Unit 17.1 Income statements
1. When revenues exceed expenses, is the result (a) net income or (b) net loss? (a) net income
2. Do income statements reflect profits of a business (a) on a certain date or (b) over a given period of time? (b) over a given period of time
3. Cost of goods sold is an important part of an income statement for service companies. (T or F) False
For Problems 4–6, fill in the missing amounts. Each problem represents a different situation. Negative values are in parentheses.
7. Calculate net sales based on gross sales of $805,000; sales returns of $5,400; and sales discounts of $15,700. Net sales = Gross sales - Sales returns - Sales discounts = $805,000 - $5,400 - $15,700 = $783,900
8. Calculate cost of goods sold based on $82,400 beginning inventory; $264,000 cost of goods purchased; and $94,800 ending inventory.
Cost of goods sold = Beginning inventory + Cost of goods purchased - Ending inventory = $82,400 + $264,000 - $94,800 = $251,600
9. Refer to Problems 7 and 8. Calculate gross profit.
Gross profit = Net sales - Cost of goods sold = $783,900 - $251,600 = $532,300 10. Refer to Problem 9. Calculate net income based on operating expenses of $371,300.
Net income = Gross profit - Operating expenses = $532,300 - $371,300 = $161,000
Unit 17.2 Balance sheets
For Problems 11–20, identify the item by placing the appropriate letter in the space.
Item Choose from
11. Accounts receivable A. Current asset
12. Accounts payable B. Plant and equipment
13. Office equipment C. Investment asset
14. Owner’s equity D. Intangible asset
15. Cash E. Current liability
16. Land held for future expansion F. Long-term liability
17. Trademark G. Equity item
18. Mortgage payable (monthly payments) 19. Building and land for present location 20. Retained earnings
21. Bihn Pham owns an engineering consulting business. Total assets are $135,700. Total liabilities are $24,800. What is Bihn’s equity in the business?
Owner’s equity = Assets - Liabilities = $135,700 - $24,800 = $110,900
22. Assets should be shown on balance sheets at current value, not original cost. (T or F) False
Chapter Review Problems
4. 5. 6.
Revenues $108,000 $120,000 $ 69,000
Total expenses $ 28,000 $130,000 $42,000
Net income (or loss) $ 80,000 ($10,000) $27,000
A E B G A C D E&F* B G
*Note: For Problem 18, part of the mortgage will be paid within 1 year (or
For Problems 23–25, fill in the missing amounts. Each problem represents a different situation.
26. For corporations, the equity section of a balance sheet is called corporate equity. (T or F) False. The equity section is called stockholders’ equity.
27. For a personal financial statement, assets are often shown at current value, not at cost. (T or F) True
28. For a personal financial statement, the difference between assets and liabilities is referred to as personal equity. (T or F)
False. The difference is called net worth.
Unit 17.3 Trend and ratio analysis
29. Vertical and horizontal analysis are used to evaluate the progress of a company over two or more accounting periods. (T or F) True
384 Chapter 17 Financial Statements: How to Read and Interpret
BBB OFFICE SUPPLY, INC.
Comparative Income Statement (2005 vs 2004)
Annual Amounts Percent of Net Sales Increase (or Decrease)
2005 2004 2005 2004 Amount Percent
Gross sales $346,200 $364,900 101.1 100.5 ($18,700) (5.1)
Sales returns 3,800 1,700 1.1 0.5 2,100 123.5
Net sales $342,400 $363,200 100.0 100.0 ($20,800) (5.7)
Cost of goods sold 153,100 148,700 44.7 40.9 4,400 3.0
Gross profit $189,300 $214,500 55.3 59.1 ($25,200) (11.7)
Total operating expenses 177,700 153,400 51.9 42.2 24,300 15.8
Net income (before income taxes) $11,600 $61,100 3.4 16.8 ($49,500) (81.0)
Less income taxes 4,000 22,000 1.2 6.1 (18,000) (81.8)
Net income (after income taxes) $7,600 $39,100 2.2 10.8 ($31,500) (80.6)
30. Comparative data for BBB Office Supply is given in the first two columns of the following pair of tables. Complete the remaining columns using vertical and horizontal analysis. Show percents with 1 decimal place.
