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Chapter 11

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Analyze a Corporate Income Statement

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Proper revenue

& expenserecognition

Improving

gross

margin

ratio

Low operatingexpenses

Improvingoperatingearnings

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Gross profit percent

should be increasing

Cost of goodssoldshould be decreasingas a percent ofnetsales

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Largest operating expensesinclude salaries,wages,utilities and supplies Lower the cost relative to sales, the more efficient

Interest expense representscharges forborrowed money

Interest revenue represents return earned oninvested money

Income tax expense Can be reduced through effective planning

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Revenue

(Cost of goodssold)

=Gross margin

(Operating expenses)

+ Interest income & (expense)

(Income tax expense)

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Income from day-to-day normal business

activities

Includes:

Revenues and operating expenses

Gains and losses

Income tax expense

Can help predict future annual income

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11-9

Estimated value of commonstock

Estimated annual future income

Investment capitalization rate=

Rate used to estimate value ofstock

The higher the rate, the higher the risk

Compared to market valueof the company

# ofcommon

shares

Marketprice per

share

x

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11-10

If the estimated value of the company:

Exceeds

Equals

Is less than

Currentmarketvalue

of

thecompany

Buy; stock

price mayincrease

Hold; stockprice steady

Sell; stockprice maygo down

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Company sells a segment of the business

Identifiable part of business

Reported beneath income from continuing

operations

Net ofincome taxes

Not considered in predictions of future

earnings

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Gains and losses that are both infrequent andunusual

Include losses from natural disasters andexpropriation of assets by foreign governments

DoNOT include gains or losses from lawsuits,

restructuring or sale of plant assets

Reported after continuing operationsnet ofincometaxes

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Change from one accounting method toanother FIFO to LIFO Straight-line depreciation to double-declining

balance

Makes difficult to compare year-to-year

statements

Reported inspecial sectionusually afterextraordinary items

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Change from one accounting method toanother FIFO to LIFO Straight-line depreciation to double-declining

balance

Makes difficult to compare year-to-year

statements

Reported inspecial sectionusually afterextraordinary items

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Key measure ofcompanyssuccess:

Reported for each element ofnet income:

Disco

nt

inued operat

io

ns,extraord

inary

item

s,et

c.

Preferred dividends only subtracted forcontinuing operations and net income

11-15

Net Income - Preferred Dividends

Average number ofcommonshares outstanding

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Key measure ofcompanyssuccess:

Reported for each element ofnet income:

Disco

nt

inued operat

io

ns,extraord

inary

item

s,et

c.

Preferred dividends only subtracted forcontinuing operations and net income

11-16

Net Income - Preferred Dividends

Average number ofcommonshares outstanding

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11-17

Other Revenues 2,400Income Tax ExpenseExtraordinary Gain 1,600Income Tax ExpenseIncome from Ops 2,880

Extraordinary Gain 4,000Sales Revenue 102,000Total Operating Expenses 97,200

1. Prepare single-step income statement.1,800 shares of common stock.

2. Estimate price of common stock if earnings capitalized at 5%.

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11-18

Sales revenue 102,000$

Other Revenues 2,400Operating Income before income tax 104,400$Total Operating Expenses 97,200Income from continuing operationsbefore income taxes 7,200$

Income tax expense 2,880Income from continuing operations 4,320Extraordinary gain of $4,000, lesstax of $1,600 2,400

Net Income 6,720$

Income StatementYear Ended December 31, 2010

Regan Books Company

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11-19

Sales revenue 102,000$

Other Revenues 2,400Operating Income before income tax 104,400$Total Operating Expenses 97,200Income from continuing operationsbefore income taxes 7,200$

Income tax expense 2,880Income from continuing operations 4,320Extraordinary gain of $4,000, lesstax of $1,600 2,400

Net Income 6,720$

Income StatementYear Ended December 31, 2010

Regan Books Company

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11-20

Sales revenue 102,000$

Other Revenues 2,400Operating Income before income tax 104,400$Total Operating Expenses

97,200Income from continuing operationsbefore income taxes 7,200$

Income tax expense 2,880Income from continuing operations 4,320Extraordinary gain of $4,000, lesstax of $1,600 2,400

Net Income 6,720$

Income StatementYear Ended December 31, 2010

Regan Books Company

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11-21

Sales revenue 102,000$

Other Revenues 2,400Operating Income before income tax 104,400$Total Operating Expenses

