©2004 prentice hall business publishing introduction to financial accounting, 3e by werner/jones9 -...

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting , 3e by Werner/Jones9 - 1

Chapter 9Chapter 9

The Balance Sheet and IncomeStatement – A Closer Look


Learning Objective 1Learning Objective 1

Describe how the balance sheetand income statement were

developed as financial statements.


Development of the Balance Development of the Balance Sheet and Income Sheet and Income

StatementStatementThe balance sheet’s function as a financialThe balance sheet’s function as a financial

statement only emerged during thestatement only emerged during theRenaissance, around A.D. 1600.Renaissance, around A.D. 1600.

Accountants developed the incomeAccountants developed the incomestatement in the late 1800s.statement in the late 1800s.

By the 1930s, it became apparent thatBy the 1930s, it became apparent thatthe balance sheet and the incomethe balance sheet and the incomestatement are best used together.statement are best used together.


The Balance SheetThe Balance Sheet

Eliason and CompanyBalance Sheet

December 31, 2004

Total assetsTotal assets $1,566,800$1,566,800

LiabilitiesLiabilities $ 901,000$ 901,000Stockholders’ equityStockholders’ equity 665,800 665,800Total liabilities and stockholders’ equityTotal liabilities and stockholders’ equity $1,566,800$1,566,800



Explain the organization andpurpose of the classified

balance sheet.


The Classified Balance The Classified Balance SheetSheet

Eliason and CompanyBalance Sheet

December 31, 2004Assets:Assets:Current assets:Current assets: CashCash $ 100$ 100 Accounts receivableAccounts receivable 251,000 251,000 InventoryInventory 298,900 298,900 Prepaid expensesPrepaid expenses 50,000 50,000

Total current assetsTotal current assets $ 600,000$ 600,000Long-term investmentsLong-term investments 34,000 34,000Property, plant, and equipment:Property, plant, and equipment: LandLand $125,000$125,000 Plant and equipmentPlant and equipment $1,075,000$1,075,000 Less: Acc. depreciationLess: Acc. depreciation – 283,200– 283,200 Plant and equipment, netPlant and equipment, net 791,800 791,800

Total property, plant, and equipmentTotal property, plant, and equipment 916,800 916,800Intangible asset – copyrightIntangible asset – copyright 16,000 16,000Total assetsTotal assets $1,566,800$1,566,800



Liabilities:Liabilities:Current liabilities:Current liabilities: Accounts payableAccounts payable $501,000$501,000 Short-term note payableShort-term note payable 50,000 50,000

Total current liabilitiesTotal current liabilities $551,000$551,000Long-term liabilities:Long-term liabilities: Bonds payableBonds payable 350,000 350,000Total liabilitiesTotal liabilities $901,000$901,000



Stockholders’ equity:Stockholders’ equity:Contributed capital:Contributed capital: Common stock, $1 par value, 100,000Common stock, $1 par value, 100,000 authorized, 10,000authorized, 10,000

shares issued and outstanding:shares issued and outstanding: $ 10,000$ 10,000 Additional paid-in capitalAdditional paid-in capital 390,000 390,000Total contributed capitalTotal contributed capital $400,000$400,000Retained earningsRetained earnings 265,800 265,800Total stockholders’ equityTotal stockholders’ equity 665,800 665,800Total liabilities and stockholders’ equityTotal liabilities and stockholders’ equity $1,566,800$1,566,800

$1,566,800$1,566,800 = = $901,000$901,000 + + $665,800$665,800


AssetsAssets

Current assets are defined as assets that areCurrent assets are defined as assets that arecash already or are expected to become cash.cash already or are expected to become cash.

One yearOne year Operating cycleOperating cycle

Cash equivalents are marketable securitiesCash equivalents are marketable securitiesthat will be converted into cash within 90 days.that will be converted into cash within 90 days.


AssetsAssets

Long-term assets are expected to benefitLong-term assets are expected to benefitthe organization for more than one year.the organization for more than one year.

Long-termLong-terminvestmentsinvestments

Property, plant,Property, plant,and equipmentand equipment

IntangibleIntangibleassetsassets


LiabilitiesLiabilities

Current liabilities are those that requireCurrent liabilities are those that requiresettlement within one year or the currentsettlement within one year or the current

operating cycle, whichever is longer.operating cycle, whichever is longer.

Long-term liabilities are those that doLong-term liabilities are those that donot require settlement within onenot require settlement within one

year or the current operating cycle.year or the current operating cycle.


