Accounting Income Statement Notes

● Four basic financial statements ○ Balance sheet ○ Income statement ○ Statement of stockholders equity ○ Statement of cash flow ● The Balance Sheet ○ Reports the economic resources a corporation owns and the sources of financing for those resources ○ The purpose of the balance sheet is to report the financial position (amount of assets, liabilities, and stockholders equity) of an accounting entity at a particular point in time ○ Content: cash, accounts receivable, plant and equipment, long term debt, common stock ○ Assets = Liabilities + Stockholders Equity ○ Permanent account ○ ● The Income Statement ○ Statement of income, statement of earnings, statement of operations ○ Reports the accountant’s primary measure of performance of a business, revenues less expenses during the accounting period ○ Revenues - Expenses = Net Income ○ Sales revenue, cost of goods sold, selling expense, interest expense ○ Temporary account that is closed every year, starts new every year ○ Taxes ○ To find the tax rate, divide the income tax expense by the income before income taxes ○ Earnings per share: hypothetically, this is what each share of common stock earned during the period (different than dividends) ■ EPS = (Net Income - Dividends on preferred stock)/Average number of shares of common stock outstanding during the period ■ For common stock, find the average of the numbers ■ EPS is intended for common stock only ■ No relationship between EPS and dividends paid ■ Always disclosed in the income statement ○ ● Statement of Stockholders Equity ○ Reports the way that net income and the distribution of dividends affected the financial position of the company during the accounting period ○ Covers a specific period of time (the accounting period) ○ Beginning and ends stockholders equity, stock issuances, net income, dividends ○ ○ Explains changes in stockholders equity accounts, including the change in the retained earnings balance caused by net income and dividends during the reporting period. ● Statement of Cash Flows ○ Reports inflows and outflows of cash during the accounting period in the categories of operating, investing, and financing ○ Reported revenues do not always equal cash collected because some sales might be on credit ○ Cash collected from customers, cash paid to suppliers, cash paid to purchase equipment, cash borrowed from banks ○ Cash flows from operating activities ■ Cash flows directly related to earning income ○ Cash flows from investing activities ■ Cash flows related to the acquisition or sale of the company’s plant and equipment and activities ○ Cash flows from financing activities ■ Cash flows directly related to the financing of the enterprise itself ■ Receipt or payment of money to investors and creditors (except for suppliers) ○ ● How to calculate Retained Earnings ○ Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earning ○ Included on the Statement of Stockholders Equity ○ The amount we have made since day 1 ○ Only way to increase it is net income ○ Decreases through net loss and dividends paid ● Basic Accounting Equation ○ Also called the balance sheet equation ○ Assets = Liabilities + Stockholders Equity ○ Shows what we mean when we refer to a company’s financial position: the economic resources that the company owns and the sources of financing for those resources ● Effects of Debits and Credits on the various financial statements accounts ○ Every transaction must have an equal debit and credit Debit Credit Assets Increase Decrease Liabilities Decrease Increase Owner’s Equity Decrease Increase Revenues Decrease Increase Expenses Increase Decrease ○ ● Assets ○ Economic resources owned by the entity ○ List in order of liquidity ■ Cash, accounts receivable, inventories, equipment ○ “Current” is within one year, “noncurrent” is more long term ● Liabilities ○ Debt or obligation based on a past transaction ○ Amount of financing provided by creditors ○ List in order of date (current first, then noncurrent liabilities) that they must be paid ● Stockholders Equity ○ Contributed capital (common stock that you sell) and retained earnings ○ Leftover value ● Accrual vs. Cash Basis ○ Accrual: public companies must used this. Recognize transactions when revenues are earned and expenses are incurred ○ Cash basis: recognize revenues and expenses when you are paid and when cash exchanges hands. Used by smaller or private companies. ● Dividends ○ Money paid from company profits to shareholders ● Flow of financial statement ○ Income statement is the first you prepare ○ The retained earnings goes to Stockholders Equity statement, second one you prepare ○ The balance statement is the third one prepared ○ The fourth is the statement of cash flows ● What if there is a significant difference between cash flow from operations