1. Income Statement Chapter 4

2. What is Income Statement? What is the major difference between Income Statement and Balance Sheet?

3. Income Statement Balance Sheet Presents the revenues And expenses and resulting net income Or net loss For a specific Period of time Reports the assets, liabilities, and owner’s equity At a specific date

4. Usefulness of the income Statement  Evaluate the past performance of the enterprise  Predict future performance  Assess the risk of achieving future cash flows

5. Limitations of the Income Statement  Items that might be relevant but cannot be reliably measured are not reported  Some numbers depend on accounting methods used  Some numbers depend on judgments and estimates

6. Format of the Income Statement  Gross Profit is the excess of net sales over the cost of goods sold.  Net Income is the amount by which revenues exceed expenses.  Net Loss is the amount by which expenses exceed revenues.  Revenue is the gross increase in owner’s equity resulting from business activities entered into for the purpose of earning income.  Expense is the cost of assets consumed or services used in the process of earning revenue.  Net sales “sales less sales returns and allowance and sales discount”  Cost of goods sold is the total cost of merchandise sold during the period.

7. Elements of income statement  Revenues  Expenses  Gains  Losses

8. Single-Step Income Statement Two groups exist  Expenses are deducted from revenues to arrive at net income or net loss  Income tax is reported separately as the last item before net income to indicate its relationship to income before income tax Revenues Expenses

9. Dan Deines Company Dan Deines Company Income Statement Income Statement For the year ended Dec 31, 2004 For the year ended Dec 31, 2004 Revenues Net Sales 2,972,413 Net Sales 2,972,413 Dividend Revenue 98,500 Dividend Revenue 98,500 Rental Revenue 72,910 Rental Revenue 72,910 Total Revenues 3,143,823 Total Revenues 3,143,823Expenses Cost of Goods Sold 1,982,542 Cost of Goods Sold 1,982,542 Selling Expenses 453,028 Selling Expenses 453,028 Administrative Expenses 350,771 Administrative Expenses 350,771 Interest Expense 126,060 Interest Expense 126,060 Income Tax Expense 66,934 Income Tax Expense 66,934 Total Expenses 2,979,489 Total Expenses 2,979,489 Net Income 164,489 Net Income 164,489 Earning per common share 1.74 Earning per common share 1.74

10. Multiple-Step Income Statement It provides more useful information because: 1.It separates operating and non-operating activities. 2.It classifies expenses by function. 3.It allows instant comparisons and ratio computations which evaluate performance of the company

11. Dan Deines Company Dan Deines Company Income Statement Income Statement For the year ended Dec 31, 2004 For the year ended Dec 31, 2004 Revenues Sales 3,053,081 Sales 3,053,081 Less: sales discount 24,241 Less: sales discount 24,241 sales returns and allowance 56,427 (80,668) sales returns and allowance 56,427 (80,668) Net Sales Revenues 2,972,413 Net Sales Revenues 2,972,413 Cost of Goods Sold Merchandise inventory, Jan 1, 2004 (beginning inventory) 461,219 Merchandise inventory, Jan 1, 2004 (beginning inventory) 461,219 Purchases 1,989,693 Purchases 1,989,693 Less: Purchase discount 10,270 Less: Purchase discount 10,270 Purchase returns and allowance 9,000 Purchase returns and allowance 9,000 Net Purchases 1,970,423 Net Purchases 1,970,423 Add: Freight and transportation-in 40,612 Add: Freight and transportation-in 40,612 Cost of Goods Purchased 2,011,035 Cost of Goods Purchased 2,011,035 Cost of goods available for sale 2,472,254 Cost of goods available for sale 2,472,254 Less: Inventory, Dec 31 489,713 Less: Inventory, Dec 31 489,713 Cost of goods sold (1,982,541) Cost of goods sold (1,982,541) Gross Profit on sales 989,872 Gross Profit on sales 989,872

12. Gross Profit on sales 989,872 Operating Expenses Selling expenses Selling expenses Sales commissions 202,644 Sales commissions 202,644 Sales office salaries 59,200 Sales office salaries 59,200 Advertising expense 38,315 Advertising expense 38,315 Freight-out and transportation 41,209 Freight-out and transportation 41,209 Shipping supplies and expense 24,712 366,080 Shipping supplies and expense 24,712 366,080 Administrative expenses Officers’ salaries 247,200 Officers’ salaries 247,200 Legal and professional services 23,721 Legal and professional services 23,721 Utilities expense 23,275 Utilities expense 23,275 Insurance expense 17,029 Insurance expense 17,029 Depreciation of building 27,064 Depreciation of building 27,064 Depreciation of office equipment 16,000 Depreciation of office equipment 16,000 Postage and stationery 19,663 Postage and stationery 19,663 Travel and entertainment 48,940 Travel and entertainment 48,940 Tel and internet expense 12,215 Tel and internet expense 12,215 Miscellaneous office expense 2,611 437,719 (803,799) Miscellaneous office expense 2,611 437,719 (803,799) Income from Operations 186,073

