Demonstration Problem

Accounting What the Numbers Mean 9e Demonstration Problem Chapter 2 – Problem 14 Prepare an Income Statement, Balance Sheet, and Statement of Changes in Owners’ Equity

Problem Definition • The following information was obtained from the records of Shae, Inc.: Merchandise inventory $264,000 Notes Payable (long term) 300,000 Sales 900,000 Buildings and equipment 504,000 Sales, general, and administrative expenses 72,000 Accounts receivable 120,000 Common stock (42,000 shares) 210,000 Income tax expense 84,000 Cash 192,000 Retained earnings, 1/1/10 129,000 Accrued liabilities 18,000 Cost of goods sold 540,000 Accumulated depreciation 216,000 Interest expense 48,000 Accounts payable 90,000 Dividends declared and paid during 2010 39,000

Problem Definition Except as otherwise indicated, assume that all balance sheet items reflect account balances at December 31, 2010, and that all income statement items reflect activities that occurred during the year ended December 31, 2010. There were no changes in paid-in-capital during the year.

Problem Definition • Prepare an income statement and statement of changes in owners’ equityfor the year ended December 31, 2010, and a balance sheet at December 31, 2010. • What is the company’s average tax rate? • What interest rate is charged on long-term debt? • What is the par value per share of common stock? e. What is the company’s dividend policy?

Problem Solution • Prepare an income statement for the year ended December 31, 2010. • Identify revenue an expense accounts: Revenues: Sales Expenses: Selling, general and administrative expenses Income tax expense Cost of goods sold Interest expense

Problem Solution • Determine the order and presentation of the revenue and expense accounts: Gross Profit is the first subtotal shown. SHAE, INC. Income Statement For the Year Ended December 31, 2010 Sales $900,000 Cost of goods sold (540,000) Gross profit $360,000 Include a financial statement heading.

Problem Solution SHAE, INC. Income Statement For the Year Ended December 31, 2010 Sales $900,000 Cost of goods sold (540,000) Gross profit $360,000 Selling, general, and admin. exp. ( 72,000) Income from operations $288,000 Income from operations (operating income) is a key measure of a firm’s financial performance for a period of time.

Problem Solution SHAE, INC. Income Statement For the Year Ended December 31, 2010 Sales $900,000 Cost of goods sold (540,000) Gross profit $360,000 Selling, general, and admin. exp. ( 72,000) Income from operations $288,000 Interest expense ( 48,000) Income before taxes $240,000 Interest expense is a non-operating expense.

Problem Solution SHAE, INC. Income Statement For the Year Ended December 31, 2010 Sales $900,000 Cost of goods sold (540,000) Gross profit $360,000 Selling, general, and admin. exp. ( 72,000) Income from operations $288,000 Interest expense ( 48,000) Income before taxes $240,000 Income tax expense ( 84,000) Net income $ 156,000

Problem Solution • Prepare a Statement of Changes in Owners’ Equity for the year ended December 31, 2010. SHAE, INC. Statement Changes in Owner’s Equity For the Year Ended December 31, 2010 Paid-in capital: Retained earnings: Include a financial statement heading. Paid-in capital and retained earnings are the two primary components of owners’ equity.

Problem Solution SHAE, INC. Statement Changes in Owner’s Equity For the Year Ended December 31, 2010 Paid-in capital: Common stock $210,000 Retained earnings: Paid-in capital includes common stock and additional funds paid-in, or contributed, by owners.

Problem Solution SHAE, INC. Statement Changes in Owner’s Equity For the Year Ended December 31, 2010 Paid-in capital: Common stock $210,000 Retained earnings: Beginning balance $129,000 Net income for the year 156,000 Less: Dividends declared and paid during year (39,000) Ending balance 246,000 Net income increases and dividends decrease retained earnings.

Problem Solution SHAE, INC. Statement Changes in Owner’s Equity For the Year Ended December 31, 2010 Paid-in capital: Common stock $210,000 Retained earnings: Beginning balance $129,000 Net income for the year 156,000 Less: Dividends declared and paid during year (39,000) Ending balance 246,000 Total owners’ equity $456,000 Total owners’ equity is the sum of PIC and RE.

