Ch11 Acct23020 Class

Chapter 11
The Income Statement & the Statement

of Stockholders’ Equity
11-1
Learning Objective 1
 Analyze a Corporate Income Statement
11-2
Earnings Quality
Proper revenue Improving

& expense gross margin
recognition ratio
Improving
Low operating operating
expenses earnings
11-3
Revenue Recognition
 Revenue is recognized when earned
Seller
Customer
collects
Seller takes
cash or
delivers possession
reasonably
product or &
assured of
service to ownership
collecting
customer of product
cash in
or service
near future
11-4
Cost of Goods Sold and Gross Profit
Gross profit percent

should be increasing
Cost of goods sold

should be decreasing
as a percent of net
sales
11-5
Operating and Other Expenses
 Largest operating expenses include salaries, wages,
utilities and supplies
 Lower the cost relative to sales, the more efficient
 Interest expense represents charges for borrowed money
 Interest revenue represents return earned on invested

money
 Income tax expense

 Can be reduced through effective planning
11-6
Operating Earnings
Revenue
(Cost of goods sold)
= Gross margin
(Operating expenses)
+ Interest income &

(expense)
(Income tax expense)
11-7
Continuing Operations
 Income from day-to-day normal business

activities
 Includes:
 Revenues and operating expenses
 Gains and losses
 Income tax expense
 Can help predict future annual income
11-8
Investment Capitalization Rate &
Value of Stock
Estimated annual future income
Estimated value of common stock =
Investment capitalization rate
Compared to market value Rate used to estimate value of stock

of the company
# of Market The higher the rate, the higher the risk

common x price per
shares share
11-9
Investment Decision Rule
If the estimated value of the company:

Buy; stock
Exceeds price may
increase
Current
market
value Hold; stock
Equals price steady
of
the
company
Sell; stock
Is less than price may
go down
11-10
Discontinued Operations
 Company sells a segment of the business

 Identifiable part of business
 Reported beneath income from continuing

operations
 Net of income taxes
 Not considered in predictions of future

earnings
11-11
Extraordinary Items
 Gains and losses that are both infrequent and unusual
 Include losses from natural disasters and

expropriation of assets by foreign governments
 Do NOT include gains or losses from lawsuits,

restructuring or sale of plant assets
 Reported after continuing operations net of income

taxes
11-12
Cumulative Effect of Change in
Accounting Method
 Change from one accounting method to another
 FIFO to LIFO
 Straight-line depreciation to double-declining
balance
 Makes difficult to compare year-to-year

statements
 Reported in special section usually after
extraordinary items
11-13
Cumulative Effect of Change in
Accounting Method
 Change from one accounting method to another
 FIFO to LIFO
 Straight-line depreciation to double-declining
balance
 Makes difficult to compare year-to-year

statements
 Reported in special section usually after
extraordinary items
11-14
Earnings per Share (EPS)
 Key measure of company’s success:
Net Income - Preferred Dividends

Average number of common shares outstanding
 Reported for each element of net income:

 Discontinued operations, extraordinary items, etc.
 Preferred dividends only subtracted for

continuing operations and net income
11-15
Earnings per Share (EPS)
 Key measure of company’s success:
Net Income - Preferred Dividends

Average number of common shares outstanding
 Reported for each element of net income:

 Discontinued operations, extraordinary items, etc.
 Preferred dividends only subtracted for

continuing operations and net income
11-16
E11-14A, p. 683
Other Revenues 2,400
Income Tax Expense—Extraordinary Gain 1,600
Income Tax Expense—Income from Ops 2,880
Extraordinary Gain 4,000
Sales Revenue 102,000
Total Operating Expenses 97,200
1. Prepare single-step income statement.