BBB OFFICE SUPPLY, INC.
Comparative Balance Sheet (Dec. 31, 2005 vs Dec. 31, 2004)
Year-end Amounts Percent of Total Increase (or Decrease)
2005 2004 2005 2004 Amount Percent Assets Current assets Cash $23,100 $36,100 17.7 22.1 ($13,000) (36.0) Accounts receivable 42,000 45,100 32.2 27.6 (3,100) (6.9) Merchandise inventory 58,100 73,800 44.5 45.2 (15,700) (21.3) Prepaid expenses 300 300 0.2 0.2 0 0
Total current assets $123,500 $155,300 94.6 95.2 ($31,800) (20.5)
Plant and equipment, net 7,100 7,900 5.4 4.8 (800) (10.1)
Total assets $130,600 $163,200 100.0 100.0 ($32,600) (20.0) Liabilities Accounts payable $18,000 $19,000 13.8 11.6 ($1,000) (5.3) Total liabilities $18,000 $19,000 13.8 11.6 ($1,000) (5.3) Stockholders’ Equity Common stock $100,000 $100,000 76.6 61.3 $0 0 Retained earnings 12,600 44,200 9.6 27.1 (31,600) (71.5)
Total stockholders’ equity $112,600 $144,200 86.2 88.4 ($31,600) (21.9)
Total liabilities and SH equity $130,600 $163,200 100.0 100.0 ($32,600) (20.0)
23. 24 25.
Total assets $128,000 $820,000 $219,000
Total liabilities $ 65,000 $148,000 $192,000
31. Refer to Problem 30. List a few noteworthy items that might make stockholders happy or concerned. The answer is a bit subjective, but here are a few ideas.
• Sales decreased 5.1%.
• Cost of goods sold increased 3.0%, even though sales decreased. • Expenses increased 15.8%, even though sales decreased. • Total stockholders’ equity decreased $31,600.
For Problems 32–38, use the data of Problem 30 to calculate the requested ratio or percent for 2005. Use one decimal place in all ratios or percents. Then, state what the ratio means.
32. Current ratio.
For each dollar of current liabilities, BBB has about $6.90 of current assets.
33. Acid-test ratio.
For each dollar of current liabilities, BBB has about $3.60 of highly liquid assets.
34. Debt ratio.
For each dollar of assets, BBB owes 13.8¢.
35. Inventory turnover.
Inventory was sold 2.3 times during the year.
36. Cost of goods sold as % of net sales.
BBB’s goods cost 44.7% of what they sold for.
37. Profit margin, before tax.
BBB’s profit is 3.4% of net sales.
38. Return on equity.
BBB’s profit, after tax, is 6.7% of stockholders’ equity.
39. LMN, Inc., has a current ratio of 1.3. The industry average for its type of business is 1.8. Is LMN’s current ratio (a) better or (b) worse than the industry average? (b) Worse
40. Refer to Problem 39. What can LMN do to improve its current ratio?
a. Increase profits. By increasing profits, LMN will have more cash or accounts receivable, thereby increasing current assets.
b. Increase term financing. By doing this, LMN will increase term liabilities and increase cash. Because long-term liabilities do not affect the current ratio, the ratio will be improved.
c. Reduce dividends. By reducing dividends, cash will not decrease as much.
d. Sell additional stock. By doing this, cash will be increased without affecting current liabilities.
41. Would a business prefer having a (a) high or (b) low inventory turnover? (a) High. Businesses prefer selling their inven-tory quickly.