and net income? ○ This could signal the existence of unusual deferrals, allocations, or valuations ○ If you have earnings, you should have cash. If you don’t have cash, you have a problem. ● Total asset turnover ratio ○ How efficient is management in using its resources to generate sales? ○ Total asset turnover ratio = Net sales (or operating revenues)/Average total assets ■ The average total assets is the average of beginning balance and end balance ○ Higher ratio is better ● Post closing trial balance ○ After the closing process is complete, all income statement accounts have a zero balance ○ The ending balance in RE now is up to date (matches the amount on the balance sheet) ● APIC = Sales price of stock - par value ○ Additional paid in capital ● Revenues vs. Gains ○ Revenues is profit from day to day ○ Gains are peripheral earnings in the company ● Expenses vs. Losses ○ Expenses are the costs made in order to earn revenue (cost of goods, salaries expense, etc.) ○ Losses are from peripheral transactions ● Deferred/unearned revenue ○ You collect cash but you have not delivered the product or given the service yet ● Journal entries to record prepayments and /or expenses not yet paid ○ You make an entry to show that the transaction is pending ● Revenue principle ○ Record income when the product is delivered or the service is performed ○ Before the product is delivered if you get paid, it is unearned revenue ● Expense matching principle ○ All expenses must be recognized at the time they are incurred ● T accounts ○ Debit on left ○ Credit on right ○ Helps visualize entries ● What is the effect on the financial statements when a required accrual fails to be recorded? ○ It looks like you have more money than you do because you did not record the expenses ■ Debit expense, credit accounts payable ■ If you do not record it, your expenses will be understated ○ If you do not record payments that will be paid to you by customers ■ Debit accounts receivable, credit sales revenue ● GAAP: generally accepted accounting principles ● FASB: financial accounting standards board ● IFRS: international financial reporting standards (similar to GAAP) ● Sole proprietorship ○ Single individual owns the company ○ Unlimited liability for losses ○ Do not share the profits ○ No paperwork ○ Can work when you please ○ Can have the company for zero cost ○ Reliable for all debt ● Partnership ○ 2+ individuals ● Corporation ○ Ownership by shares of stock ○ Double taxation (corporation tax and tax on dividends) ○ Limited liability ○ Ease of transfer of ownership ○ Continuity of life ○ Opportunity to raise large amounts of money ● Financial reporting to external users ○ Management is responsible for preparing the financial statements ○ Provide financial information about the entity that could be useful to existing/potential investors, lenders, creditors in making decisions ● ● ● ● ● ● ● ○ Pervasive cost benefit constraint: the benefits of reporting this information should outweigh the costs ○ High quality = relevance and faithful representation ○ Comparability, verifiability, timeliness, understandable ○ Helps users asses amount, timings, and uncertainty of future cash inflows and outflows ○ Elements to be reported: assets, liabilities, stockholders equity, investments, distributions, revenues, expenses, gains, losses 10K: annual report that must be audited by a CPA 10Q: quarterly report that is not audited (3 per year) 8K: reveals anything the company does that can affect the market Edgar: electronic data gathering and retrieval Treasury stock: company buys back its own stock ○ To issue to employees ○ To resell at a higher price Common stock = shares × par value Net profit margin = net income ÷ net sales ○ How effective you are in generating profits on sales Four basic financial statements 1. Income Statement 2. Statement of Stockholders Equity 3. Balance Sheet 4. Statement of Cash Flows What are the objectives of each financial statements 1. Income Statement a. Shows the reader how much profit or loss an organization generated during a reporting period 2. Statement of Stockholders Equity a. Highlights the changes in value to stockholders' or shareholders' equity, or ownership interest in a company, from the beginning of a given accounting period to the end of that period. 3. Balance Sheet a. A snapshot at a single point in time of the company's accounts – covering its assets, liabilities and shareholders' equity. The purpose of the balance sheet is to give users an idea of the company's financial position along with displaying what the company owns and owes. 4. Statement of Cash Flows a. Provide information about cash receipts, cash payments, and the net change in cash resulting from the operating, investing, and financing activities of a company during the period. How to calculate Retained Earnings (increases and decreases) 1. Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earning 2. Included on the Statement of Stockholders Equity 3. The amount we have made since day 1 4. Only way to increase it is net income 5. Decreases through net loss and dividends paid Basic accounting equation ● Assets = Liabilities + Stockholders Equity Be familiar with the effects of Debits & Credits on the various financial statements accounts (YOU MUST KNOW THIS) Debit Credit Assets INC DEC Liabilities DEC INC Owners Equity DEC INC Revenues DEC INC Expenses INC DEC Assets - what are they? ● Something owned that has economic value in the future ● Ex: Cash, short-term investments, Accounts Receivable, Supplies, prepaid expense, equipment, land, intangibles(Intellectual property) ● Listed in order of liquidity Liabilities - what are they? ● A debt or obligation based on a passed transaction ● Ex: Accounts payable, accrued expenses, Notes payable, unearned revenue. Stockholders/Owners' Equity - what is it? ● The residual value of what is left over after liabilities are taken out of assets Dividends - what are they? ● Money paid from the companies profits to the shareholders Current vs Noncurrent Assets & Liabilities ● Current = Within one year (12 months) ● Noncurrent = Lasting longer than 12 months Various classifications of the Statement of Cash Flows - what activity falls within each? ● Operating- Day to day activities ● Financing- Obtaining money to fund the business ● Investing- Purchasing new equipment, people, etc. to better your company How are current assets listed? ● In order of liquidity How are current liabilities listed? ● In order of maturity aka when they are due How are Retained Earnings increased & decreased? ● Retained earnings are affected by any increases or decreases in net income and dividends paid to shareholders. Revenues v Gains ● Revenue is the amount earned from a company's main activities such as selling merchandise or providing services. A gain results from a peripheral activity, such as selling the old delivery truck. Expenses v Losses ● An expense is a cost used up in earning revenues in a company's main operations. A loss is associated with a "peripheral" or "incidental" transaction. Deferred/Unearned Revenue - what are they? ● Revenue that is gained before the product or service is performed ● Is recorded as a liability Journal entries to record prepayments and/or expenses not yet paid ● Is recorded as a liability Revenue principle ● Income is recorded when it is earned and irrespective of when the associated cash is actually received by the business. Expense matching principle ● The Expense Matching Principle states that all expenses must be matched in the same accounting period as the revenues they helped to earn. T-Accounts What is the 'effect' on the financial statements when a required 'accrual' fails to be recorded? ● An accrued expense is paid after being recorded on the books ● If an accrual fails to be recorded, the company's financials do not show expenses that the company owes and therefore does not give an accurate representation of the companies earnings. ● BLUF: Not recording an accrual makes the company seem like it has more money then it does. The above is NOT ALL INCLUSIVE, do not study just from it. Other Material We need to Know: Classified Balance Sheet ● More detailed balance sheet that includes noncurrent and current assets and liabilities. Current Ratio ● Current Assets/Current Liabilities Working Capital ● Current Assests - Current Liabilities Straight Line Depreciation ● (Equipment Value - Residual Value) / (Estimated us of Life) Calculating Earnings Per Share ● Net Income After Taxes - Preferred stock Dividends / Average Outstanding Common Stock ● Ex: ○ NIAT = $200,000 ○ Jan 1. = 100,000 outstanding stock ○ Dec 31. = 200,000 outstanding stock ○ Prefered stock dividend = $25,000 ■ Equation (200,000−25,000 )/(( 100,000 +200,000 )/2)=¿ 1.17 ● Remember ● It is ALWAYS senior management's responsibility to report accurate financial documentation Financial Documents to Memorize ● 10K: annual report that must be audited by a CPA ● 10Q: quarterly report that is not audited (3 per year) ● 8K: reveals anything the company does that can affect the market What does EDGAR stand for ● Electronic Data Gathering and Retrieval What is a Treasury Stock ● Stock that is bought back by the company either to: ○ Issue to employees ○ Resell at a higher price Calculating Common Stock using its par value ● Shares × Par Value Organizations to Memorize ● GAAP: Generally Accepted Accounting Principles ● FASB: Financial Accounting Standards Board ● IFRS: International Financial Reporting Standards (similar to GAAP) How to calculate additional paid in capital ● (Current Market Price - Par Value) x Shares Outstanding