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Chapter 4

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  1. Chapter 4 Income Statement and Statement of Owners’ Equity

  2. Learning Objective 1 Prepare a basic income statement and describe the information it provides.

  3. Introduction to theIncome Statement The income statement is a financial tool that provides information about a company’s past performance.

  4. The Accounting Elements 1. Assets 2. Liabilities 3. Equity 4. Investment by owners 5. Distributions to owners 6. Comprehensive income 7. Revenues 8. Expenses 9. Gains 10. Losses

  5. The Accounting Elements Revenues 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.

  6. The Accounting Elements Expenses 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.

  7. The Income Statement Revenues Expenses Net income (or Net loss) – =

  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 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

  9. Learning Objective 2 Distinguish between single-step and multiple-step income statements.

  10. Single-Step Income Statement Revenues – Expenses = Net income

  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

  12. Add: Other revenues and gains Less: Other expenses and losses = Multiple-Step Income Statement Gross margin (Sales revenues – Cost of goods sold) – Operating expenses = Operating income

  13. Multiple-Step Income Statement Income before income tax – Income tax expense = Net Income

  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

  15. Learning Objective 3 Explain the impact of net income or net loss on owners’ equity.

  16. Net Income as an Increasein 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.

  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.

  18. Learning Objective 4 Prepare a basic statement of owners’ equity for a proprietorship, partnership, and corporation and describe the information the statement provides.

  19. Statement of owner’s equity Introduction to the Statementof Owners’ Equity The statement of owners’ equity is a bridge between the income statement and the balance sheet. Income Statement

  20. Introduction to the Statementof Owners’ Equity Beginning owners' equity + Contributions by owners + Net income – Distributions to owners = Ending owners' equity

  21. 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 Deduct: Drawings 500 Jessica, capital, January 31, 2003 $11,660 Proprietorships –Statement of Capital

  22. 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 Statement of Partners’ Capital

  23. Jessica’s Beauty Supply, Inc. Statement of Stockholders’ Equity For the Month Ended January 31, 2003 Preferred Stock Additional Paid-in Capital Preferred Common Stock 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 Statement ofStockholders’ Equity

  24. Statement ofStockholders’ Equity Jessica’s Beauty Supply, Inc. Statement of Stockholders’ Equity For the Month Ended January 31, 2003 Additional Paid-in Capital Common Retained Earnings Total Stock- holders’ Equity 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

  25. 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 Retained earnings, January 31, 2003 $1,120 Statement of Retained Earnings

  26. Learning Objective 5 Define drawings and dividends and discuss the circumstances under which they are paid.

  27. Proprietorships andPartnerships – 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.

  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.

  29. Cash Dividends onCommon Stock To be able to pay a cash dividend, a corporation must have two things… Sufficient retained earnings Sufficient cash

  30. Effect of Net Income, Loss, and Dividends on Retained Earnings Year20012002200320042005 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

  31. Dividend Dates April 30, 2002 Date of declaration Date of record May 10, 2002 June 10, 2002 Date of Payment

  32. Learning Objective 6 Describe the articulation of income statements, statements of owners’ equity, and balance sheets.

  33. 1 Income statement 2 Statement of owners’ equity 3 Balance sheet Articulation Articulation (or connection) is the link between the income statement and the balance sheet.

  34. 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 Articulation AmongFinancial Statements

  35. Articulation AmongFinancial Statements Statement of Stockholders’ Equity For the Month Ended January 31, 2003 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 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

  36. Articulation AmongFinancial Statements Balance Sheet January 31, 2003 Assets: Liabilities: Cash $ 82,120 Notes payable $ 50,000 Land 50,000 Bonds payable 200.000 Building 120,000 Total liabilities $250,000 Equipment 35,000 Stockholders’ equity: Truck 25,000 Preferred stock 20,000 Paid-in capital – preferred 1,000 Common stock 4,000 Paid-in capital – common 36,000 Total contributed capital $ 61,000 Retained earnings 1,120 Total stockholders’ equity $ 62,120 Total liabilities and Total assets $312,120 stockholders’ equity $312,120

  37. Learning Objective 7 Explain the content and purpose of the operating activities section of the statement of cash flows.

  38. Statement of Cash Flows for Jessica’s Beauty Supply, Inc. For the Month Ended January 31, 2003 Cash flows from operating activities: Cash collections from customers $3,230 Cash received for rent 990 Cash paid for merchandise – 955 Cash paid for wages – 675 Cash paid for utilities – 310 Cash paid for interest – 120 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 building –120,000 Purchase of computer equipment – 35,000 Purchase of truck – 25,000 Net cash flows from investing activities –230,000

  39. 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 preferred stock 21,000 Borrowing on notes payable 50,000 Sale of bonds 200,000 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

  40. Learning Objective 8 Use financial ratios to evaluate business profits.

  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

  42. Profitability Ratios Net profit margin ratio = Net profit ÷ Net sales What is the net profit margin ratio for Jessica’s Beauty Supply, Inc.? $1,620 ÷ $3,230 = 50.2%

  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

  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

  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

  46. End of Chapter 4