42. What can be done to improve inventory turnover?
a. Do more advertising. By doing more advertising, sales should increase, thereby contributing to a quicker inventory turnover.
b. Improve sales staff. Maybe the sales staff is not assisting customers adequately. By giving better assistance, sales should increase.
c. Reduce inventory. If inventory is excessive, reducing inventory may be a good strategy. However, if the inventory is not excessive, decreasing inventory may lead to a decrease in sales.
Current ratio = Current assets = $123,500 ≈ 6.9 Current liabilities $18,000
Acid-test ratio = Cash + Accounts receivable = $23,100 + $42,000 = $65,100 ≈ 3.6
Current liabilities $18,000 $18,000
Debt ratio = Total liabilities = $18,000 ≈ .138 ≈ 13.8% Total assets $130,600
Inventory turnover = Cost of goods sold = $153,100 = $153,100 ≈ 2.3 Average inventory ($73,800 + $58,100) ÷2 $65,950
Cost of goods sold as % of net sales = Cost of goods sold = $153,100 ≈ .447 ≈44.7% Net sales $342,400
Profit margin, before tax = Net income, before tax = $11,600 ≈ 0.034 ≈ 3.4%
Net sales $342,400
Return on equity = Net income, after tax = $7,600 ≈ .067 ≈ 6.7%
386 Chapter 17 Financial Statements: How to Read and Interpret
Challenge problems
For Problems 43–47, answer from the following choices: sole proprietorship, general partnership, corporation, LLC.
43. For which entity or entities are the owner(s) personally responsible for the company’s debts? Sole proprietorship and partnership
44. Which entity or entities file a federal income tax return? Partnership, corporation, and LLC
45. Which entity or entities pay federal income tax directly to the IRS? Corporation
46. For which entity or entities are distributions of extra cash taxable to the owners? Corporation
47. Which entity or entities can be owned by only one person? Sole proprietorship, corporation, and LLC
48. A three-person general partnership quits doing business and has only $60,000 with which to pay $90,000 of debt. Which statement is true? (a) The partners are not personally liable for the $30,000 difference; (b) each partner is liable for exactly $10,000; (c) any of the partners may be sued for the entire $30,000 difference. (c)
49. ABC Corporation had annual profit of $1,200,000. Assume that the corporation pays 40% of federal and state income taxes; the remainder is paid to stockholders as dividends. Assuming that stockholders pay 35% of dividends as federal and state income taxes, determine the total percent of income taxes paid as a result of the $1,200,000 profit.
Income tax paid by corporation: $1,200,000 ×40% $480,000
Income tax paid by stockholders:
Profit $1,200,000
Less income tax paid by corporation - 480,000
Available for dividends $ 720,000 ×35% + 252,000
Total $732,000
Percent of profit paid as income tax = = .610 = 61%
50. Prepare an income statement for Fisher’s Clothing Store, Inc. Income statement items for the first 3 months of 2006 were as follows: gross sales, $1,653,800; sales returns, $143,700; beginning inventory, $436,000; purchases, $922,800; pur-chase returns, $5,300; purpur-chase discounts, $13,800; transportation in, $3,400; ending inventory, $461,900; total operat-ing expenses, $296,600; income taxes, $110,000. Use the format of Illustration 17-3.
$732,000 $1,200,000
FISHER’S CLOTHING STORE, INC. Income Statement for the Quarter Ended March 31, 2006 Revenue from sales
Gross sales $1,653,800
Less: Sales returns 143,700
Net sales $1,510,100
Cost of goods sold
Merchandise inventory, January 1, 2006 $436,000
Purchases $922,800
Less: Purchase returns $5,300 Purchase discounts 13,800
Subtotal 19,100
Net purchases $903,700
Add transportation in 3,400
Cost of goods purchased 907,100
Goods available for sale $1,343,100
Merchandise inventory, March 31, 2006 461,900
Cost of goods sold 881,200
Gross profit from sales $628,900
Less operating expenses 296,600
Net income (before income taxes) $332,300
Less income tax expense 110,000
51. Wayne’s Corner Market, Inc., had assets and liabilities on June 30, 2006, as follows: cash, $22,800; accounts payable, $38,100; store equipment, $42,000 less accumulated depreciation of $10,500; merchandise inventory, $42,200; notes payable, $5,000 (the entire amount is due in 18 months); prepaid expenses, $800. So far, 1,000 shares of stock have been issued (at $20 per share). Prepare a classified balance sheet like that of Illustration 17-4. In the process, determine the amount of retained earnings.
