Chapter 5 Part 2 Businesses take actual count of inventory at least once per year Actual count of inventory may differ from amount on the books due to: ◦ Theft or Damage – Inventory Shrinkage ◦ Errors GENERAL JOURNAL DATE REF DESCRIPTION DEBIT CREDIT Cost of goods sold Inventory To adjust for shrinkage Copyright (c) 2009 Prentice Hall. All rights reserved. 2 $ 40,500 (per books) -40,200 (physical count) $ 300 (shrinkage) GENERAL JOURNAL DATE DESCRIPTION REF DEBIT Cost of Goods Sold Inventory Adjustment for shrinkage CREDIT 300 300 3 Prepare a merchandiser’s financial statements Copyright (c) 2009 Prentice Hall. All rights reserved. 4 Multi-step Lists several important subtotals ◦ Gross profit ◦ Operating income More popular Single-step Groups all revenue and all expenses together ◦ No subtotals Works well for service companies Copyright (c) 2009 Prentice Hall. All rights reserved. 5 Step 1 – Net Sales Revenue Sales Revenue – Sales Discounts – Sales Returns and Allowances Net Sales Revenue 6 Step 2: Gross Profit Net sales - Cost of goods sold Gross profit 7 Step 3: Operating Income Operating Expenses 8 Step 3: Operating Income Net sales Cost of goods sold Gross profit -Operating expenses Operating income 9 Step 4: Net Income (Loss) + Other revenues - Other expenses 10 Net sales Cost of goods sold Gross profit -Operating expenses Operating income Other revenue and expense Net income (loss) 11 Greg’s Groovy Tunes Income Statement Year Ended December 31, 2011 Sales Revenue $169,300 Less: Sales Ret. & Allowances (2,000) Sales Discounts (1,400) (3,400) Net Sales Revenue $165,900 Cost of Goods Sold (90,800) Gross Profit 75,100 Operating Expenses: Wages expense $10,200 Rent expense 8,400 Insurance expense 1,000 Depreciation expense 600 Supplies expense 500 20,700 Operating Income 54,400 Other revenue and (expenses): Interest expense (1,300) Net Income $53,100 12 Multi-step Lists several important subtotals ◦ Gross profit ◦ Operating income More popular Single-step Groups all revenue and all expenses together ◦ No subtotals Works well for service companies Copyright (c) 2009 Prentice Hall. All rights reserved. 13 A single-step income statement is one of two commonly used formats for the income statement or profit and loss statement. The single-step format uses only one subtraction to arrive at net income. Net Income = (Revenues + Gains) – (Expenses + Losses) 14 15 The multiple-step profit and loss statement segregates the operating revenues and operating expenses from the nonoperating revenues, nonoperating expenses, gains, and losses. The multiple-step income statement also shows the gross profit (net sales minus the cost of goods sold). 16 17 Net sales Cost of goods sold Expenses Net income (loss) 18 Greg’s Groovy Tunes Income Statement Year Ended December 31, 2011 Sales Revenue $169,300 Less: Sales Ret. & Allowances (2,000) Sales Discounts (1,400) (3,400) Net Sales Revenue $165,900 Operating Expenses: Cost of goods sold Wages expense Rent expense Interest expense Insurance expense Depreciation expense Supplies expense Total expense Net Income $90,800 10,200 8,400 1,300 1,000 600 500 (112,800) $53,100 19 Shows relationship of each item to a base amount on financial statements Income statement – each item expressed as percentage of net sales Balance sheet – each item expressed as percentage of total assets 20 Percentages based on total revenues: Cost of goods sold: 2010: 90,000/150,000 = 60% 2011: 90,800/165,900 = 54.7% Wages Expenses: 2010: 7,500/150,000 = 5% 2011: 10,200/165,900 = 6.1% 21 Percentages based on total revenues: Rent Expense: 2010: 8,400/150,000 = 5.6% 2011: 8,400/165,900 = 5.1% Interest Expense: 2010: 1,500/150,000 = 1% 2011: 1,300/165,900 = .8% 22 Percentages based on total revenues: Insurance Expense: 2010: 1,500/150,000 1% 2011: 1,000/165,900 = .6% Depreciation Expense: 2010: 3,000/150,000 = 2% 2011: 1,600/165,900 = .4% 23 Percentages based on total revenues: Supplies Expense: 2010: 600/ 150,000 = .4% 2011: 500/165,900 = .3% 24 Comparative Vertical Analysis Income Statement Years Ended December 31, 2011 and 2010 2011 Net Sales $165,900 2010 100.0% $150,000 100.0% Cogs 90,800 54.7% 90,000 60% Wages Expense 10,200 6.1 7,500 5 8,400 5.1 8,400 5.6 1,300 .8 1,500 1 1,000 .6 1,500 1 Depreciation Expense 600 .4 3,000 2 Supplies Expense 500 .3 600 .4 Rent Expense Interest Expense Insurance Expense Total Expenses 112,800 68% 112,500 75% Net Income $53,100 32% 37,500 25% 25 Greg’s Groovy Tunes Statement of Owner’s Equity Year Ended December 31, 2011 Amy Toms, Capital, Dec. 31, 2010 $25,900 Net Income 53,100 Subtotal $88,550 Greg Moore, Withdrawals (54,100) Greg Moore, Capital, Dec. 31, 2011 $24,900 26 Greg’s Groovy Tunes Balance Sheet December 31, 2011 Assets Current Assets Cash Accounts Receivable Inventory Prepaid Insurance Supplies Total Current Assets Furniture $33,200 Accumulated depreciation (3,000) Total Assets $2,800 4,600 40,200 200 100 $47,900 30,200 $78.100 Liabilities Current Liabilities Accounts Payable Unearned Serv. Revenue Wages payable Total Current Liabilities Long-term Liabilities: Notes payable Total Liabilities Owner’s Equity Greg Moore, Capital Total Liabilities & Owner’s Equity 27 $39,500 700 400 $40,600 12,600 53,200 24,900 $78,100 Use gross profit percentage and inventory turnover to evaluate a business Copyright (c) 2009 Prentice Hall. All rights reserved. 