Reporting Earnings and Financial Position Chapter F4 Reporting Earnings and Financial Position Electronic Presentation by Douglas Cloud Pepperdine University

Once you have completed this chapter, you should be able to: Objectives 1. Identify the primary financial statements issued by businesses. 2. Explain information presented on a company’s income statement. 3. Explain information presented on a company’s balance sheet. 4. Explain information presented on a company’s statement of stockholders’ equity. Once you have completed this chapter, you should be able to: Continued

Objectives 5. Identify some of the primary limitations of financial statements.

Objective 1 Identify the primary financial statements issued by businesses.

The Purpose of Financial Statements Most business organizations prepare three financial statements to report general-purpose accounting information: 1. An income statement 2. A balance sheet 3. A statement of cash flows

Sometimes called an earnings statement... Income Statement Sometimes called an earnings statement... …or a profit and loss (P & L) statement. An income statement reports an organization’s revenues and expenses for a fiscal period.

Balance Sheet The balance sheet reports the balances of the asset, liability, and owners’ equity accounts at a particular date. …or as a statement of financial condition. Sometimes referred to as a statement of financial position…

Statement of Cash Flows This statement enables creditors, investors, and other users to assess a company’s ability to meet its cash requirements.

Statement of Stockholders’ Equity This statement reports changes in a corporation’s stockholders’ equity for a fiscal period.

Objective 2 Explain information presented on a company’s income statement.

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net income $ 52,990 Earnings per share Average number of common shares 4,000 Sales revenue is revenue from sales of goods and services. $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 Gross profit is a measure of how much a company earned directly from the sale of its products during the current fiscal period. Gross profit is the difference between the selling price of goods or services sold during a period and the cost of the goods or services sold. $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 …and that are not directly associated with specific goods or services. Operating expenses are costs of resources consumed as part of operating activities during a fiscal period… $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Operating income is the excess of gross profit over operating expenses. Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Other revenues and expenses are not directly related to a company’s primary operating activities. Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 These are considered non-operating items and are reported following operating income. Here we see Interest Expense, which is a common non-operating item. Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Most corporations pay income taxes on their earnings. Mom’s Cookie Company paid 30 percent of taxable income ($75,700 x .30 = $22,710). Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 Net income is not cash $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 Net income is the amount of profit earned by a company during a fiscal period. $ 13.25

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Earnings per share is a measure of the earnings performance of each share of common stock during a fiscal period. Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 $ 13.25

Average Number of Shares Outstanding Mom’s Cookie Company issued 1,000 shares on January 1 and 9,000 shares on September 1. 1,000 x 8/12 = 667 10,000 x 4/12 = 3,333 Average 4,000

Earnings per Share EPS = EPS = $13.25 (rounded) Earnings per share of $13.25 for Mom’s Cookie Company was calculated as follows: $52,990 net income 4,000 average shares EPS = $13.25 (rounded) EPS =

For the Month Ended December 31, 2004 Mom’s Cookie Company Income Statement For the Month Ended December 31, 2004 Exhibit 1 Sales revenue $686,400 Cost of goods sold (457,600) Gross profit 228,800 Selling, general, and administrative expenses (148,300) Operating income 80,500 Interest expense (4,800) Pretax income 75,700 Income taxes (22,710) Net Income $ 52,990 Earnings per share Average number of common shares 4,000 $ 13.25

Income Statement for Krispy Kreme Exhibit 2

There are a number of new items listed, such as Equity loss in joint venture and Minority interest. These accounts are analyzed in a more advanced accounting course. Krispy Kreme’s income statement is a consolidated statement because it includes a number of companies owned by the corporation. Also note that Krispy Kreme reported two sets of earnings per share numbers, basic and diluted earnings per share.

Objective 3 Explain information presented on a company’s balance sheet.

LEARNING NOTE An organization’s operating cycle is the period from the time cash is used to acquire or produce goods until these goods are sold and cash is received.

Mom’s Cookie Company Account Balances At December 31, 2004 Exhibit 3 Assets Current assets: Cash $ 10,680 Accounts receivable 8,570 Merchandise inventory 23,600 Supplies 690 Prepaid rent 2,000 Total current assets 45,540 Property and equipment, at cost 215,660 Accumulated depreciation (25,500) Total assets $235,700 Continued

Exhibit 3 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 9,610 Unearned revenue 4,250 Interest payable 650 Notes payable, current portion 5,000 Total current liabilities 19,510 Notes payable, long-term 73,200 Total liabilities 92,710 Stockholders’ equity: Common stock, 10,000 shares issued 100,000 Retained earnings 42,990 Total stockholders’ equity 142,990 Total liabilities and stockholders’ equity $235,700

Mom’s Cookie Company Account Balances At December 31, 2004 Exhibit 3 Assets Current assets: Cash $ 10,680 Accounts receivable 8,570 Merchandise inventory 23,600 Supplies 690 Prepaid rent 2,000 Total current assets 45,540 Property and equipment, at cost 215,660 Accumulated depreciation (25,500) Total assets $235,700

Balance Sheet Current assets are cash or other resources that management expects to convert to cash or consume during the next fiscal year. Liquid assets are resources that can be converted to cash in a relatively short period.