Examples of Current andExamples of Current andLong-Term AssetsLong-Term Assets

Long-TermLong-Term

Long-term investmentsLong-term investmentsProperty, plant, and equipmentProperty, plant, and equipmentIntangible assetsIntangible assetsOther long-term assetsOther long-term assets

CurrentCurrent

CashCashMarketable securitiesMarketable securitiesAccounts receivableAccounts receivableInventoryInventoryPrepaid expensesPrepaid expenses


Examples of Current andExamples of Current andLong-Term LiabilitiesLong-Term Liabilities

Long-Term Long-Term

Notes payableNotes payableMortgages payableMortgages payableBonds payableBonds payableOthersOthers

Current Current

Accounts payableAccounts payableNotes payableNotes payableAccrued expensesAccrued expensesUnearned revenueUnearned revenuePayable for:Payable for: Wages, taxes, interest, othersWages, taxes, interest, others Current portion of long-term debtCurrent portion of long-term debt


Owners’ EquityOwners’ Equity

Contributed capitalContributed capital The amount paid into theThe amount paid into thecompany by its ownerscompany by its owners

Retained earningsRetained earnings Earnings reinvestedEarnings reinvestedby the corporationby the corporation



Explain why recurring andnonrecurring items are

presented separately onthe income statement.


Organization of theOrganization of theIncome StatementIncome Statement

Eliason and CompanyEliason and CompanyIncome StatementIncome Statement

For the Year Ended December 31, 2004For the Year Ended December 31, 2004

RevenueRevenue $752,500$752,500Less: ExpensesLess: Expenses 840,400 840,400Net lossNet loss $ (87,900)$ (87,900)


Eliason and CompanyEliason and CompanyIncome StatementIncome Statement

Sales revenueSales revenue $752,500$752,500Less: Cost of goods soldLess: Cost of goods sold 352,800 352,800Gross profit on salesGross profit on sales $399,700$399,700Less operating expenses:Less operating expenses: SellingSelling $60,250$60,250 General and administrativeGeneral and administrative 96,250 96,250

Total operating expensesTotal operating expenses 156,500 156,500Operating incomeOperating income $243,200$243,200Less other expenses:Less other expenses: Interest expenseInterest expense 30,650 30,650Income before taxes and extraordinary itemIncome before taxes and extraordinary item $212,550$212,550Less income taxesLess income taxes 64,660 64,660Income before extraordinary itemIncome before extraordinary item $147,890$147,890Extraordinary loss (less taxes of $87,420)Extraordinary loss (less taxes of $87,420) –235,790–235,790Net lossNet loss $ (87,900) $ (87,900)


Nonrecurring ItemsNonrecurring Items

Nonrecurring items (net of tax)Nonrecurring items (net of tax)

– – Discontinued operationsDiscontinued operations– – Extraordinary itemsExtraordinary items

– – Cumulative effect of changesCumulative effect of changesin accounting principlesin accounting principles


Partial Income Statement for Partial Income Statement for Toy Box, Inc., Year Ended Toy Box, Inc., Year Ended

12/31/200512/31/2005Income from continuing operationsIncome from continuing operations $ 96,390$ 96,390Discontinued operations:Discontinued operations: Income from discontinued operationsIncome from discontinued operations ($118,800, less: Income taxes of $47,520)($118,800, less: Income taxes of $47,520) $71,280$71,280 Loss on disposal of discontinued operationsLoss on disposal of discontinued operations ($90,000, less: Income taxes of $36,000)($90,000, less: Income taxes of $36,000) –54,000–54,000 17,280 17,280Income before extraordinary item andIncome before extraordinary item and cumulative effect of a change incumulative effect of a change in accounting principleaccounting principle $113,670$113,670Extraordinary gain ($220,000, less: Taxes of $88,000)Extraordinary gain ($220,000, less: Taxes of $88,000) 132,000 132,000Income before cumulative effect of aIncome before cumulative effect of a change in accounting principlechange in accounting principle $245,670$245,670Cumulative effect of a change in accountingCumulative effect of a change in accounting principle ($62,000, less: Taxes of $24,800)principle ($62,000, less: Taxes of $24,800) – 37,200– 37,200Net incomeNet income $208,470$208,470



Interpret the net of taxdisclosure of discontinued

operations, extraordinary items,and accounting changes.


Income Tax DisclosureIncome Tax Disclosure

The accounting profession has decided thatThe accounting profession has decided thatthe only tax expense shown on the incomethe only tax expense shown on the income

statement as a separate line item will be thestatement as a separate line item will be theamount associated with continuing operations.amount associated with continuing operations.

Nonrecurring items on the income statementNonrecurring items on the income statementare shown “less income tax” or “net of tax.”are shown “less income tax” or “net of tax.”