13. Other revenues and gains Dividend revenue 98,500 Dividend revenue 98,500 Gain on sale of assets 20,910 Gain on sale of assets 20,910 Rental revenue 50,000 171,410 Rental revenue 50,000 171,410 357,483 357,483 Other expenses and losses Loss on sale of investments 20,000 Loss on sale of investments 20,000 Interest on bonds and notes 106,060 (126,060) Interest on bonds and notes 106,060 (126,060) Income before income tax 231,423 Income tax (66,934) Income tax (66,934) Net income for the year 164,489 Earnings per common share 1.74

14. Income Statement Sections 1- Operating Section A- Sales or Revenue Usually presented as sales minus sales discounts, returns, and allowances. B- Cost of Goods represents the amount a product cost you. C- Selling expenses represent expenses needed to sell products (e.g., sales salaries and commissions, advertising, freight, shipping, depreciation of sales equipment). D- General and administrative expenses represent expenses to manage the business (e.g., officer salaries, legal and professional fees, utilities, insurance, depreciation of office building and equipment, stationery supplies)

15. 2- Non-operating section A- Other revenues or gains - revenues and gains from other than primary business activities (e.g. rent, patents). It also includes unusual gains and losses that are either unusual or infrequent, but not both (e.g. sale of securities or fixed assets). B- Other expenses or losses - expenses or losses not related to primary business operations. 3- Income Tax 4- Irregular items A- Discontinued operations (e.g. Shifting business location, stopping production temporarily).  Discontinued operations are classified as a separate items shown in a separate section in the income statement after continuing operations but before extraordinary items.

16. B- Extraordinary items - unusual (abnormal) and infrequent, for example, unexpected nature disaster, expropriation, prohibitions under new regulations. Note: nature disaster might not qualify depending on location.  Separate section in the income statement entitled “Extraordinary items” between discontinued operations and changes in principles. C- Changes in accounting principle - for example, changing method of computing depreciation from straight-line to sum-of-the- years'-digits. However, changes in estimates (e.g. estimated useful life of a fixed asset) do not qualify.  The effect on net income of adopting the new accounting principle should be disclosed as a separate item following extraordinary items in the income statements. “between extraordinary items and net income”

17. 5- Earnings per share Net Income – Preferred Dividends = Earnings per Share Net Income – Preferred Dividends = Earnings per Share Weighted Average of Common Weighted Average of Common Shares Outstanding Shares Outstanding EPS is “the net income earned by each share of outstanding common stock”. Outstanding stock is “capital stock that has been issued and is being held by stockholders”. Dividend is “a distribution by a corporation to its stockholders on proportional basis”.

18. Summary Income before income tax Income tax Discontinued operations Extraordinary items Changes in principles Net income EPS

19. Exercise Presented below are selected ledger accounts of Garden Corporation at Dec 31, 2004 Sales 3,040,000 Depreciation of Furniture 15,000 Sales discount 40,000 Sales commissions 17,000 Freight-out 12,000 Miscellaneous expense 3,000 Officers’ salaries 120,000 Loss on sale of assets 6,000 Inventory, Jan 1, 2004 40,000 Insurance expense 4,000 Loss due to earthquake 275,200 Tel expense 5,000 Purchases 2,020,000 Advertising expense 8,000 Gain on sales of investments 200,000 Rent expense 30,000 Purchase returns and allowance 20,000 Freight-in 8,000 Inventory, Dec 31 88,000 Instructions Prepare the income statement for 2004. Assume that 100,000 shares of common stock are outstanding. And dividends applicable to preferred stock SR10,000.

20. Garden Corporation Income Statement For the year ended Dec 31, 2004 Revenues Sales 3,040,000 Less: sales discount 40,000 (40,000) Net Sales Revenues 3,000,000 Cost of Goods Sold Inventory, Jan 1, 2004 40,000 Purchases 2,020,000 Less: Purchase returns and allowance 20,000 Net Purchases 2,000,000 Add: Freight-in 8,000 Cost of Goods Purchased 2,008,000 Cost of goods available for sale 2,048,000 Less: Inventory, Dec 31 88,000 Cost of goods sold (1,960,000) Gross Profit on sales 1,040,000

21. Garden Corporation Income Statement For the year ended Dec 31, 2004 Gross Profit on sales 1,040,000 Operating Expenses Selling expenses Sales commissions 17,000 Advertising expense 8,000 Freight-out 12,000 37,000 Administrative expenses Officers’ salaries 120,000 Insurance expense 4,000 Depreciation of Furniture 15,000 Rent expense 30,000 Tel expense 5,000 Miscellaneous expense 3,000 177,000 (214,000) Income from Operations 826,000

22. Garden Corporation Income Statement For the year ended Dec 31, 2004 Income from Operations 826,000 Other revenues and gains Gain on sale of investments 200,000 1,026,000 Other expenses and losses Loss on sale of assets (6,000) Income before income tax 1,026,000 Income tax (20%) (205,200) Income before Extraordinary items 820,800 Extraordinary items: Loss due to earthquake (275,200) Net income for the year 545,600 Earnings per common share 5.3