Mom’s Cookie Company Account Balances At December 31, 2004 Exhibit 3 Assets Current assets: Cash $ 10,680 Accounts receivable 8,570 Merchandise inventory 23,600 Supplies 690 Prepaid rent 2,000 Total current assets 45,540 Property and equipment 215,660 Accumulated depreciation (25,500) Total assets $235,700

Balance Sheet Property and equipment (often called fixed assets or plant assets) are long-term tangible assets that are used in a company’s operations rather than being held for resale. The process of allocating the cost of natural resources to expenses is known as depletion. The process of allocating the cost of plant and equipment to expenses is known as depreciation.

Balance Sheet Current liabilities are those obligations that management expects to fulfill during the next fiscal year. Accounts, wages, interest, unearned revenues, and income taxes payable all fit in this category.

Exhibit 3 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 9,610 Unearned revenue 4,250 Interest payable 650 Notes payable, current portion 5,000 Total current liabilities 19,510 Notes payable, long-term 73,200 Total liabilities 92,710 Stockholders’ equity: Common stock, 10,000 shares issued 100,000 Retained earnings 42,990 Total stockholders’ equity 142,990 Total liabilities and stockholders’ equity $235,700

Balance Sheet Long-term liabilities are those obligations that are not classified as current liabilities. Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 9,610 Unearned revenue 4,250 Interest payable 650 Notes payable, current portion 5,000 Total current liabilities 19,510 Notes payable, long-term 73,200 Exhibit 3

Current Assets – Current Liabilities Balance Sheet The difference between current asset and current liabilities is known as working capital. Current Assets – Current Liabilities Current assets $45,540 Current liabilities 19,510 Working capital $26,030 Mom’s Cookie Company

Current Assets ÷ Current Liabilities Balance Sheet The ratio of current asset and current liabilities is known as working capital ratio. Current Assets ÷ Current Liabilities Current assets $45,540 Current liabilities $19,510 Mom’s Cookie Company = 2.33

Balance Sheet Stockholders’ equity includes (1) amounts paid by owners to a corporation for the purchase of shares of stock and (2) retained earnings, profits reinvested in the corporation. Stockholders’ equity: Common stock, 10,000 shares issued 100,000 Retained earnings 42,990 Total stockholders’ equity 142,990 Total liabilities and stockholders’ equity $235,700

Balance Sheet for Krispy Kreme Exhibit 4

Balance Sheet for Krispy Kreme Exhibit 4

Other Balance Sheet Content Other Current Assets Short-term investments are stocks or debt of other companies that are expected to be sold in the near future. Allowances for Doubtful Accounts is an account that is used to report the estimated losses resulting from selling on credit and customers being unable to pay.

Other Balance Sheet Content Other Long-Term Assets Intangible assets are long-term legal rights resulting from the ownership of patents, copyrights, trademarks, and similar items. Long-term investments occur when a company lends money to or purchases stock issued by other organizations and does not intend to sell those investments in the coming fiscal year.

Other Balance Sheet Content A careful review of notes to the financial statements sometimes is important for a proper understanding of the items reported by a company.

Other Balance Sheet Content Other Long-Term Liabilities Deferred taxes represent income tax expenses that have not been paid and will not be paid during the coming year. Minority interest represents the portion of a corporation’s subsidiaries not owned by the parent corporation.

Other Balance Sheet Content Stockholders’ Equity The number of shares of common stock authorized is the maximum number of shares the company can issue under the current charter.

Other Balance Sheet Content Comprehensive Income Comprehensive income is the change in a company’s owners’ equity during a period that is the result of all non-owner transactions and activities.

Objective 4 Explain information presented on a company’s statement of stockholders’ equity.

The Statement of Stockholders’ Equity The statement of stockholders’ equity provides information about changes in owners’ equity for a corporation during a fiscal period.

Changes in Corporate Equity Exhibit 5

The Statement of Stockholders’ Equity Dividends are a reduction in Retained Earnings and are reported on the statement of stockholders’ equity.

The Statement of Stockholders’ Equity Income Statement Net income Statement of Stockholders’ Equity Beginning stockholders’ Equity + Net income – Dividends + Stock issued – Stock repurchased Ending stockholders’ equity Balance Sheet Stockholders’ equity

Interrelationships Among Financial Statements Amounts on the Balance Sheet Beginning of Fiscal Period Changes Reported on the Income Statement and Statement of Cash Flows + – Amounts on the Balance Sheet End of Fiscal Period =

Interrelationships Among Financial Statements The relationship among financial statements in which the numbers on one statement explain numbers on other statements is called articulation.

Objective 5 Identify some of the primary limitations of financial statements.

Limitations of Financial Statements 1. Many of the numbers reported in financial statements result from estimates and allocations.

Limitations of Financial Statements 2. Use of historical costs reports assets and liabilities at the purchase or exchange price at the time acquired or incurred.

Limitations of Financial Statements 3. There is no guarantee that all important transactions are fully reported in a company’s financial statements.

Limitations of Financial Statements 4. Certain types of resources and costs, such as well-trained workers and skilled managers, are not reported in the financial statements.

Limitations of Financial Statements 5. Financial statement information is not always timely.

CHAPTER F4 THE END