1. What, if anything, is wrong with this income statement heading?
An income statement is for a period of time, not a certain date. The last line should read something like “For June 2006,” “For quarter ending June 30, 2006,” or “For six months ending June 30, 2006.”
2. Given: gross sales, $220,000; sales returns, $1,500; sales discounts, $2,000; beginning inventory, $92,000; cost of goods purchased, $145,000; ending inventory, $95,000; operating expenses, $30,000. Calculate: (a) net sales, (b) cost of goods sold, (c) gross profit, and (d) net income.
a. Net sales = Gross sales - Sales returns - Sales discounts = $220,000 - $1,500 - $2,000 = $216,500 b. Cost of goods sold = Beginning inventory + Cost of goods purchased - Ending inventory =
$92,000 + $145,000 - $95,000 = $142,000
c. Gross profit = Net sales - Cost of goods sold = $216,500 - $142,000 = $74,500 d. Net income = Gross profit - Operating expenses = $74,500 - $30,000 = $44,500
3. Given: cash, $28,000; accounts receivable, $52,000; merchandise inventory, $60,000; prepaid expenses, $2,000; land for future expansion, $50,000; accounts payable, $24,000. Calculate the equity of the business.
Assets: $28,000 + $52,000 + $60,000 + $2,000 + $50,000 = $192,000
Liabilities - 24,000
Equity $168,000
Practice Test
WAYNE’S CORNER MARKET, INC. Balance Sheet: June 30, 2006
Assets Current assets
Cash $22,800
Merchandise inventory 42,200
Prepaid expenses 800
Total current assets $65,800
Plant and equipment
Store equipment $42,000
Less accumulated depreciation 10,500
31,500 Total assets $97,300 Liabilities Current liabilities Accounts payable $38,100 Long-term liabilities Notes payable 5,000 Total liabilities $43,100 Stockholders’ Equity
Common stock: 1,000 shares @ $20 $20,000
Retained earnings 34,200
Total stockholders’ equity 54,200
Total liabilities and stockholders’ equity $97,300
ALPINE ENGINEERING
Income Statement4. Given: net sales, $152,800; total operating expenses, $42,100. What percent of net sales are operating expenses? Round to the nearest tenth of a percent. $42,100 ÷$152,800 ≈.276 ≈27.6%
5. For each item, calculate (a) the dollar amount of increase and (b) the percent change (rounded to the nearest tenth of a percent).
6. Given: total current assets, $120,000; total assets, $280,000; total current liabilities, $72,000; total liabilities, $150,000; beginning inventory, $60,000; ending inventory, $68,000; cost of goods sold, $140,000. Calculate (a) current ratio, (b) debt ratio, and (c) inventory turnover. Use 1 decimal place in each ratio. For each ratio, tell what it means.
a.
For each dollar of current liabilities, the company has about $1.70 of current assets. b.
For each dollar of assets, the company owes about 53.6¢. c.
Inventory was sold 2.2 times during the year.
388 Chapter 17 Financial Statements: How to Read and Interpret
Increase (or Decrease)
Item 2006 2005 Amount Percent
Cash $27,000 $23,000 $4,000 17.4
Accounts receivable $52,000 $58,000 ($6,000) (10.3)
Current ratio = Current assets = $120,000 ≈ 1.7 Current liabilities $72,000
Debt ratio = Total liabilities = $150,000 ≈ .536 ≈ 53.6% Total assets $280,000