2. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 1 Chapter 4 Income Statement and Statement of Owners’ Equity

3. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 2 Learning Objective 1 Prepare a basic income statement and describe the information it provides.

4. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 3 Introduction to the Income Statement The income statement is a financial tool that provides information about a company’s past performance.

5. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 4 The Accounting Elements 1. Assets 1. Assets 2. Liabilities 2. Liabilities 3. Equity 3. Equity 4. Investment by owners 4. Investment by owners 5. Distributions to owners 5. Distributions to owners 6. Comprehensive income 6. Comprehensive income 7. Revenues 7. Revenues 8. Expenses 8. Expenses 9. Gains 9. Gains 10. Losses

6. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 5 The Accounting Elements Revenues are inflows or other enhancements of assets to an entity. They result from delivering or producing goods, rendering services, or other activities that constitute the entity’s major or central operations.

7. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 6 The Accounting Elements Expenses are outflows or other using up of assets. They result from delivering or producing goods, rendering services, or other activities that constitute the entity’s major or central operations.

8. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 7 The Income Statement Revenues – Expenses = Net income (or Net loss)

9. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 8 The Income Statement Tiffany & Co. Income Statement For the Year Ended January 31, 2001 (in thousands) Net sales$1,668,056 Cost of sales 719,642 Gross profit$ 948,414 Selling, general, and administrative expenses 621,018 administrative expenses 621,018 Earnings from operations$ 327,396 Interest expense and financing cost –16,207 Other income, net 6,452 Earnings before income taxes$ 317,641 Provision for income taxes 127,057 Net earnings$ 190,584

10. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 9 Learning Objective 2 Distinguish between single-step and multiple-step income statements.

11. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 10 Single-Step Income Statement Revenues Net income –= Expenses

12. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 11 Single-Step Income Statement Jessica’s Beauty Supply, Inc. Income Statement For the Month Ended January 31, 2003 Revenues: Sales$3,230 Rent revenue 990 Total revenues$4,220 Expenses: Cost of goods sold$ 955 Wages expenses 675 Utilities expense 310 Interest expense 120 Total expenses 2,060 Income before income tax$2,160 Income tax expense 540 Net income$1,620

13. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 12 Gross margin (Sales revenues – Cost of goods sold) Operating income Operating expenses –= Multiple-Step Income Statement Add:Other revenues and gains Less:Other expenses and losses =

14. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 13 Multiple-Step Income Statement Income before income tax Net Income – = Income tax expense

15. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 14 Multiple-Step Income Statement Jessica’s Beauty Supply, Inc. Income Statement For the Month Ended January 31, 2003 Sales$3,230 Less: Cost of goods sold 955 Gross margin$2,275 Operating expenses: Wages expenses$675 Utilities expense 310 Total operating expenses 985 Operating income$1,290 Other revenues: Rent 990 Other expenses: Interest – 120 Income before income tax$2,160 Income tax expense 540 Net income$1,620

16. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 15 Learning Objective 3 Explain the impact of net income or net loss on owners’ equity.

17. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 16 Net Income as an Increase in Owners’ Equity A company’s equity will change by the amount of its net income or loss. A company that has income on their income statement will have a greater amount of retained earnings.

18. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 17 Distribution to Owners Distributions to owners decrease ownership interest (or equity) in an enterprise. Distributions to owners represent a return on the investment they made.

19. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 18 Learning Objective 4 Prepare a basic statement of owners’ equity for a proprietorship, partnership, and corporation and describe the information the statement provides.

20. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 19 Introduction to the Statement of Owners’ Equity The statement of owners’ equity is a bridge between the income statement and the balance sheet. Statement of owner’s equity IncomeStatement

21. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 20 Introduction to the Statement of Owners’ Equity

22. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 21 Proprietorships – Statement of Capital Jessica’s Beauty Supply Statement of Capital For the Month Ended January 31, 2003 Jessica, capital, January 1, 2003$ 0 Add: Contributions by owner 10,000 Net income 2,160 $12,160 $12,160 Deduct: Drawings 500 Jessica, capital, January 31, 2003$11,660

23. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 22 Statement of Partners’ Capital Jessica and Stephanie’s Beauty Supply Statement of Partners’ Capital For the Month Ended January 31, 2003 Jessica, capital, January 1, 2003$ 0 Add:Jessica contribution 6,000 Net income 1,296 Less:Drawings – 400 Jessica, capital, January 31, 2003$ 6,896 Stephanie, capital, January 1, 2003$ 0 Add:Stephanie contribution 4,000 Net income 864 Less:Drawings – 100 Jessica, capital, January 31, 2003 4,764 Total partners’ capital, January 31, 2003$11,660

24. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 23 Statement of Stockholders’ Equity Jessica’s Beauty Supply, Inc. Statement of Stockholders’ Equity For the Month Ended January 31, 2003 Balance, January 1, 2003$ 0$0$ 0 Common stock issued 4,000 Preferred stock issued 20,000 1,000 Net income Preferred dividends Common dividends Balance, January 31$20,000$1,000$ 4,000 Preferred Stock Additional Paid-in Capital Preferred Common Stock

25. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 24 Statement of Stockholders’ Equity Jessica’s Beauty Supply, Inc. Statement of Stockholders’ Equity For the Month Ended January 31, 2003 Balance, January 1, 2003$ 0$0$ 0 Common stock issued 36,000 40,000 Preferred stock issued 21,000 Net income 1,620 1,620 Preferred dividends (100) (100) Common dividends (400) (400) Balance, January 31$36,000$1,120$62,120 Additional Paid-in Capital Common Retained Earnings Total Stock- holders’ Equity

26. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 25 Statement of Retained Earnings Jessica’s Beauty Supply, Inc. Statement of Retained Earnings For the Month Ended January 31, 2003 Retained earnings, January 1, 2003$0 Add: Net income 1,620 $1,620 Deduct: Preferred Dividends(100) Common Dividends(400) 500 Common Dividends(400) 500 Retained earnings, January 31, 2003$1,120

27. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 26 Learning Objective 5 Define drawings and dividends and discuss the circumstances under which they are paid.

28. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 27 Proprietorships and Partnerships – Drawings The distributions to the owners of proprietorships and partnerships are called drawings or withdrawals. Partnership agreements may state explicitly when and in what amounts partners may take withdrawals.

29. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 28 Corporations – Dividends Distributions to owners of a corporation are called dividends. Dividend distributions to shareholders must be proportionate to the number of shares they own.

30. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 29 Cash Dividends on Common Stock Sufficient retained earnings To be able to pay a cash dividend, a corporation must have two things… Sufficientcash

31. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 30 Effect of Net Income, Loss, and Dividends on Retained Earnings Year2001 2002 2003 2004 2005 Beginning balance$ 0$ 800$1,300$ 700$1,150 Net income (loss) 800 1,000 (100) 950 400 $800$1,800$1,200$1,650$1,550 Dividends 0 – 500 – 500 – 500 – 500 Ending balance$800$1,300$ 700$1,150$1,050

32. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 31 Dividend Dates Date of declaration Date of record Date of Payment April 30, 2002 May 10, 2002 June 10, 2002

33. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 32 Learning Objective 6 Describe the articulation of income statements, statements of owners’ equity, and balance sheets.

34. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 33 Articulation Articulation (or connection) is the link between the income statement and the balance sheet. Income statement Statement of owners’ equity Balance sheet

35. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 34 Articulation Among Financial Statements Jessica’s Beauty Supply, Inc. Income Statement For the Month Ended January 31, 2003 Sales$3,230 Cost of goods sold 955 Gross margin$2,275 Total operating expenses 985 Operating income$1,290 Other revenues less expenses 870 Income before income tax$2,160 Income tax expense 540 Net income$1,620

36. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 35 Articulation Among Financial Statements Statement of Stockholders’ Equity For the Month Ended January 31, 2003 Preferred stock$20,000 Additional paid-in capital preferred 1,000 Common stock 4,000 Additional paid-in capital common 36,000 Retained earnings 1,120 Total stockholders’ equity$62,120 Balance, January 1, 2003$ 0 Common stock issued 40,000 Preferred stock issued 21,000 Net income 1,620 Preferred dividends (100) Common dividends (400) Balance, January 31, 2003$62,120

37. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 36 Articulation Among Financial Statements Assets:Liabilities: Cash$ 82,120 Notes payable$ 50,000 Cash$ 82,120 Notes payable$ 50,000 Land 50,000 Bonds payable 200.000 Land 50,000 Bonds payable 200.000 Building 120,000Total liabilities$250,000 Building 120,000Total liabilities$250,000 Equipment 35,000Stockholders’ equity: Equipment 35,000Stockholders’ equity: Truck 25,000 Preferred stock 20,000 Truck 25,000 Preferred stock 20,000 Paid-in capital – preferred 1,000 Paid-in capital – preferred 1,000 Common stock 4,000 Common stock 4,000 Paid-in capital – common 36,000 Paid-in capital – common 36,000 Total contributed capital$ 61,000 Total contributed capital$ 61,000 Retained earnings 1,120 Retained earnings 1,120 Total stockholders’ equity$ 62,120 Total liabilities and Total assets$312,120 stockholders’ equity$312,120 Balance Sheet January 31, 2003

38. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 37 Learning Objective 7 Explain the content and purpose of the operating activities section of the statement of cash flows.

39. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 38 Statement of Cash Flows for Jessica’s Beauty Supply, Inc. Statement of Cash Flows for Jessica’s Beauty Supply, Inc. Cash flows from operating activities: Cash collections from customers$3,230 Cash collections from customers$3,230 Cash received for rent 990 Cash received for rent 990 Cash paid for merchandise – 955 Cash paid for merchandise – 955 Cash paid for wages – 675 Cash paid for wages – 675 Cash paid for utilities – 310 Cash paid for utilities – 310 Cash paid for interest – 120 Cash paid for interest – 120 Cash paid for income taxes – 540 Cash paid for income taxes – 540 Net cash flows from operating activities$ 1,620 Cash flows from investing activities: Purchase of land– 50,000 Purchase of land– 50,000 Purchase of building–120,000 Purchase of building–120,000 Purchase of computer equipment– 35,000 Purchase of computer equipment– 35,000 Purchase of truck– 25,000 Purchase of truck– 25,000 Net cash flows from investing activities –230,000 For the Month Ended January 31, 2003

40. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 39 Statement of Cash Flows for Jessica’s Beauty Supply, Inc. Statement of Cash Flows for Jessica’s Beauty Supply, Inc. Net cash flows from operating activities$ 1,620 Net cash flows from investing activities –230,000 Cash flows from financing activities Sale of common stock 40,000 Sale of common stock 40,000 Sale of preferred stock 21,000 Sale of preferred stock 21,000 Borrowing on notes payable 50,000 Borrowing on notes payable 50,000 Sale of bonds200,000 Sale of bonds200,000 Cash paid for dividends – 500 Cash paid for dividends – 500 Net cash flows from financing activities 310,500 Increase in cash$ 82,120 Cash at the beginning of the period 00 Cash at the end of the period$ 82,120

41. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 40 Learning Objective 8 Use financial ratios to evaluate business profits.

42. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 41 Profitability Ratios The gross profit margin ratio expresses a company’s gross profit as a percentage of sales revenue. Gross profit margin ratio = Gross profit ÷ Net sales

43. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 42 Profitability Ratios What is the net profit margin ratio for Jessica’s Beauty Supply, Inc.? Net profit margin ratio = Net profit ÷ Net sales $1,620 ÷ $3,230 = 50.2%

44. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 43 Profitability Ratios The rate of return on assets ratio shows the amount of profit produced for a given level of assets. Rate of return on assets ratio = Net income ÷ Average total assets

45. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 44 Profitability Ratios Rate of return on common equity ratio = (Net income – Total preferred dividends) ÷ Average common stockholders’ equity Dividend payout ratio = Total cash dividends ÷ Net income

46. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 45 Profitability Ratios Earnings per share = (Net income – Total preferred dividends) ÷ Average common shares outstanding Price earnings ratio = Average market price per share of stock ÷ Earnings per share

47. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones4 - 46 End of Chapter 4