Income Tax DisclosureIncome Tax Disclosure

Income from discontinued operations:Income from discontinued operations:$118,000 × 40% = $47,520 tax$118,000 × 40% = $47,520 tax

$118,000 – $47,520 tax = $71,280$118,000 – $47,520 tax = $71,280

Loss Loss on disposal of discontinued operation:on disposal of discontinued operation:$90,000 × 40% = $36,000 tax$90,000 × 40% = $36,000 tax

$90,000 – $36,000 tax savings = $54,000 loss$90,000 – $36,000 tax savings = $54,000 loss


Effect of Tax onEffect of Tax onGains and LossesGains and Losses

GainGain

Taxlessens

gain

Net oftaxgain

Totalgain

LossLossTax

lessensloss

Net oftaxlossTotal

loss


Discontinued OperationsDiscontinued Operations

Income or loss of a segment that is to beIncome or loss of a segment that is to beeliminated, and any gain or loss from theeliminated, and any gain or loss from the

actual disposal of that segment, are reportedactual disposal of that segment, are reportedas nonrecurring items on the income statement.as nonrecurring items on the income statement.

A A business segmentbusiness segment may be a portion of anmay be a portion of anentity representing either a separate majorentity representing either a separate major

line of business or a class of customer.line of business or a class of customer.


Extraordinary ItemsExtraordinary Items

An extraordinary item is an event that is bothAn extraordinary item is an event that is bothunusualunusual in nature and in nature and infrequentinfrequent in occurrence.in occurrence.

It can’t be just one or the other, it most be both.It can’t be just one or the other, it most be both.

Significant items that are either unusualSignificant items that are either unusualin nature in nature oror infrequent in occurrenceinfrequent in occurrence

are listed under other gains and losses.are listed under other gains and losses.

They should not be shown net of tax.They should not be shown net of tax.


Extraordinary ItemsExtraordinary Items

Although they are not necessarily unusual andAlthough they are not necessarily unusual andinfrequent, accounting rules require that anyinfrequent, accounting rules require that any

gain or loss resulting from extinguishmentgain or loss resulting from extinguishmentof debt must be reported as extraordinary.of debt must be reported as extraordinary.


Change in Accounting Change in Accounting PrinciplesPrinciples

This nonrecurring item can resultThis nonrecurring item can resultfrom either of two scenarios:from either of two scenarios:

The adoption of a newThe adoption of a newaccounting standardaccounting standard

Change from one acceptableChange from one acceptableaccounting method to anotheraccounting method to another


Change in Accounting Change in Accounting PrinciplesPrinciples

The cumulative effect of an accounting changeThe cumulative effect of an accounting changeis the total of the difference between the prioris the total of the difference between the priorincome a company actually reported, and theincome a company actually reported, and theincome the company income the company would havewould have reported if reported ifthe company had used the newly adoptedthe company had used the newly adopted

accounting principle all along.accounting principle all along.


Comprehensive IncomeComprehensive Income

Income from theIncome from theincome statementincome statement Other comprehensive incomeOther comprehensive income

Foreign currencyForeign currency

Certain pensionCertain pensionliabilitiesliabilities

Unrealized holdingUnrealized holdinggains and lossesgains and losses

Comprehensive incomeComprehensive income


Comprehensive IncomeComprehensive Income

A separate statement ofA separate statement ofcomprehensive incomecomprehensive income

A combined statement of incomeA combined statement of incomeand comprehensive incomeand comprehensive income

Comprehensive income includedComprehensive income includedin the statement of changesin the statement of changes

in stockholders’ equityin stockholders’ equity



Calculate earnings per share andCalculate earnings per share anddescribe how it is presenteddescribe how it is presented

on the income statement.on the income statement.


Stockholders’ Equity Section Stockholders’ Equity Section of Toy Box, Inc.’s Balance of Toy Box, Inc.’s Balance

SheetSheetDecember 31 2005 2004

Contributed Capital:Contributed Capital: 4% Preferred stock, $100 par value4% Preferred stock, $100 par value 5,000 shares authorized, issued,5,000 shares authorized, issued, and outstandingand outstanding $ 500,000$ 500,000 $ 500,000$ 500,000 Common stock, $10 par value,Common stock, $10 par value, Authorized shares: 100,000Authorized shares: 100,000 issued and outstanding:issued and outstanding: 2005: 90,000; 2004: 85,0002005: 90,000; 2004: 85,000 900,000 900,000 850,000 850,000 Additional paid-in capitalAdditional paid-in capital 450,000 450,000 390,000 390,000Total contributed capitalTotal contributed capital $1,850,000$1,850,000 $1,740,000$1,740,000Retained earningsRetained earnings 794,050 794,050 675,580 675,580Total stockholders’ equityTotal stockholders’ equity $2,644,050$2,644,050 $2,415,580$2,415,580


Earnings Per ShareEarnings Per Share

Basic earnings per shareBasic earnings per share is earnings per common is earnings per commonshare based on the average number ofshare based on the average number of

common shares outstanding during the year.common shares outstanding during the year.

