year ended Dec 31, 2004

RevenuesRevenues

Sales 3,053,081Sales 3,053,081

Less: sales discount 24,241Less: sales discount 24,241

sales returns and allowance sales returns and allowance 56,42756,427 ( (80,668)80,668)

Net Sales Revenues Net Sales Revenues 2,972,4132,972,413

Cost of Goods SoldCost of Goods Sold

Merchandise inventory, Jan 1, 2004 Merchandise inventory, Jan 1, 2004 (beginning inventory)(beginning inventory) 461,219461,219

Purchases 1,989,693Purchases 1,989,693

Less:Less: Purchase discount 10,270 Purchase discount 10,270

Purchase returns and allowance Purchase returns and allowance 9,0009,000

Net Purchases 1,970,423Net Purchases 1,970,423

Add:Add: Freight and transportation-in Freight and transportation-in 40,61240,612

Cost of Goods Purchased Cost of Goods Purchased 2,011,0352,011,035

Cost of goods available for sale 2,472,254 Cost of goods available for sale 2,472,254

Less:Less: Inventory, Dec 31 Inventory, Dec 31 489,713489,713

Cost of goods soldCost of goods sold ( (1,982,541)1,982,541)

Gross Profit on sales 989,872Gross Profit on sales 989,872

Gross Profit on sales 989,872Gross Profit on sales 989,872

Operating ExpensesOperating Expenses

Selling expensesSelling expenses

Sales commissions 202,644Sales commissions 202,644

Sales office salaries 59,200 Sales office salaries 59,200

Advertising expense 38,315Advertising expense 38,315

Freight-out and transportation 41,209Freight-out and transportation 41,209

Shipping supplies and expense 24,712 Shipping supplies and expense 24,712 366,080366,080

Administrative expensesAdministrative expenses

Officers’ salaries 247,200Officers’ salaries 247,200

Legal and professional services 23,721Legal and professional services 23,721

Utilities expense 23,275Utilities expense 23,275

Insurance expense 17,029Insurance expense 17,029

Depreciation of building 27,064Depreciation of building 27,064

Depreciation of office equipment 16,000Depreciation of office equipment 16,000

Postage and stationery 19,663 Postage and stationery 19,663

Travel and entertainment 48,940Travel and entertainment 48,940

Tel and internet expense 12,215 Tel and internet expense 12,215

Miscellaneous office expense Miscellaneous office expense 2,611 2,611 437,719437,719 ( (803,799)803,799)

Income from Operations 186,073Income from Operations 186,073

Income from Operations 186,073Income from Operations 186,073

Other revenues and gainsOther revenues and gains

Dividend revenue 98,500Dividend revenue 98,500

Gain on sale of assets 20,910Gain on sale of assets 20,910

Rental revenue Rental revenue 50,00050,000 171,410171,410

357,483357,483

Other expenses and lossesOther expenses and losses

Loss on sale of investments 20,000Loss on sale of investments 20,000

Interest on bonds and notes 106,060 (Interest on bonds and notes 106,060 (126,060)126,060)

Income before income tax 231,423Income before income tax 231,423

Income tax (Income tax ( 66,934)66,934)

Net income for the year 164,489Net income for the year 164,489

Earnings per common share 1.74Earnings per common share 1.74

Income Statement SectionsIncome Statement Sections

1- Operating Section1- Operating Section

A-A- Sales or RevenueSales or Revenue Usually presented as sales minus Usually presented as sales minus sales discounts, returns, and allowances.sales discounts, returns, and allowances.

B-B- Cost of GoodsCost of Goods represents the amount a product cost represents the amount a product cost you. you.

C-C- Selling expensesSelling expenses represent expenses needed to sell represent expenses needed to sell products (e.g., sales salaries and commissions, advertising, freight, products (e.g., sales salaries and commissions, advertising, freight, shipping, depreciation of sales equipment).shipping, depreciation of sales equipment).

D- D- General and administrative expensesGeneral and administrative expenses represent represent expenses to manage the business (e.g., officer salaries, legal and expenses to manage the business (e.g., officer salaries, legal and professional fees, utilities, insurance, depreciation of office building professional fees, utilities, insurance, depreciation of office building and equipment, stationery supplies) and equipment, stationery supplies)

2- 2- Non-operating sectionNon-operating section

A- A- Other revenues or gainsOther revenues or gains - revenues and gains from - revenues and gains from other than primary business activities (e.g. rent, patents). It also other than primary business activities (e.g. rent, patents). It also includes unusual gains and losses that are either unusual or includes unusual gains and losses that are either unusual or

infrequent, but not both (e.g. sale of securities or fixed assets).infrequent, but not both (e.g. sale of securities or fixed assets). B-B- Other expenses or lossesOther expenses or losses - expenses or losses not - expenses or losses not

related to primary business operations.related to primary business operations.

3- Income Tax3- Income Tax

4- 4- Irregular items Irregular items A- A- Discontinued operationsDiscontinued operations (e.g. Shifting business (e.g. Shifting business

location, stopping production temporarily).location, stopping production temporarily). Discontinued operations are classified as a separate items shown in Discontinued operations are classified as a separate items shown in

a separate section in the income statement a separate section in the income statement after continuing after continuing operations but before extraordinary items.operations but before extraordinary items.

