accounting what the numbers mean - professor...

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9- 1Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.


Marshall,McManus,andViele11thEdition

AccountingWhattheNumbersMean

CHAPTER9:TheIncomeStatementandtheStatementof

CashFlows


Revenue is generated when a firm sells a product or provides a service to a client or

customer and receives cash, creates an account receivable, or satisfies an obligation.

Revenue is generally measured by the amount of cash received or expected to be received

from a transaction.

IncomeStatement

Learning Objective 9-1: Explain what revenue is and what the two criteria are that permit revenue recognition.9- 4

Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

RevenueRevenueisrealizedwhentheproductorservicehas

beenexchangedforcash,claimstocash,oranassetthatisreadilyconvertibletoaknown

amountofcash.

Revenueisearnedwhenthefirmhascompleted,orsubstantiallycompleted,theactivitiesitmustperformtobeentitledtotherevenuebenefits.

Companies should disclose unusual revenue recognition methods, such as percentage-of-

completion or installment methods.Learning Objective 9-1: Explain what revenue is and what the two criteria are that permit revenue recognition.


SalesRevenueOn March 15, Matrix, Inc. sold inventory on account to

a customer in the ordinary course of business.

Learning Objective 9-1: Explain what revenue is and what the two criteria are that permit revenue recognition.9- 6


SalesRevenue

Sales returns: Merchandise returned by the customer.

Sales allowances: A reduction in the amount owed by the customer as a result of defective merchandise received.

Sales discounts: A reduction in the amount owed by the customer to encourage prompt payment on account.

Sales 814,337$ Less: Sales returns and allowances (12,800) Less: Sales discounts (16,287) Net sales 785,250$

Matrix, Inc. - Calculation of Net Sales

Learning Objective 9-1: Explain what revenue is and what the two criteria are that permit revenue recognition.

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ShippingTerms

FOB Shipping Point

Ownership transfers to buyer when merchandise is passed to carrier, and

the buyer pays the shipping costs.

Ownership transfers to buyer when merchandise is

passed to buyer, and the seller pays the shipping costs.

FOB Destination

Seller Buyer

MerchandiseCarrier

Learning Objective 9-2: Describe how cost of goods sold is determined under both perpetual and periodic inventory accounting systems.9- 8


CostofGoodsSold

However, calculation of cost of goods sold in a periodicinventory system is determined at the end of the period:

Beginning inventory 47,000$ Gross purchases 361,200$ Less: Purchase discounts (3,500) Less: Purchase returns and allowances (1,800) Net Purchases 355,900 Add: Freight-In 2,000 357,900 Cost of goods available for sale 404,900 Less: Ending inventory (53,100) Cost of goods sold 351,800$

In a perpetual inventory system, cost of goods sold is determined for each sale.

Learning Objective 9-2: Describe how cost of goods sold is determined under both perpetual and periodic inventory accounting systems.


RecordingCostofGoodsSoldUnder a perpetual system, a record is made of every

purchase and every sale, and a continuous record of the quantity and cost of each item is maintained. When an item is sold, its cost is transferred from the inventory asset to the cost of goods sold expense with the following effect on the

financial statements:

Learning Objective 9-2: Describe how cost of goods sold is determined under both perpetual and periodic inventory accounting systems.9- 10


GrossProfitGross profit is the excess of sales over cost of goods sold.

YearItem 2016 2015 2014

Sales 400,000$ 355,000$ 320,000$ Cost of goods sold 285,000 250,000 225,000 Gross profit 115,000 105,000 95,000

Gross profit ratio = Gross profit ÷ Net sales

YearGross Profit Sales

Gross Profit Ratio

2016 $115,000 ÷ $400,000 = 28.75%2015 105,000 ÷ 355,000 = 29.58%2014 95,000 ÷ 320,000 = 29.69%

Learning Objective 9-3: Discuss the significance of gross profit and describe how the gross profit ratio is calculated and used.


SettingSalesPricewithGrossProfitRatio

Selling price = Cost of product ÷ (1 – Desired gross profit ratio)

Matrix, Inc. purchases a product for resale at a cost of $70 per unit. The company desires to earn a gross profit

rate of 30% on all sales. What is the required selling price per unit?

Selling price = $70 ÷ (1 – .30)Selling price = $100 per unit

Learning Objective 9-3: Discuss the significance of gross profit and describe how the gross profit ratio is calculated and used.9- 12


ExpensesOutflows or other using up of assets or incurring

liabilities from delivering or producing goods, rendering services, or carrying out other activities that constitute

the entity’s ongoing central operations.