Basic earnings per share =Basic earnings per share =(Net income – Preferred dividends)(Net income – Preferred dividends)

÷ Weighted average number of÷ Weighted average number ofcommon shares outstandingcommon shares outstanding



Assume that during 2005, Toy Box had 85,000Assume that during 2005, Toy Box had 85,000common shares outstanding for three monthscommon shares outstanding for three months

of the year and 90,000 shares outstandingof the year and 90,000 shares outstandingfor the remaining nine months.for the remaining nine months.

What is the weighted average numberWhat is the weighted average numberof common shares outstanding?of common shares outstanding?



Number of Period WeightedDates Shares Outstanding of Time Amount

1/1 to 3/311/1 to 3/31 85,00085,000 ×× 3/123/12 21,25021,2504/1 to 12/314/1 to 12/31 90,00090,000 ×× 9/129/12 67,50067,500

Weighted average sharesWeighted average shares88,75088,750

How much are the preferred dividends?How much are the preferred dividends?

$500,000 × 4% = $20,000$500,000 × 4% = $20,000



($208,470 – $20,000) ÷ 88,750 = $2.12($208,470 – $20,000) ÷ 88,750 = $2.12

What are the earnings per share?What are the earnings per share?

Assume that each of the 5,000 shares of ToyAssume that each of the 5,000 shares of ToyBox’s 4% preferred stock is convertible to 6Box’s 4% preferred stock is convertible to 6

shares of common stock, a total of 30,000 shares.shares of common stock, a total of 30,000 shares.


Diluted Earnings Per ShareDiluted Earnings Per Share

What are the diluted earnings per share?What are the diluted earnings per share?

(Adjusted net income – Adjusted preferred dividends)(Adjusted net income – Adjusted preferred dividends)÷ Adjusted weighted average number÷ Adjusted weighted average number

of common shares outstandingof common shares outstanding

($208,470 – $0) ÷ (88,750 + 30,000) = $1.76($208,470 – $0) ÷ (88,750 + 30,000) = $1.76


Earnings Per Share Income Earnings Per Share Income Statement PresentationStatement Presentation

Income from continuing operationsIncome from continuing operations $0.86$0.86 $0.81$0.81Income from discontinuedIncome from discontinued operations, net of income taxoperations, net of income tax 0.80 0.80 0.60 0.60Loss on disposal of discontinuedLoss on disposal of discontinued operation, net of income taxoperation, net of income tax –0.61–0.61 –0.45–0.45Gain from discontinuedGain from discontinued operation, net of income taxoperation, net of income tax $0.19$0.19 $0.15$0.15Income before extraordinary item andIncome before extraordinary item and cumulative change in accounting principlecumulative change in accounting principle $1.05$1.05 $0.96$0.96Extraordinary gain, net of income taxExtraordinary gain, net of income tax 1.49 1.49 1.11 1.11Income before cumulative effect ofIncome before cumulative effect of a change in accounting principlea change in accounting principle $2.54$2.54 $2.07$2.07Cumulative effect of a change inCumulative effect of a change in accounting principle, net of taxaccounting principle, net of tax –0.42–0.42 –0.31–0.31Net incomeNet income $2.12$2.12 $1.76$1.76

Earnings per Common Share Basic Diluted



Describe the additionalinformation provided

by comparativefinancial statements.


Comparative Financial Comparative Financial StatementsStatements

Norton Tire Company, Inc.Income Statements

For the Years Ended December 31, 2003, 2002, and 2001(in thousands)

SalesSales $14,745$14,745 $12,908$12,908 $10,888$10,888Less: Cost of goods soldLess: Cost of goods sold 10,213 10,213 8,761 8,761 7,661 7,661Gross profit on salesGross profit on sales $ 4,532$ 4,532 $ 4,147$ 4,147 $ 3,227$ 3,227Selling, general, andSelling, general, and administrative expensesadministrative expenses 3,627 3,627 2,997 2,997 2,087 2,087Operating incomeOperating income $ 905$ 905 $ 1,150$ 1,150 $ 1,140$ 1,140Interest expenseInterest expense 145 145 138 138 107 107Income before taxesIncome before taxes $ 760$ 760 $ 1,012$ 1,012 $ 1,033$ 1,033Income taxesIncome taxes 266 266 354 354 362 362Net incomeNet income $ 494$ 494 $ 658$ 658 $ 671$ 671