97,200Income from continuing operationsbefore income taxes 7,200$

Income tax expense 2,880Income from continuing operations 4,320Extraordinary gain of $4,000, lesstax of $1,600 2,400

Net Income 6,720$

Income StatementYear Ended December 31, 2010

Regan Books Company

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11-22

Sales revenue 102,000$

Other Revenues 2,400Operating Income before income tax 104,400$Total Operating Expenses

97,200Income from continuing operationsbefore income taxes 7,200$

Income tax expense 2,880Income from continuing operations 4,320Extraordinary gain of $4,000, lesstax of $1,600 2,400

Net Income 6,720$

Income StatementYear Ended December 31, 2010

Regan Books Company

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11-23

Income from continuing operations ($4,320 / 1,800) 2.40Extraordinary gain ($2,400 / 1,800) 1.33

Net Income ($6,720 / 1,800) 3.73$

Earnings per share (1800 shares)

Estimated annual

Estimated value of=

EPS in the future=

$2.40= $48.00

one share of Investment .05

Regan Booksstock capitalization rate

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11-24

Income from continuing operations ($4,320 / 1,800) 2.40Extraordinary gain ($2,400 / 1,800) 1.33

Net Income ($6,720 / 1,800) 3.73$

Earnings per share (1800 shares)

Estimated annual

Estimated value of=

EPS in the future=

$2.40= $48.00

one share of Investment .05

Regan Booksstock capitalization rate

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11-25

Income from continuing operations ($4,320 / 1,800) 2.40Extraordinary gain ($2,400 / 1,800) 1.33

Net Income ($6,720 / 1,800) 3.73$

Earnings per share (1800 shares)

Estimated annual

Estimated value of=

EPS in the future=

$2.40= $48.00

one share of Investment .05

Regan Booksstock capitalization rate

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11-26

Income from continuing operations ($4,320 / 1,800) 2.40Extraordinary gain ($2,400 / 1,800) 1.33

Net Income ($6,720 / 1,800) 3.73$

Earnings per share (1800 shares)

Estimated annual

Estimated value of=

EPS in the future=

$2.40= $48.00

one share of Investment .05

Regan Booksstock capitalization rate

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Account for a Corporations Income Taxes

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Federal corporate income tax rate = 35%

Most states also levy a tax,usually around 5%

Income tax expense Reported onincome statement

Based oncurrent year earnings

Income tax payable Current liability on the balance sheet

Amount to be paid to government

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Income Statement Reports results of operations Based on accrual account

Income Tax Return Filed with IRS to determine taxes owed Based on tax laws

Depreciationcommon difference Straight-line for accounting purposes Accelerated for tax purposes

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Whencorporationsuse different methods foraccounting and taxes:

Income tax expense doesnot equal income taxpayable

The result is a deferred tax liability or asset

Income tax expense < Income tax payable

Income tax expense > Income tax payable

Deferred tax asset

Deferred tax liability

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Correction of anaccounting error from aprevious period

Related revenue orexpense item has beenclosed into RetainedEarnings

Beginning retainedearningsis adjusted forthe amount of the error

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Change instockholders equity from allnon-owner transactions

Net Income plus:

Unrealized gains (losses) on available-for-saleinvestments

Foreigncurrency translation adjustments

Not included innet income or EPS calculations

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11-33

Income Before Tax 122,000Taxable Income 94,000

Tax Rate 30%

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DATE ACCOUNT TITLES ANDEXPLANATION DEBIT CREDIT

1. Income Tax Expense ($122,000 .30). 36,600

Recorded income tax for the year.

11-34

1. Record income taxes

Income before Income Tax(From Income Statement)

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DATE ACCOUNT TITLES ANDEXPLANATION DEBIT CREDIT

1. Income Tax Expense ($122,000 .30). 36,600

Income Tax Payable ($94,000 .30).... 28,200

Recorded income tax for the year.

11-35

1. Record income taxes

Taxable Income

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DATE ACCOUNT TITLES ANDEXPLANATION DEBIT CREDIT

1. Income Tax Expense ($122,000 .30). 36,600

Income Tax Payable ($94,000 .30).... 28,200

Deferred Tax Liability.. 8,400

Recorded income tax for the year.

