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Glencoe Accounting Copyright © by The McGraw-Hill Companies, Inc. All rights reserved.

Owner’s equity in a corporation is called stockholders’ equity. A merchandiser’s income statement has a Cost of Merchandise Sold section, and a corporation’s income statement shows income tax expense. Additionally, a corporation prepares the statement of retained earnings, the balance sheet, and the statement of cash flows.


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Explain how to record ownership of a corporation.

Explain the relationship between the work sheet and the financial statements for a merchandising corporation.

Explain how a corporation’s financial statements differ from a sole proprietorship.

Analyze the financial data contained on the statements.

Prepare an income statement, statement of retained earnings, and balance sheet.

Describe the statement of cash flows for a merchandising corporation.


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Key Terms

Capital Stock

stockholder’s equity

retained earnings

compatibility

The Ownership of a Corporation

Section 19.1

reliability

relevance

full disclosure

materiality

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Accounting for a Corporation


Section 19.1

A corporation may be owned by one person or

thousands.

The ownership of a corporation is

represented by shares of stock.

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Section 19.1

Corporations have a Capital Stock account

instead of the sole proprietorship’s owner’s capital

account.

This is a stockholders’ equity account that is the

value of the stockholders’ claims to the corporation.

Capital StockThe account that represents the total amount of investment in the

corporation by its stockholders (owners).

stockholders’ equityThe value of the stockholders’ claims to the corporation.

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Section 19.1

Stockholders’ equity must be reported

in two parts:

Equity contributed by the stockholders

Equity earned through business profits

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Section 19.1

Stockholders

contribute to equity

by purchasing

shares of stock.

This amount is

recorded in the

Capital Stock

account.

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Section 19.1

The net income earned and retained by a corporation is recorded in the retained earnings account.

retained earningsA corporation’s accumulated net income

that is not distributed to stockholders.

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Section 19.1

Business Transaction

On January 1 stockholders invested $25,000 in exchange for shares of stock of the corporation.

See page 556Home




Section 19.1

Compare the Balance Sheet for a Sole Proprietorship and a Corporation

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Characteristics of Financial Information


Section 19.1

Who Uses Financial Information?

Managers

Creditors

Stockholders

Government Agencies

Employees

Consumers

General Public

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Section 19.1

ComparabilityAllows

information to be compared from one period to another

the comparison of information between businesses

comparabilityAccounting characteristic that allows the financial information to be compared from one period to another period; also allows the

comparison of financial information between businesses.Home




Section 19.1

What Is

Reliability?

reliabilityA characteristic requiring that accounting information be

reasonably free of bias and error.

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Section 19.1

What Is

Relevance?

relevanceAn accounting characteristic requiring that all information that

would affect the decisions of financial statement users be disclosed in the financial reports.

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Section 19.1

What Is

Full Disclosure?

full disclosureAccounting principle requiring a financial report to include

enough information so that it is complete.

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Section 19.1

What Is

Materiality?

materialityAn accounting guideline stating that information

considered important (relative to the other information) should be included in financial reports.

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A Corporation’s Financial Statements


Section 19.1

A merchandising corporation can prepare four financial statements:

The Income Statement

The Statement of Returned Earnings

The Balance Sheet

The Statement of Cash Flows

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Key Terms

net sales

net purchases

gross profit on sales

operating expenses

The Income StatementSection 19.2

selling expenses

administrative expenses

operating income

vertical analysis

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Five Sections of the Income Statement

Revenue

Cost of Merchandise Sold

Gross Profit on Sales

Operating Expenses

Net Income (or Loss)

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The Revenue Section Reports the Net Sales for the Period

See page 561

net salesThe amount of sales for the period less any sales

discounts, returns, and allowances.

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Calculating the Cost of Merchandise Sold.

Computing the cost of merchandise sold requires two steps:

Determine the cost of all merchandise available for sale

Calculate the cost of merchandise sold

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Calculating the Cost of Merchandise Available for Sale

Add Net Purchases to the Beginning Inventory Amount.

net purchasesThe total cost of all merchandise purchased during a period,

less any purchases, discounts, returns, and allowances.Home




See page 563

Calculating the Cost of Merchandise Sold

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The gross profit on sales is the profit made before operating expenses are

deducted.

gross profit on salesThe amount of profit made during the fiscal period

before expenses are deducted; it is found by subtracting the cost of merchandise sold from net sales.