2003 2002 2001



Assets:Assets:Current assets:Current assets: CashCash $ 2,240$ 2,240 $1,936$1,936 Accounts receivableAccounts receivable 2,340 2,340 2,490 2,490 Merchandise inventoryMerchandise inventory 776 776 693 693 Prepaid expensesPrepaid expenses 200 200 160 160Total current assetsTotal current assets $ 5,556$ 5,556 $5,279$5,279Property, plant, and equipment:Property, plant, and equipment: Buildings, netBuildings, net $ 4,046$ 4,046 $2,889$2,889 Equipment, netEquipment, net 1,123 1,123 864 864Total plant and equipmentTotal plant and equipment $ 5,169$ 5,169 $3,753$3,753

Total assetsTotal assets $10,725$10,725 $9,032$9,032

2003 2002



Liabilities:Liabilities:Current liabilities:Current liabilities: Accounts payableAccounts payable $ 1,616$ 1,616 $1,080$1,080 Notes payableNotes payable 2,720 2,720 2,920 2,920Total current liabilitiesTotal current liabilities $ 4,336$ 4,336 $4,000$4,000Long-term liabilitiesLong-term liabilities 2,000 2,000 1,600 1,600Total liabilitiesTotal liabilities $ 6,336$ 6,336 $5,600$5,600

Stockholders’ equity:Stockholders’ equity:Common stock, no par valueCommon stock, no par value $ 3,000$ 3,000 $2,400$2,400Retained earningsRetained earnings 1,389 1,389 1,032 1,032Total stockholders’ equityTotal stockholders’ equity $ 4,389$ 4,389 $3,432$3,432Total liabilities andTotal liabilities and stockholders’ equitystockholders’ equity $10,725$10,725 $9,032$9,032

2003 2002



Calculate several financialratios based on incomestatement and balance

sheet information.


Using Financial InformationUsing Financial Information

The The asset turnover ratioasset turnover ratio shows the shows theamount of sales produced for aamount of sales produced for a

given level of assets used.given level of assets used.

Asset turnover ratio =Asset turnover ratio =Net sales ÷ Average total assetsNet sales ÷ Average total assets

Norton’s asset turnover ratio =Norton’s asset turnover ratio =$14,745 ÷ $9,878.50 = 1.49 times$14,745 ÷ $9,878.50 = 1.49 times


Receivables turnover ratio =Receivables turnover ratio =Net sales ÷ Average accounts receivableNet sales ÷ Average accounts receivable

The The receivables turnover ratioreceivables turnover ratiomeasures how efficiently a companymeasures how efficiently a company

manages its accounts receivable.manages its accounts receivable.

Norton’s receivables turnover ratio =Norton’s receivables turnover ratio =$14,745 ÷ $2,415 = 6.11 times$14,745 ÷ $2,415 = 6.11 times



Average accounts receivableAverage accounts receivablecollection period in days =collection period in days =

365 ÷ Accounts receivable turnover365 ÷ Accounts receivable turnover


Norton’s average collection period =Norton’s average collection period =365 ÷ 6.11 = 59.74 days365 ÷ 6.11 = 59.74 days


Current ratio =Current ratio =Current assets ÷ Current liabilitiesCurrent assets ÷ Current liabilities

The The current ratiocurrent ratio measures the company’s measures the company’sability to meet its short-term financialability to meet its short-term financial

obligations with current assets.obligations with current assets.

Norton’s current ratio =Norton’s current ratio =$5,556 ÷ $4,336 = 1.28$5,556 ÷ $4,336 = 1.28



Quick ratio = (Cash + Short-term investmentsQuick ratio = (Cash + Short-term investments+ Current receivables) ÷ Current liabilities+ Current receivables) ÷ Current liabilities

The The quick ratioquick ratio considers only current assets considers only current assetsthat are highly liquid in the numerator.that are highly liquid in the numerator.



Times-interest-earned =Times-interest-earned =Earnings before interest and income taxesEarnings before interest and income taxes

÷ Interest expense÷ Interest expense

Times-interest-earned ratioTimes-interest-earned ratioindicates a company’s ability to earnindicates a company’s ability to earn

(cover) its periodic interest payments.(cover) its periodic interest payments.



End of Chapter 9End of Chapter 9

©2004 prentice hall business publishing introduction to financial accounting, 3e by werner/jones9 -...

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