1,800 shares of common stock.
Estimate price of common stock if earnings capitalized at 5%.
11-17
E11-14A, p. 683
Regan Books Company
Income Statement
Year Ended December 31, 2010
Sales revenue $ 102,000
Operating Income before income tax $ 104,400
Income from continuing operations
before income taxes $ 7,200
Income tax expense 2,880
Income from continuing operations 4,320
Extraordinary gain of $4,000, less
tax of $1,600 2,400
Net Income $ 6,720
11-18
Misp
rint i
E11-14A, p. 683 from n Slides
Vista
Regan Books Company
Income Statement
Income from continuing operations
tax of $1,600 2,400
Net Income $ 6,720
11-19
E11-14A, p. 683
Regan Books Company
Income Statement
Total Operating Expenses
tax of $1,600 2,400
Net Income $ 6,720
11-20
E11-14A, p. 683
Regan Books Company
Income Statement
tax of $1,600 2,400
Net Income $ 6,720
11-21
E11-14A, p. 683
Regan Books Company
Income Statement
tax of $1,600 2,400
Net Income $ 6,720
11-22
E11-14A (cont.)
Earnings per share (1800 shares)
Income from continuing operations ($4,320 / 1,800) 2.40
Extraordinary gain ($2,400 / 1,800) 1.33
Net Income ($6,720 / 1,800) $ 3.73
Estimated annual
Estimated value of EPS in the future $2.40
one share of = Investment = .05 = $48.00
Regan Books stock capitalization rate
11-23
E11-14A (cont.)
Net Income ($6,720 / 1,800) $ 3.73
Estimated annual
11-24
E11-14A (cont.)
Net Income ($6,720 / 1,800) $ 3.73
Estimated annual
11-25
E11-14A (cont.)
Net Income ($6,720 / 1,800) $ 3.73
Estimated annual
11-26
 Account for a Corporation’s Income Taxes
11-27
Corporate Income Taxes
 Federal corporate income tax rate = 35%

 Most states also levy a tax, usually around 5%
 Income tax expense

 Reported on income statement
 Based on current year earnings
 Income tax payable

 Current liability on the balance sheet
 Amount to be paid to government
11-28
Differences Between Accounting Income
and Taxable Income
 Income Statement
 Reports results of operations
 Based on accrual account
 Income Tax Return

 Filed with IRS to determine taxes owed
 Based on tax laws
 Depreciation common difference

 Straight-line for accounting purposes
 Accelerated for tax purposes
11-29
Deferred Taxes
 When corporations use different methods for

accounting and taxes:
 Income tax expense does not equal income tax
payable
 The result is a deferred tax liability or asset
Income tax expense < Income tax payable Deferred tax asset
Income tax expense > Income tax payable Deferred tax liability
11-30
Prior Period Adjustments
 Correction of an
accounting error from a
previous period
 Related revenue or
expense item has been
closed into Retained
Earnings
 Beginning retained
earnings is adjusted for the
amount of the error
11-31
Comprehensive Income Out o
f Or d
from er
Vista
 Change in stockholders’ equity from all
non-owner transactions
 Net Income plus:

 Unrealized gains (losses) on available-for-sale
investments
 Foreign currency translation adjustments
▪ Not included in net income or EPS calculations
11-32
S 11-9, p. 680
Income Before Tax 122,000
Taxable Income 94,000
Tax Rate 30%
11-33
S 11-9, p. 680
1. Record income taxes
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
1. Income Tax Expense ($122,000 × .30)…. 36,600
Recorded income tax for the year.
Income before Income Tax

(From Income Statement)
11-34
S 11-9, p. 680

Income Tax Payable ($94,000 × .30).... 28,200
Taxable Income
11-35
S 11-9, p. 680

Income Tax Payable ($94,000 × .30).... 28,200
Deferred Tax Liability………………….. 8,400
Plug Figure:
CR = Liability
DR = Asset
11-36
S 11-9 (continued)
2. INCOME STATEMENT
Income before income tax………………… $122,000
Income tax expense………………………... (36,600)
Net income…………………………………... $ 85,400
11-37
S 11-9 (continued)
2. INCOME STATEMENT
Income before income tax………………… $122,000
Income tax expense………………………... (36,600)
Net income…………………………………... $ 85,400
BALANCE SHEET
Current liabilities:
Income tax payable…………………….. $ 28,200
Long-term liabilities:
Deferred tax liability……………………. 8,400
11-38
 Analyze a Statement of Stockholders’ Equity
11-39
Statement of Stockholders’ Equity
 Includes all equity accounts