28 Gross Profit Net Sales Carefully watched measure Small increase may indicate rise in income Small decrease may indicate trouble Copyright (c) 2009 Prentice Hall. All rights reserved. 29 Gross Profit Net Sales What is Gross Profit? It is what you have left from sales after paying for the cost of making those sales, to pay all other expenses. If your costs of inventory starts to rise and you don’t raise your prices to increase net sales, this ration will start to fall this means your overall profits are being squeezed. Net Sales Less: Cost of Goods Sold -------------------------------Gross Profit Copyright (c) 2009 Prentice Hall. All rights reserved. 30 Gross Profit-$75,100 Net Sales- $165,900 45.3% Carefully watched measure Small increase may indicate rise in income Small decrease may indicate trouble Copyright (c) 2009 Prentice Hall. All rights reserved. 31 Cost of goods sold Average inventory Measures how rapidly inventory is sold (To get the amount of cost of goods sold that I did this year, how many times was the amount I kept in inventory replaced?) Because inventory costs money to keep around, the more cost of goods sold I can get from a very small inventory the better.) The higher the turnover, the more quickly inventory is sold Copyright (c) 2009 Prentice Hall. All rights reserved. 32 Cost of goods sold Average inventory To get the amount of cost of goods sold that I did this year, how many times was the amount I kept in inventory replaced?) Because inventory costs money to keep around, the more cost of goods sold I can get from a very small inventory the better. Copyright (c) 2009 Prentice Hall. All rights reserved. 33 Compute the Rate of Inventory turnover assuming that Groovy Tunes had a 12/31/10 Inventory of $38,600 and a $40,200 Inventory on 12/31/11 34 Inventory Turnover: Cost of goods sold = $90,800 = 2.3 times Average inventory $(38,600+40,200)/2 35 Adjust and close the accounts of a merchandising business Copyright (c) 2009 Prentice Hall. All rights reserved. 36 Greg’s Groovy Tunes Income Statement Year Ended December 31, 2011 Sales Revenue $169,300 Less: Sales Ret. & Allowances (2,000) Sales Discounts (1,400) (3,400) Net Sales Revenue $165,900 Cost of Goods Sold (90,800) Gross Profit 75,100 Operating Expenses: Wages expense $10,200 Rent expense 8,400 Insurance expense 1,000 Depreciation expense 600 Supplies expense 500 20,700 Operating Income 54,400 Other revenue and (expenses): Interest expense (1,300) Net Income $53,100 37 1. Close all income statement accounts with credit balances to Income Summary 2. Close all income statement accounts with debit balances to Income Summary 3. Close Income Summary to Capital 4. Close Withdrawals to Capital 38 GENERAL JOURNAL DATE DESCRIPTION Dec 31 Sales Revenue Income Summary REF DEBIT CREDIT 169,300 169,300 39 1. Close all income statement accounts with credit balances to Income Summary 2. Close all income statement accounts with debit balances to Income Summary 3. Close Income Summary to Capital 4. Close Withdrawals to Capital 40 GENERAL JOURNAL DATE DESCRIPTION Dec 31 Income Summary Sales Ret. & Allowances Sales Discounts Cost of goods sold Wages Expense Rent Expense Depreciation Expense Insurance Expense REF DEBIT CREDIT 116,200 2,000 1,400 90,800 10,200 8,400 600 1,000 Supplies Expense 500 Interest Expense 1,300 41 1. Close all income statement accounts with credit balances to Income Summary 2. Close all income statement accounts with debit balances to Income Summary 3. Close Income Summary to Capital 4. Close Withdrawals to Capital 42 GENERAL JOURNAL DATE DESCRIPTION Dec 31 Income Summary Greg Moore, Capital (169,300 – 116,200) REF DEBIT CREDIT 53,100 53,100 43 1. Close all income statement accounts with credit balances to Income Summary 2. Close all income statement accounts with debit balances to Income Summary 3. Close Income Summary to Capital 4. Close Withdrawals to Capital 44 GENERAL JOURNAL DATE DESCRIPTION Dec 31 Income Summary Greg Moore, Capital (169,300 – 116,200) 31 Greg Moore Capital REF DEBIT CREDIT 53,100 53,100 54,100 Greg Moore, Withdrawals 54,100 45