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CENTURY 21 ACCOUNTING © Thomson/South-Western
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
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
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
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
CENTURY 21 ACCOUNTING © Thomson/South-Western
6
LESSON 15-1
INCOME STATEMENT INFORMATION
ON A WORK SHEET page 448
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
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
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)
CENTURY 21 ACCOUNTING © Thomson/South-Western
LESSON 15-2
Analyzing 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
CENTURY 21 ACCOUNTING © Thomson/South-Western
12
LESSON 15-1
ANALYZING AN INCOME STATEMENT
SHOWING A NET LOSS page 457
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
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.
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
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
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
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
CENTURY 21 ACCOUNTING © Thomson/South-Western
LESSON 15-3
Preparing a Statement of
Stockholder’s Equity
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
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)
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
CENTURY 21 ACCOUNTING © Thomson/South-Western
LESSON 15-4
Preparing a Balance Sheet
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
CENTURY 21 ACCOUNTING © Thomson/South-Western
25
LESSON 15-1
BALANCE SHEET INFORMATION ON A
WORK SHEET page 464
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
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
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.
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
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
CENTURY 21 ACCOUNTING © Thomson/South-Western
31
LESSON 15-1
COMPLETED BALANCE SHEET page 469
(continued on next slide)
CENTURY 21 ACCOUNTING © Thomson/South-Western
32
LESSON 15-1
COMPLETED BALANCE SHEET page 469
(continued from previous slide)