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operating expensesThe cash spent or assets consumed to earn a revenue

for a business; operating expenses do not include federal income tax expense.

Operating Expenses

Selling Expenses

Administrative Expenses

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selling expensesExpenses a business incurs to sell or market its

merchandise or services.

Operating Expenses

Selling Expenses


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administrative expensesCosts related to the management of a business

(for example, office expenses).

Operating Expenses

Selling Expenses


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operating incomeThe excess of gross profit over operating expenses;

taxable income.

The federal corporate income tax amount is presented separately on the

income statement so the income statement shows the amount of

operating income.

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Analyzing Amounts on the Income Statement


vertical analysisA method of analysis that expresses financial statement

items as percentages of a base amount.

Vertical analysis enables users to more easily view relationships.

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Key Terms

statement of retainedearnings

horizontal analysis

base period

cash inflows

The Statement of RetainedEarnings, Balance Sheet, and

Statement of Cash FlowsSection 19.3

cash outflows

operating activities

investing activities

financing activities

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The Statement of Retained Earnings



Statement of Retained Earnings

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The Statement of Retained Earnings



Statement of Retained Earnings

statement of retained earningsA financial statement that reports the changes in the Retained Earnings account during the period.

See page 569

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The Balance Sheet



The balance sheet reports the balances of all

asset, liability, and stockholders’ equity

accounts for a specific date. The assets are

listed first, followed by the Liabilities section

and the Stockholders’ Equity section.

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The Balance Sheet



The Starting Line’s Balance Sheet

See page 570Home


Analyzing Amounts on the Balance Sheet



Horizontal analysis uses dollar amounts expressed as

percentages to compare the same items on financial

statements for two or more accounting periods or dates.

A base period is usually used for comparison.

horizontal analysisThe comparison of the same item(s) on financial statements for two

or more accounting periods or dates; used to determine changes from one period to another.

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Analyzing Amounts on the Balance Sheet



Horizontal analysis uses dollar amounts expressed as

percentages to compare the same items on financial

statements for two or more accounting periods or dates.

A base period is usually used for comparison.

base periodA period, usually a year, that is used for

comparison.

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cash inflowReceipts of cash.

See page 573

The Statement of Cash FlowsShows Cash Inflows and Cash Outflows

cash outflowPayments of cash.

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Cash Flows from Operating Activities

operating activitiesBusiness activities involving normal

business operations.

To determine operating cash inflows and outflows, the income statement

and balance sheet amounts are converted to the cash basis of

accounting.

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investing activitiesBusiness activities involving investments

and plant assets.

Investing Activities

Loans the business makes

Payments received for loans

Purchase and sale of plant assets

Investments

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What AreFinancing Activities?

financing activitiesBusiness activities involving debt and

equity transactions.

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Typical Cash Inflows and Outflowsfor the Three Activities of a Business

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Question 1

Match the characteristic of financial information to its definition.

A. The information in the financial reports is complete.

B. The information is relatively free of errors and bias.

C. All information that would affect decision making is included.

D. Information from one period can be used to evaluate the information for a different but similar period.

E. All important and relevant information should be included.

1. comparability________

2. reliability ________

3. relevance________

4. full disclosure________

5. materiality________

DB

C

A

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Question 2

List the steps necessary to determine the amount to report in the Cost of Merchandise Sold section of the income statement.

Step 1: List the amount of beginning merchandise inventory.

Step 2: Calculate the Cost of Delivered Merchandise by adding amounts in the Purchases and Transportation In accounts.

Step 3: Calculate the amount of Net Purchases by subtracting the Purchases Discounts

and Purchases Returns and Allowances from the Cost of Delivered Merchandise.

Step 4: Add Net Purchases to beginning merchandise inventory to determine the Cost of Merchandise Available for sale during the period.

Step 5: Subtract the amount of ending merchandise inventory from the Cost of Merchandise Available for sale. The result is the Cost of Merchandise Sold.

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Question 3

“The wide use of computer accounting software makes the understanding of accounting less important.” Do you agree or disagree with that statement, and why?

Answers will vary. While computerized accounting programs make the posting and entry of accounting transactions faster and eliminate errors in transferring data from the journal to the ledger, this does not mean that an understanding of accounting is less important. It can be argued that it is more important in this case to have a sound understanding of accounting principles to be able to follow what is happening in the business transaction so a person can determine whether it has been entered correctly.

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