CHAPTER 9 The Income Statement and the Statement of Cash Flows
Income Statement Revenues 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.
Revenue Revenue is realized when the product or service has been exchanged for cash, claims to cash, or an asset that is readily convertible to a known amount of cash. Revenue isearnedwhen the firm has completed, or substantially completed, the activities it must perform to be entitled to the revenue benefits. Companies should disclose unusual revenue recognition methods, such as percentage-of-completion or installment methods.
Sales Revenue Matrix, Inc. sold $12,500 of inventory onopen accounts receivable.
Sales Revenue 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. Cash Discounts: A reduction in the amount owed by the customer to encourage prompt payment on account.
Merchandise Shipping Terms Buyer Seller FOB Shipping Point (Buyer Pays) FOB Destination (Seller Pays)
Gains/Losses Increases (gains) or decreases (losses) in an entity’s net assets resulting from nonoperating activities. Gains/losses are usually reported as other income and excluded from operating income.
Expenses Outflows or other using up of assets or incurrences of liabilities from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing central operations. • Some expenses are recognized concurrently with the revenues to which they relate (matching principle). • Some expenses are recognized in the period in which they are incurred (administrative salaries). • Some expenses result from an allocation of the cost of an asset to the period that is expected to benefit from the asset’s use (depreciation).
Cost of Goods Sold In a perpetual inventory system, cost of goods sold is determined for each sale. In a periodic inventory system, cost of goods sold is determined at the end of each accounting period as follows . . .
Perpetual System Matrix, Inc. sold merchandise inventory to a customer for $1,000 cash. The merchandise has a cost basis of $750 to Matrix.
Gross Profit Ratio = Gross Profit ÷ Net Sales Gross Profit Gross profit is the excess of sales revenue over cost of goods sold.
Setting Sales Price with GP Ratio Selling Price = Cost of Product ÷ (1 – GP rate) 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
Operating expenses are usually reported in the following classifications on the income statement: • Selling expenses. • General and administrative expenses. • Research and development expenses. Operating Expenses
Income Available to Common Shareholders Weighted-Average Common Shares Outstanding Basic EPS = Income Available to Common Shareholders = Net Income − Preferred Stock Dividends Earnings Per Share Matrix, Inc. reports net income of $3,672,000 in 2004. Matrix has 100,000 shares of $100 par value, 8%, cumulative preferred stock outstanding.
BasicEPS $3,672,000 − $800,0001,202,500 = = $2.39 Weighted-Average Shares
Earnings Per Share When a entity has options, convertible debt, 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 known as Diluted Earnings Per Share.
Income Statement Alternatives Single-Step Multiple-Step
Unusual Items Reported in Income • Discontinued operations • Extraordinary items • Cumulative effect of a change in accounting principle • Minority interest in earnings of subsidiaries
OperatingActivities InvestingActivities FinancingActivities Statement of Cash Flows Provide relevant information about the cash receipts and cash payments of an enterprise during a period. The statement shows why cash and cash equivalents changed during the period by reporting net cash provided or used by . . .
CASH INFLOWS Operating Activities Investing Activities Financing Activities Cash received from revenues Sale of operational assets Sale of investments Collections of loans Issuance of stock Issuance of bonds and notes Enterprise Cash paid for expenses Purchase of operational assets Purchase of investments Loans to others Payment of dividends Repurchase of stock Repayment of debt CASH OUTFLOWS
Cash Flows from Operating Activities DirectPresentation Supplemental Reconciliation
Items Not Affecting Cash You can see below that depreciation and similar items do not affect cash. Net income is reduced by depreciation expense, but cash flows remain unaffected.
Statement of Cash Flows Indirect Presentation About 98% of major corporation use the Indirect Method of Presentation!
Interpreting the Statement A business entity should have positive cash flows from operation activities. If operating activities do not generate cash, the entity must look to outside parties for funds to meet its day-to-day activities.