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1. Record income taxes

Plug Figure:CR = LiabilityDR = Asset

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2. INCOMESTATEMENT

Income before income tax $122,000

Income tax expense... (36,600)

Net income... $ 85,400

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2. INCOMESTATEMENT

Income before income tax $122,000

Income tax expense... (36,600)

Net income... $ 85,400

BALANCESHEET

Current liabilities:

Income tax payable.. $ 28,200Long-term liabilities:

Deferred tax liability. 8,400

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Analyze a Statement of Stockholders Equity

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Includes all equity accounts(example on following slide)

Show activity in each account From beginning balance to ending balance

Increases and decreases

Also includes accumulated other comprehensiveincome: Unrealized gain or loss oninvestments Foreigncurrency translation adjustment

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11-41

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Req. 1$1,140,000 ($40,000 + $1,100,000)

Req. 2The stock dividend:decreasedretained earnings by $84,000increasedtotal paid-incapital by $84,000 ($6,000 + $78,000)had no effecton total stockholders equityhad no effecton total assets

Req. 3Cost of treasury stock Mason purchased = $8,000Masonscost of treasury stock sold = $5,000Masonsold the treasury stock for $12,000 ($5,000 + $7,000)

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Req. 1$1,140,000 ($40,000 + $1,100,000)

Req. 2The stock dividend:decreasedretained earnings by $84,000increasedtotal paid-incapital by $84,000 ($6,000 + $78,000)had no effecton total stockholders equityhad no effecton total assets

Req. 3Cost of treasury stock Mason purchased = $8,000Masonscost of treasury stock sold = $5,000Masonsold the treasury stock for $12,000 ($5,000 + $7,000)

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Req. 1$1,140,000 ($40,000 + $1,100,000)

Req. 2The stock dividend:decreasedretained earnings by $84,000increasedtotal paid-incapital by $84,000 ($6,000 + $78,000)had no effecton total stockholders equityhad no effecton total assets

Req. 3Cost of treasury stock Mason purchased = $8,000Masonscost of treasury stock sold = $5,000Masonsold the treasury stock for $12,000 ($5,000 + $7,000)

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11-45

Common Stock 542,500$1.75 par value400,000 shares authorized310,000 shares issued

Additional Paid-in Capital 700,000Retained Earnings 630,000Total Stockholders Equity 1,872,500

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11-46

_____*310,000 shares .02 $20 per share = $124,000.

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11-47

_____*310,000 shares .02 $20 per share = $124,000.

310,000 X .02 X $20

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11-48

_____*310,000 shares .02 $20 per share = $124,000.

310,000 X .02 X $1.75

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11-49

_____*310,000 shares .02 $20 per share = $124,000.

124,000 10,850

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11-50

_____*310,000 shares .02 $20 per share = $124,000.

2,000 X 18

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11-51

_____*310,000 shares .02 $20 per share = $124,000.

2,000 X 1.75 36,000 3,500

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11-52

_____*310,000 shares .02 $20 per share = $124,000.

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11-53

_____*310,000 shares .02 $20 per share = $124,000.

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Understand Managers and Auditors

Responsibilities for the Financial Statements

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Internal controls over financial reporting in

accordance withGAAP

Standard for preparing financial statements

Designed to produce relevant and reliableinformation for investors and creditors

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Companies hire Certified PublicAccountants

(CPAs) to examine financial statements

Examinationiscalled an external audit

CPAs are independent of the company they areauditing

CPA firmsissue audit reports Provide opinionif financial statements are in

accordance withGAAP

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11-57

Clean opinion; Statements are fairlypresented

Qualified

Except for opinion; Statements arereliable except for one or more items

AdverseStatements are unreliable and not in

accordance with GAAP

DisclaimerNo opinion; auditor was unable to form

an opinion

Unqualified

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1. Who is responsible for the financial statements?Management ofAshburnham Computer is responsible for thecompanys financial statements.

Req. 2The accounting standard for financial statementsisaccounting principles generally accepted in the United States ofAmerica.

Req. 3Management has established and maintainsinternalaccounting control over financial reporting to fulfillits responsibility for reliable financial information.

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1. Who is responsible for the financial statements?Management ofAshburnham Computer is responsible for thecompanys financial statements.

Req. 2The accounting standard for financial statementsisaccounting principles generally accepted in the United States ofAmerica.

Req. 3Management has established and maintainsinternalaccounting control over financial reporting to fulfillits responsibility for reliable financial information.

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1. Who is responsible for the financial statements?Management ofAshburnham Computer is responsible for thecompanys financial statements.

