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CENTURY 21 ACCOUNTING © Thomson/South-Western LESSON 15-1 Preparing an Income Statement

LESSON 15-1 Preparing an Income Statement

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Page 1: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

LESSON 15-1

Preparing an Income

Statement

Page 2: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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)

2

LESSON 15-1

Page 3: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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

3

LESSON 15-1

Page 4: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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

4

LESSON 15-1

Page 5: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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

5

LESSON 15-1

Page 6: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

6

LESSON 15-1

INCOME STATEMENT INFORMATION

ON A WORK SHEET page 448

Page 7: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

7

LESSON 15-1

6. Contra account amounts

REVENUE SECTION OF AN INCOME STATEMENT

FOR A MERCHANDISING BUSINESS

1

2

3 4

5

6

page 449

7 8 9

1. Heading

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)

2. Revenue section

Page 8: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

8

LESSON 15-1

COST OF MERCHANDISE SOLD SECTION OF AN

INCOME STATEMENT FOR A MERCHANDISING

BUSINESS

1

2 3

page 450

4 6 5

1. Cost of

Merchandise Sold

section

2. Beginning inventory

(Trial Balance)

3. Purchases

section

4. Total cost of

merchandise

available for sale

5. Ending inventory

(Balance Sheet)

6. Cost of

merchandise sold

Page 9: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

9

LESSON 15-1

COMPLETING AN INCOME STATEMENT

FOR A MERCHANDISING BUSINESS

1

2

4

5

page 452

7

3

6 7. Component percentage

(divided by Net Sales)

6. Double lines

5. Net Income after

Federal Income Tax

4. Less Federal

Income Tax Expense (Income Statement)

3. Net Income before

Federal Income Tax (Gross Profit on Sales – Expenses)

2. Expenses section

1. Gross Profit on Sales (Net Sales - Cost of Merchandise Sold)

Page 10: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

LESSON 15-2

Analyzing an Income

Statement

Page 11: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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

11

LESSON 15-1

Page 12: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

12

LESSON 15-1

ANALYZING AN INCOME STATEMENT

SHOWING A NET LOSS page 457

Page 13: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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

13

LESSON 15-1

Page 14: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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%

14

LESSON 15-1

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.

Page 15: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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

15

LESSON 15-1

Page 16: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

Analyzing an Income Statement Showing a

Net Loss

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

16

LESSON 15-1

Page 17: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

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

17

LESSON 15-1

Page 18: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

18

LESSON 15-1

Price-Earnings

Ratio =

Earnings per

Share ÷

Market Price

per Share

Earnings

per Share =

Number of

Shares

Outstanding

÷

Net Income

after Federal

Income Tax

FINANCIAL RATIOS page 459

Earnings per Share

Price-Earnings Ratio

$32.13 = 2,500 ÷ $80,313.95

10.7 = $32.13 ÷ $345.00

Page 19: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

LESSON 15-3

Preparing a Statement of

Stockholder’s Equity

Page 20: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

20

LESSON 15-1

TERMS REVIEW

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

page 463

Page 21: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

21

LESSON 15-1

CAPITAL STOCK SECTION OF THE STATEMENT

OF STOCKHOLDERS’ EQUITY

1 2

3 4

5

page 461

1. Heading

2. Capital Stock and Par Value

5. Total stock issued at the end of the year

3. Stock at the beginning of the year (2,000 shares x $50)

4. Stock issued during the year (500 shares x $50)

Page 22: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

22

LESSON 15-1

RETAINED EARNINGS SECTION OF THE

STATEMENT OF STOCKHOLDERS’ EQUITY

1 2 3

4

page 462

4. Dividends declared (Balance Sheet—debit col.)

6

7

5

2. Beginning balance (Balance Sheet—credit col.)

7. Total stockholders’ equity

6. Ending balance 3. Net income after federal

income tax (Income Statement—debit col.)

5. Increase in retained earnings

1. Retained Earnings

Page 23: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

LESSON 15-4

Preparing a Balance Sheet

Page 24: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

24

LESSON 15-1

TERMS REVIEW

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

page 471

Page 25: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

25

LESSON 15-1

BALANCE SHEET INFORMATION ON A

WORK SHEET page 464

Page 26: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

BALANCE SHEET INFORMATION ON A

WORK SHEET

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

26

LESSON 15-1

Page 27: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

27

LESSON 15-1

CURRENT ASSETS SECTION OF A

BALANCE SHEET

1

2

3

4

5

page 465

3. Book value of

accounts receivable

4. Asset accounts 1. Heading

2. Begin assets section 5. Current assets

Page 28: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

28

LESSON 15-1

PLANT ASSETS SECTION OF A

BALANCE SHEET

1

2

3

page 466

4

5 1. Write the heading Plant Assets.

2. Calculate the book value of office equipment.

3. Use the same procedure to calculate the book value of store equipment.

4. Calculate total plant assets.

5. Calculate total assets.

Page 29: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

29

LESSON 15-1

LIABILITIES SECTION OF A BALANCE

SHEET

1

3

page 467

1. Heading

2. Account title and

amount of each

current liability

3. Total liabilities

2

Page 30: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

30

LESSON 15-1

STOCKHOLDERS’ EQUITY SECTION OF A

BALANCE SHEET

1

page 468

5. Total liabilities and

stockholders’ equity

4

6

5

2 3

2. Capital stock

1. Stockholders’ Equity

3. Retained earnings

4. Total stockholders’ equity

6. Double rules

Page 31: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

31

LESSON 15-1

COMPLETED BALANCE SHEET page 469

(continued on next slide)

Page 32: LESSON 15-1 Preparing an Income Statement

CENTURY 21 ACCOUNTING © Thomson/South-Western

32

LESSON 15-1

COMPLETED BALANCE SHEET page 469

(continued from previous slide)