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
Notes Payable (long term)
Sales
Buildings and equipment
Sales, general, and administrative expenses
Accounts receivable
120,000
Common stock (42,000 shares)
Income tax expense
Cash
Retained earnings, 1/1/10
Accrued liabilities
18,000
Cost of goods sold
540,000
Accumulated depreciation
Interest expense
Accounts payable
$264,000
300,000
900,000
504,000
72,000
210,000
84,000
192,000
129,000
216,000
48,000
90,000
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
a. 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.
b. What is the company’s average tax rate?
c. What interest rate is charged on long-term debt?
d. 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
Cost of goods sold
Gross profit
$900,000
(540,000)
$360,000
Include a
financial
statement
heading.
Problem Solution
SHAE, INC.
Income Statement
For the Year Ended December 31, 2010
Sales
Cost of goods sold
Gross profit
Selling, general, and admin. exp.
Income from operations
$900,000
(540,000)
$360,000
( 72,000)
$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
Cost of goods sold
Gross profit
Selling, general, and admin. exp.
Income from operations
Interest expense
Income before taxes
$900,000
(540,000)
$360,000
( 72,000)
$288,000
( 48,000)
$240,000
Interest expense is a non-operating expense.
Problem Solution
SHAE, INC.
Income Statement
For the Year Ended December 31, 2010
Sales
Cost of goods sold
Gross profit
Selling, general, and admin. exp.
Income from operations
Interest expense
Income before taxes
Income tax expense
Net income
$900,000
(540,000)
$360,000
( 72,000)
$288,000
( 48,000)
$240,000
( 84,000)
$ 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:
Paid-in capital and retained
earnings are the two primary
components of owners’ equity.
Include a
financial
statement
heading.
Problem Solution
SHAE, INC.
Statement Changes in Owner’s Equity
For the Year Ended December 31, 2010
Paid-in capital:
Common stock
Retained earnings:
Paid-in capital includes common
stock and additional funds paid-in,
or contributed, by owners.
$210,000
Problem Solution
SHAE, INC.
Statement Changes in Owner’s Equity
For the Year Ended December 31, 2010
Paid-in capital:
Common stock
Retained earnings:
Beginning balance
Net income for the year
Less: Dividends declared and paid during year
Ending balance
$210,000
$129,000
156,000
(39,000)
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
Retained earnings:
Beginning balance
Net income for the year
Less: Dividends declared and paid during year
Ending balance
Total owners’ equity
$210,000
$129,000
156,000
(39,000)
Total owners’ equity is the sum of PIC and RE.
246,000
$456,000
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
Accounts receivable
Merchandise inventory
Total current assets
Non-current assets
Total assets
$192,000
120,000
264,000
$576,000
Current assets are listed in order
of liquidity, or nearness to cash.
Liabilities:
Owners’ Equity:
Total liabilities and owners’ equity
Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2010
Assets:
Cash
Accounts receivable
Merchandise inventory
Total current assets
Buildings and equipment
Less: Accumulated depreciation
Total assets
Liabilities:
Owners’ Equity:
Total liabilities and owners’ equity
$192,000
120,000
264,000
$576,000
504,000
(216,000) 288,000
$864,000
Accumulated depreciation is a
contra asset account.
Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2010
Assets:
Total assets
Liabilities:
Accounts payable
Accrued liabilities
Notes payable (long term)
Total liabilities
Owners’ Equity:
Total liabilities and owners’ equity
$864,000
$ 90,000
18,000
300,000
$408,000
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
Retained earnings
Total owners’ equity
Total liabilities and owners’ equity
$210,000
246,000
456,000
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
Total liabilities and owners’ equity
456,000
$864,000
Total assets = Total liabilities + Total owners’ equity
Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2010
Assets:
Cash
Accounts receivable
Merchandise inventory
Total current assets
Buildings and equipment
Less: Accumulated depreciation
Total assets
Liabilities:
Owners’ Equity:
Total liabilities and owners’ equity
Completed asset
side of balance
sheet.
$192,000
120,000
264,000
$456,000
504,000
(216,000)
288,000
$864,000
Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2010
Completed liability
and owners’ equity
side.
Assets:
Total assets
Liabilities:
Accounts payable
Accrued liabilities
Notes payable (long term)
Total liabilities
Owners’ equity:
Common stock
Retained earnings
Total owners’ equity
Total liabilities and owners’ equity
$864,000
$ 90,000
18,000
300,000
$408,000
$210,000
246,000
456,000
$864,000
Problem Solution
a.
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.
b. What is the company’s average tax rate?
c. What interest rate is charged on long-term debt?
d. 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
a.
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.
b. What is the company’s average tax rate?
c. What interest rate is charged on long-term
debt?
d. What is the par value per share of common
stock?
e. What is the company’s dividend policy?
Problem Solution
The interest rate charged on long-term debt
is a function of interest expense divided by
long-term debt:
$48,000 / $300,000 = 16% interest rate
This assumes that the year-end balance of long-term debt
is representative of the average long-term debt account
balance throughout the year.
Problem Solution
a.
b.
c.
d.
e.
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?
What is the company’s dividend policy?
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
a.
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.
b. What is the company’s average tax rate?
c. What interest rate is charged on long-term debt?
d. What is the par value per share of common
stock?
e. What is the company’s dividend policy?
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 understanding
of 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