(example on following slide)
 Show activity in each account

 From beginning balance to ending balance
 Increases and decreases
 Also includes accumulated other comprehensive

income:
 Unrealized gain or loss on investments
 Foreign currency translation adjustment
11-40
Statement of Stockholders’ Equity
11-41
S 11-11, p. 681
Req. 1
$1,140,000 ($40,000 + $1,100,000)
Req. 2
The stock dividend:
decreased retained earnings by $84,000
increased total paid-in capital by $84,000 ($6,000 + $78,000)
had no effect on total stockholders’ equity
had no effect on total assets
Req. 3
Cost of treasury stock Mason purchased = $8,000
Mason’s cost of treasury stock sold = $5,000
Mason sold the treasury stock for $12,000 ($5,000 + $7,000)
11-42
S 11-11, p. 681
Req. 1
$1,140,000 ($40,000 + $1,100,000)
Req. 2
The stock dividend:
Req. 3
11-43
S 11-11, p. 681
Req. 1
$1,140,000 ($40,000 + $1,100,000)
Req. 2
The stock dividend:
Req. 3
11-44
E11-21A, p. 685
Common Stock 542,500
$1.75 par value
400,000 shares authorized
310,000 shares issued
Additional Paid-in Capital 700,000
Retained Earnings 630,000
Total Stockholder’s Equity 1,872,500
11-45
E11-21A,
nS
l idesp. 685
i nt i
is pr Vis ta
M
from
_____
*310,000 shares × .02 × $20 per share =
$124,000.
11-46
E11-21A, p. 685
310,000 X .02 X $20
_____
*310,000 shares × .02 × $20 per share =
$124,000.
11-47
E11-21A, p. 685
310,000 X .02 X $1.75
_____
*310,000 shares × .02 × $20 per share =
$124,000.
11-48
E11-21A, p. 685
124,000 – 10,850
_____
*310,000 shares × .02 × $20 per share =
$124,000.
11-49
E11-21A, p. 685
_____ 2,000 X 18
*310,000 shares × .02 × $20 per share =
$124,000.
11-50
E11-21A, p. 685
_____ 2,000 X 1.75 36,000 – 3,500

*310,000 shares × .02 × $20 per share =
$124,000.
11-51
E11-21A, p. 685
_____
*310,000 shares × .02 × $20 per share =
$124,000.
11-52
E11-21A, p. 685
_____
*310,000 shares × .02 × $20 per share =
$124,000.
11-53
 Understand Managers’ and Auditors’

Responsibilities for the Financial Statements
11-54
Management’s Responsibility
 Internal controls over financial reporting in

accordance with GAAP
 Standard for preparing financial statements
 Designed to produce relevant and reliable
information for investors and creditors
11-55
Auditor’s Report
 Companies hire Certified Public Accountants

(CPAs) to examine financial statements
 Examination is called an external audit
 CPAs are independent of the company they are
auditing
 CPA firms issue audit reports

 Provide opinion if financial statements are in
accordance with GAAP
11-56
Types of Audit Reports
Clean opinion; Statements are fairly
Unqualified presented
“Except for” opinion; Statements are

Qualified reliable except for one or more items
Statements are unreliable and not in

Adverse accordance with GAAP
No opinion; auditor was unable to form

Disclaimer an opinion
11-57
S 11-12, p. 682
1. Who is responsible for the financial statements?