B-B- Extraordinary itemsExtraordinary items - unusual (abnormal) and - unusual (abnormal) and infrequent, for example, unexpected nature disaster, expropriation, infrequent, for example, unexpected nature disaster, expropriation, prohibitions under new regulations. Note: nature disaster might not prohibitions under new regulations. Note: nature disaster might not qualify depending on location.qualify depending on location.

Separate section in the income statement entitled “Extraordinary Separate section in the income statement entitled “Extraordinary items” between discontinued operations and changes in principles.items” between discontinued operations and changes in principles.

C- Changes in accounting principleC- Changes in accounting principle - for example, - for example, changing method of computing depreciation from straight-line to changing method of computing depreciation from straight-line to sum-of-the-years'-digits. However, changes in estimates (e.g. sum-of-the-years'-digits. However, changes in estimates (e.g. estimated useful life of a fixed asset) do not qualify.estimated useful life of a fixed asset) do not qualify.

The effect on net income of adopting the new accounting principle The effect on net income of adopting the new accounting principle should be disclosed as a separate item should be disclosed as a separate item following extraordinary following extraordinary items in the income statements. “between extraordinary items items in the income statements. “between extraordinary items and net income”and net income”

5- Earnings per share5- Earnings per share

Net Income – Preferred DividendsNet Income – Preferred Dividends = Earnings per Share = Earnings per Share

Weighted Average of Common Weighted Average of Common

Shares OutstandingShares Outstanding

EPSEPS is “the net income earned by each share of outstanding common is “the net income earned by each share of outstanding common stock”.stock”.

Outstanding stockOutstanding stock is “capital stock that has been issued and is being is “capital stock that has been issued and is being held by stockholders”.held by stockholders”.

DividendDividend is “a distribution by a corporation to its stockholders on is “a distribution by a corporation to its stockholders on proportional basis”.proportional basis”.

SummarySummary

Income before income taxIncome before income tax

Income taxIncome tax

Discontinued operationsDiscontinued operationsExtraordinary itemsExtraordinary items

Changes in principlesChanges in principles

Net incomeNet income

EPSEPS

ExerciseExercisePresented below are selected ledger accounts of Garden Corporation at Presented below are selected ledger accounts of Garden Corporation at

Dec 31, 2004Dec 31, 2004Sales 3,040,000 Depreciation of Furniture 15,000 Sales 3,040,000 Depreciation of Furniture 15,000

Sales discount 40,000 Sales commissions 17,000 Sales discount 40,000 Sales commissions 17,000

Freight-out Freight-out 12,000 Miscellaneous expense 12,000 Miscellaneous expense 3,000 3,000

Officers’ salaries 120,000 Officers’ salaries 120,000 Loss on sale of assetsLoss on sale of assets 6,000 6,000

IInventory, Jan 1, 2004nventory, Jan 1, 2004 40,000 Insurance expense 4,000 40,000 Insurance expense 4,000

Loss due to earthquake 275,200 Loss due to earthquake 275,200 Tel expenseTel expense 5,000 5,000

Purchases Purchases 2,020,000 Advertising expense 8,000 2,020,000 Advertising expense 8,000

Gain on sales of investments 200,000 Gain on sales of investments 200,000 Rent expense Rent expense 30,000 30,000

Purchase returns and allowance 20,000 Freight-in Purchase returns and allowance 20,000 Freight-in 8,000 8,000

Inventory, Dec 31 88,000 Inventory, Dec 31 88,000

InstructionsInstructions

Prepare the income statement for 2004. Assume that 100,000 shares of common stock are outstanding. Prepare the income statement for 2004. Assume that 100,000 shares of common stock are outstanding. And dividends applicable to preferred stock SR10,000.And dividends applicable to preferred stock SR10,000.

Garden Corporation

Income Statement

For the year ended Dec 31, 2004

Revenues

Sales 3,040,000

Less: sales discount 40,000 (40,000)

Net Sales Revenues 3,000,000

Cost of Goods Sold

Inventory, Jan 1, 2004 40,000

Purchases 2,020,000

Less: Purchase returns and allowance 20,000

Net Purchases 2,000,000

Add: Freight-in 8,000

Cost of Goods Purchased 2,008,000

Cost of goods available for sale 2,048,000

Less: Inventory, Dec 31 88,000

Cost of goods sold (1,960,000)

Gross Profit on sales 1,040,000

Garden Corporation

Income Statement

For the year ended Dec 31, 2004

Gross Profit on sales 1,040,000

Operating Expenses

Selling expenses

Sales commissions 17,000

Advertising expense 8,000

Freight-out 12,000 37,000

Administrative expenses

Officers’ salaries 120,000

Insurance expense 4,000

Depreciation of Furniture 15,000

Rent expense 30,000

Tel expense 5,000

Miscellaneous expense 3,000 177,000 (214,000)

Income from Operations 826,000

Garden Corporation

Income Statement

For the year ended Dec 31, 2004

Income from Operations 826,000

Other revenues and gains

Gain on sale of investments 200,000

1,026,000

Other expenses and losses

Loss on sale of assets (6,000)

Income before income tax 1,026,000

Income tax (20%) (205,200)

Income before Extraordinary items 820,800

Extraordinary items:

Loss due to earthquake (275,200)

Net income for the year 545,600

Earnings per common share 5.3