1. Some expenses are recognized concurrently with the revenues to which they relate (matching principle).

2. Some expenses are recognized in the period in which they are incurred (administrative salaries).

3. Some expenses result from an allocation of the cost of an asset to the period (depreciation).

Learning Objective 9-4: Identify the principal categories and components of “other operating expenses” and show how these items are reported on the income statement.

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OperatingExpenses

Operating expenses usually are reported in the following classifications on the income statement:1. Selling expenses.

2. General and administrative expenses.

3. Research and development expenses.

Learning Objective 9-4: Identify the principal categories and components of “other operating expenses” and show how these items are reported on the income statement. 9- 14


Multiple-StepIncomeStatementMatrix, Inc.

Income StatementFor the Year Ended December 31, 20xx

Sales, net 785,250$ Cost of goods sold 351,800 Gross profit 433,450 Operating expenses: Selling expenses 197,350$ General and administrative exp. 78,500 Depreciation expense 17,500 293,350 Income from operations 140,100 Other revenues and gains: Interest income 62,187 Gain on sale of plant assets 24,600 86,787 Other expenses and losses: Interest expense 27,000 Loss on sale of investments 9,000 (36,000) Income before taxes 190,887 Income tax expense 62,500 Net income 128,387$

Learning Objective 9-5: Explain what “income from operations” includes and discuss why this income statement subtotal is significant to managers and financial analysts.

Although only an intermediate subtotal

on the income statement, income from operations is

frequently interpreted as the most

appropriate measure of management’s

ability to utilize the firm’s operating

assets.


EarningsPerShareBasic earnings per share is calculated by dividing net income by the average number of

shares of common stock outstanding during the year.

Learning Objective 9-6: Describe the components of the earnings per share calculation and discuss the reasons for some of the refinements made in that calculation.

Assumptions:On September 1, 2016, the beginning of its fiscal year, Cruisers, Inc., had 200,000 shares of common stock outstanding.On December 3, 2016, 40,000 additional shares were issued for cash.On June 28, 2017, 15,000 shares of common stock were acquired as treasury stock (and are no longer outstanding).Weighted-average calculation:

Period Number of MonthsNumber of Shares Outstanding Months × Shares

9/1–12/3 3 200,000 600,00012/3–6/28 7 240,000 1,680,0006/28–8/31 2 225,000 450,000Totals 12 2,730,000

Weighted Average number of shares outstanding = 2,730,000 ÷12= 227,500

First, we calculate the weighted-

average number of shares of common

stock.


Weighted-AverageShares



EarningsPerShare

When an entity has stock options, convertible bonds, or convertible preferred stock, there is the potential for the dilution of basic earnings per share. When any of these securities are

present, we test to see if, in fact, there is dilution.


When dilution is determined, we report a second earnings per share statistic known as diluted earnings per share.


IncomeStatementAlternatives

Matrix, Inc.Income Statement

For the Year Ended December 31, 20xx

Revenues and gains: Sales, net 785,250$ Interest income 62,187 Gain on sale of plant assets 24,600 Total revenues and gains 872,037

Expenses and losses: Cost of goods sold 351,800$ Selling expenses 197,350 General and administrative exp. 78,500 Depreciation expense 17,500 Interest expense 27,000 Income tax expense 62,500 Loss on sale of investments 9,000 Total expenses and losses 743,650 Net income 128,387$



Sales, net 785,250$ Cost of goods sold 351,800 Gross profit 433,450 Operating expenses: Selling expenses 197,350$ General and administrative 78,500 Depreciation expense 17,500 293,350 Income from operations 140,100 Other revenues and gains: Interest income 62,187 Gain on sale of plant assets 24,600 86,787 Other expenses and losses: Interest expense 27,000 Loss on sale of investments 9,000 (36,000) Income before taxes 190,887 Income tax expense 62,500 Net income 128,387$

Single-Step Multiple-Step

Learning Objective 9-7: Compare and contrast the alternative income statement presentation models.

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UnusualorInfrequentlyOccurringItemsReportedonanIncomeStatement

� Discontinued operations;� Extraordinary items; and� Noncontrolling interest in earnings of

subsidiaries.Income before extraordinary item 785,250$ Extraordinary Loss: Earthquake loss (net of tax benefit of $22,500) (52,500) Net income 732,750$

Learning Objective 9-8: Discuss the meaning and significance of each of the unusual or infrequently occurring items that may appear on the income statement. 9- 20


GainsandLosses

Increases (gains) or decreases (losses) in an

entity’s net assets result from

nonoperatingactivities.

Gains/losses are usually reported as other income

and excluded from operating income.