Management of Ashburnham Computer is responsible for the
company’s financial statements.
Req. 2
The accounting standard for financial statements is accounting
principles generally accepted in the United States of America.
Req. 3
Management has established and maintains internal
accounting control over financial reporting to fulfill
its responsibility for reliable financial information.
11-58
S 11-12, p. 682

Req. 2
Req. 3
Management has established and maintains internal
accounting control over financial reporting to fulfill
11-59
S 11-12, p. 682

2. What accounting standard is used to prepare the financial

statements?
Req. 3
Management has established and maintains internal accounting
control over financial reporting to fulfill
11-60
S 11-12, p. 682


statements?
Req. 3
11-61
S 11-12, p. 682


statements?
3. Management action for reliability of financial information?

11-62
S 11-12, p. 682


statements?
3. Management action for reliability of financial information?

11-63
S 11-12 (continued)
4. What entity gave an independent opinion on the financial statements?
Independent Registered Public Accounting Firm,
auditors located in Portage, Michigan, gave an outside
opinion on Ashburnham’s financial statements.
Independent Registered Public Accounting Firm
released its opinion on December 28, 2010.
Req. 5
The audit covered Ashburnham’s balance sheets at
September 30, 2010, and September 30, 2009,
income statements (statements of operations),
statements of shareholders’ equity and cash flows
for the three years ended September 30, 2010.
11-64
S 11-12 (continued)
Req. 5
11-65
S 11-12 (continued)
5. What did the audit cover?

11-66
S 11-12 (continued)
5. What did the audit cover?

11-67
S 11-12 (continued)
6. What standard was used to conduct the audit?

The standard for conducting an audit is the standards
of the Public Company Accounting Oversight Board (United
States).
Req. 7
The auditor believed that Ashburnham’s financial
statements conformed to U.S. generally accepted
accounting principles.
11-68
S 11-12 (continued)

States).
Req. 7
11-69
S 11-12 (continued)

States).
7. What was the auditor’s opinion?

11-70
S 11-12 (continued)

States).
7. What was the auditor’s opinion?

11-71
End of Chapter 11
11-72

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Chapter 11

The Income Statement & the Statement

 Analyze a Corporate Income Statement

Proper revenue Improving

 Revenue is recognized when earned

Gross profit percent

Cost of goods sold

 Interest expense represents charges for borrowed money

 Interest revenue represents return earned on invested

 Income tax expense

(Cost of goods sold)

+ Interest income &

(Income tax expense)

 Income from day-to-day normal business

 Can help predict future annual income

Compared to market value Rate used to estimate value of stock

# of Market The higher the rate, the higher the risk

If the estimated value of the company:

 Company sells a segment of the business

 Reported beneath income from continuing

 Not considered in predictions of future

 Include losses from natural disasters and

 Do NOT include gains or losses from lawsuits,

 Reported after continuing operations net of income

 Makes difficult to compare year-to-year

 Makes difficult to compare year-to-year

 Key measure of company’s success:

Net Income - Preferred Dividends

 Reported for each element of net income:

 Preferred dividends only subtracted for

 Key measure of company’s success:

Net Income - Preferred Dividends

 Reported for each element of net income:

 Preferred dividends only subtracted for

1. Prepare single-step income statement.

 Account for a Corporation’s Income Taxes

 Federal corporate income tax rate = 35%

 Income tax expense

 Income tax payable

 Income Tax Return

 Depreciation common difference

 When corporations use different methods for

 The result is a deferred tax liability or asset

 Net Income plus:

Tax Rate 30%

1. Income Tax Expense ($122,000 × .30)…. 36,600

Recorded income tax for the year.

Income before Income Tax

1. Income Tax Expense ($122,000 × .30)…. 36,600

Recorded income tax for the year.

1. Income Tax Expense ($122,000 × .30)…. 36,600

 Analyze a Statement of Stockholders’ Equity

 Includes all equity accounts

 Show activity in each account

 Also includes accumulated other comprehensive

310,000 X .02 X $20

310,000 X .02 X $1.75

_____ 2,000 X 1.75 36,000 – 3,500

 Understand Managers’ and Auditors’

 Internal controls over financial reporting in

 Companies hire Certified Public Accountants

 CPA firms issue audit reports

“Except for” opinion; Statements are