Problem Solution • Prepare a balance sheet at December 31, 2010. SHAE, INC. Balance Sheet December 31, 2010 Assets: Liabilities: Owners’ Equity: The report format of the balance sheet shows assets above liabilities and owners’ equity.

Problem Solution SHAE, INC. Balance Sheet December 31, 2010 Assets: Cash $192,000 Accounts receivable 120,000 Merchandise inventory 264,000 Total current assets $576,000 Non-current assets Total assets Liabilities: Owners’ Equity: Total liabilities and owners’ equity Current assets are listed in order of liquidity, or nearness to cash.

Problem Solution SHAE, INC. Balance Sheet December 31, 2010 Assets: Cash $192,000 Accounts receivable 120,000 Merchandise inventory 264,000 Total current assets $576,000 Buildings and equipment 504,000 Less: Accumulated depreciation (216,000) 288,000 Total assets $864,000 Liabilities: Owners’ Equity: Total liabilities and owners’ equity Accumulated depreciation is a contra asset account.

Problem Solution SHAE, INC. Balance Sheet December 31, 2010 Assets: Total assets $864,000 Liabilities: Accounts payable $ 90,000 Accrued liabilities 18,000 Notes payable (long term) 300,000 Total liabilities $408,000 Owners’ Equity: Total liabilities and owners’ equity As with assets, liabilities are often classified as current and non-current.

Problem Solution SHAE, INC. Balance Sheet December 31, 2010 Assets: Total assets $864,000 Liabilities: Total liabilities $408,000 Owners’ Equity: Common stock $210,000 Retained earnings 246,000 Total owners’ equity 456,000 Total liabilities and owners’ equity CS, RE, and Total OE are taken from the Statement of Changes in OE.

Problem Solution SHAE, INC. Balance Sheet December 31, 2010 Assets: Total assets $864,000 Liabilities: Total liabilities $408,000 Owners’ Equity: Total owners’ equity 456,000 Total liabilities and owners’ equity $864,000 Total assets = Total liabilities + Total owners’ equity

Problem Solution SHAE, INC. Balance Sheet December 31, 2010 Assets: Cash $192,000 Accounts receivable 120,000 Merchandise inventory 264,000 Total current assets $456,000 Buildings and equipment 504,000 Less: Accumulated depreciation (216,000) 288,000 Total assets $864,000 Liabilities: Owners’ Equity: Total liabilities and owners’ equity Completed asset side of balance sheet.

Problem Solution SHAE, INC. Balance Sheet December 31, 2010 Assets: Total assets $864,000 Liabilities: Accounts payable $ 90,000 Accrued liabilities 18,000 Notes payable (long term) 300,000 Total liabilities $408,000 Owners’ equity: Common stock $210,000 Retained earnings 246,000 Total owners’ equity 456,000 Total liabilities and owners’ equity $864,000 Completed liability and owners’ equity side.

Problem Solution • Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2010, and a balance sheet at December 31, 2010. • What is the company’s average tax rate? • What interest rate is charged on long-term debt? • What is the par value per share of common stock? e. What is the company’s dividend policy?

Problem Solution The company’s average income tax rate would be computed by dividing income tax expense by earnings before taxes: $84,000 / $240,000 = 35% average tax rate

Problem Solution The interest rate charged on long-term debt is a function of interest expense divided by long-term debt: This assumes that the year-end balance of long-term debt is representative of the average long-term debt account balance throughout the year. $48,000 / $300,000 = 16% interest rate

Problem Solution The par value per share of common stock can be determined simply by dividing the dollar amount for common stock by the number of common shares outstanding: $210,000 / 42,000 shares = $5 par value per share

Problem Solution Shae, Inc. appears to have a policy of paying a fixed percentage of net income as a dividend to shareholders, computed as the dividends declared and paid divided by net income: $39,000 / $156,000 = 25% dividend payout policy

Accounting What the Numbers Mean 9e You should now have a better understandingof how to prepare financial statements. Remember that there is a demonstration problem for each chapter that is here for your learning benefit. David H. Marshall Wayne W. McManus Daniel F. Viele

Demonstration Problem