2. What accounting standard is used to prepare the financialstatements?

The accounting standard for financial statementsisaccounting principles generally accepted in the United States ofAmerica.

Req. 3Management has established and maintainsinternalaccounting control over financial reporting to fulfillits responsibility for reliable financial information.

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1. Who is responsible for the financial statements?Management ofAshburnham Computer is responsible for thecompanys financial statements.

2. What accounting standard is used to prepare the financialstatements?

The accounting standard for financial statementsisaccounting principles generally accepted in the United States ofAmerica.

Req. 3Management has established and maintainsinternalaccounting control over financial reporting to fulfillits responsibility for reliable financial information.

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1. Who is responsible for the financial statements?Management ofAshburnham Computer is responsible for thecompanys financial statements.

2. What accounting standard is used to prepare the financialstatements?

The accounting standard for financial statementsisaccounting principles generally accepted in the United States ofAmerica.

3. Management action for reliability of financial information?Management has established and maintainsinternalaccounting control over financial reporting to fulfillits responsibility for reliable financial information.

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1. Who is responsible for the financial statements?Management ofAshburnham Computer is responsible for thecompanys financial statements.

2. What accounting standard is used to prepare the financialstatements?

The accounting standard for financial statementsisaccounting principles generally accepted in the United States ofAmerica.

3. Management action for reliability of financial information?Management has established and maintainsinternalaccounting control over financial reporting to fulfillits responsibility for reliable financial information.

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4. What entity gave an independent opinion on the financialstatements?

Independent Registered PublicAccounting Firm,auditors located inPortage,Michigan, gave an outside

opinion onAshburnhams financial statements.Independent Registered PublicAccounting Firmreleased its opinion onDecember 28, 2010.

Req. 5The audit covered Ashburnhams balance sheets at

September 30, 2010, and September 30, 2009,income statements (statements of operations),statements ofshareholders equity and cash flowsfor the three years ended September 30, 2010.

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4. What entity gave an independent opinion on the financialstatements?

Independent Registered PublicAccounting Firm,auditors located inPortage,Michigan, gave an outside

opinion onAshburnhams financial statements.Independent Registered PublicAccounting Firmreleased its opinion onDecember 28, 2010.

Req. 5The audit covered Ashburnhams balance sheets at

September 30, 2010, and September 30, 2009,income statements (statements of operations),statements ofshareholders equity and cash flowsfor the three years ended September 30, 2010.

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4. What entity gave an independent opinion on the financialstatements?

Independent Registered PublicAccounting Firm,auditors located inPortage,Michigan, gave an outside

opinion onAshburnhams financial statements.Independent Registered PublicAccounting Firmreleased its opinion onDecember 28, 2010.

5. What did the audit cover?The audit covered Ashburnhams balance sheets at

September 30, 2010, and September 30, 2009,income statements (statements of operations),statements ofshareholders equity and cash flowsfor the three years ended September 30, 2010.

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4. What entity gave an independent opinion on the financialstatements?

Independent Registered PublicAccounting Firm,auditors located inPortage,Michigan, gave an outside

opinion onAshburnhams financial statements.Independent Registered PublicAccounting Firmreleased its opinion onDecember 28, 2010.

5. What did the audit cover?The audit covered Ashburnhams balance sheets at

September 30, 2010, and September 30, 2009,income statements (statements of operations),statements ofshareholders equity and cash flowsfor the three years ended September 30, 2010.

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6. What standard was used to conduct the audit?

The standard for conducting an audit is thestandards of the Public Company Accounting Oversight

Board (United States).

Req. 7

The auditor believed that Ashburnhams financialstatements conformed toU.S. generally accepted

accounting principles.

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6. What standard was used to conduct the audit?

The standard for conducting an audit is thestandards of the Public Company Accounting Oversight

Board (United States).

Req. 7

The auditor believed that Ashburnhams financialstatements conformed toU.S. generally accepted

accounting principles.

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6. What standard was used to conduct the audit?

The standard for conducting an audit is thestandards of the Public Company Accounting Oversight

Board (United States).

7. What was the auditors opinion?

The auditor believed that Ashburnhams financialstatements conformed toU.S. generally accepted

accounting principles.

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6. What standard was used to conduct the audit?

The standard for conducting an audit is thestandards of the Public Company Accounting Oversight

Board (United States).

7. What was the auditors opinion?

The auditor believed that Ashburnhams financialstatements conformed toU.S. generally accepted

accounting principles.

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