Sales, net 785,250$ Cost of goods sold 351,800 Gross profit 433,450 Operating expenses: Selling expenses 197,350$ General and administrative exp. 78,500 Depreciation expense 17,500 293,350 Income from operations 140,100 Other revenues and gains: Interest income 62,187 Gain on sale of plant assets 24,600 86,787 Other expenses and losses: Interest expense 27,000 Loss on sale of investments 9,000 (36,000) Income before taxes 190,887 Income tax expense 62,500 Net income 128,387$

Learning Objective 9-8: Discuss the meaning and significance of each of the unusual or infrequently occurring items that may appear on the income statement.


StatementofCashFlows

Provides relevant information about the cash receipts and cash payments of an enterprise

during a period. This statement shows why cash and cash equivalents changed during the period

by reporting net cash provided or used by . . .

OperatingActivities

�InvestingActivities

�FinancingActivities

�

Learning Objective 9-9: Describe the purpose and outline the general format of the statement of cash flows.9- 22


CashInflowsandOutflowsInvesting ActivitiesOperating Activities Financing Activities

Sale of operational assetsSale of investmentsCollections of loans

Cash received from revenues

Issuance of stockIssuance of bonds

and notes

Enterprise

Purchase of operational assetsPurchase of investments

Loans to others

Cash paid for expenses

Payment of dividendsRepurchase of stockRepayment of debt

Cash OutflowsLearning Objective 9-9: Describe the purpose and outline the general format of the statement of cash flows.


ItemsNotAffectingCashYou can see below that depreciation and amortization do not affect cash. Net income is reduced by these items, but cash

flows remain unaffected.

Learning Objective 9-9: Describe the purpose and outline the general format of the statement of cash flows.9- 24


CashFlowsfromInvestingandFinancingActivities

1. Investing activities relate primarily to the purchase and sale of noncurrent assets, such as land, buildings, or equipment.

2. Investments in debt or equity securities of other entities are also shown as investing uses.

3. The lending of money and subsequent collection of loans are considered investing activities as well.

Learning Objective 9-10: Illustrate the difference between the direct and indirect methods of presenting cash flows from operating activities.

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CashFlowsfromOperatingActivities

Net Income 15,020$ Add (Deduct) items not affecting cash: Depreciation expense 5,000 Increase in accounts payable 4,600 Noncontrolling interest in subsidiaries25,000 Gain on sale of land (17,250) Increase in accounts receivable (3,000) Increase in inventory (2,000) Net Cash Flow from Operations 27,370$

DirectPresentation

Cash Flows from Operating Activities: Cash received from customers 175,000$ Cash paid to suppliers 120,000 Cash paid for operating expenses 27,630 Cash flows from operating activities 27,370

Cash Flows from Investing Activities:

Proceeds from sale of equipment 43,000

Cash Flows from Financing Activities:

Proceeds from sale of stock 50,000$ Principal paid on bonds (100,000) Principal paid on notes (10,000) (60,000) Net cash increase for the period 10,370 Add: Beginning cash balance 21,000 Ending cash balance 31,370$

Supplemental Reconciliation

Note that net cash flow from operations and cash flows from operating activities reconcile.

Learning Objective 9-10: Illustrate the difference between the direct and indirect methods of presenting cash flows from operating activities.9- 26


StatementofCashFlows

Net income 15,020$

Add (Deduct) items not affecting cash: Depreciation expense 5,000 Increase in accounts payable 4,600 Noncontrolling interest in subsidiaries 25,000 Gain on sale of land (17,250) Increase in accounts receivable (3,000) Increase in inventory (2,000) Net cash flows from operations 27,370 Cash Flows from Investing Activities: Proceeds from sale of equipment 43,000Cash Flows from Financing Activities: Proceeds from sale of Stock $50,000 Principal paid on bonds (100,000) Principal paid on notes (10,000) (60,000) Net cash flows for the period 10,370 Add: Beginning cash balance 21,000 Ending cash balance 31,370

Indirect Presentation

About 99% of major corporations

use the indirect method of

presentation!

Learning Objective 9-10: Illustrate the difference between the direct and indirect methods of presenting cash flows from operating activities.

The indirect presentation of the statement of cash flows begins with net income and

calculates net cash from operating activities in the

same manner as the reconciliation used with the

direct method.


InterpretingtheStatementofCashFlows

A business entity should have positive cash flows from operating activities. If operating activities do not generate cash, the entity must look to outside parties for funds to meet its day-to-day activities.

Learning Objective 9-11: Summarize why the statement of cash flows is significant to financial analysts and investors.9- 28


EndofChapter9

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