McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-1 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-1 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. CHAPTER 9 The Income Statement and the Statement of Cash Flows

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-2 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-2 Income Statement Revenues Revenue is generated when a firm sells a product or provides a service to a client or customer and receives cash, creates an account receivable, or satisfies an obligation. Revenue is generally measured by the amount of cash received or expected to be received from a transaction. L O 1

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-3 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-3 Revenue Revenue is realized when the product or service has been exchanged for cash, claims to cash, or an asset that is readily convertible to a known amount of cash. Revenue is earned when the firm has completed, or substantially completed, the activities it must perform to be entitled to the revenue benefits. Companies should disclose unusual revenue recognition methods, such as percentage-of- completion or installment methods. L O 1

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-4 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-4 Sales Revenue On March 15, Matrix, Inc. sold $12,500 of inventory on open accounts receivable. On March 15, Matrix, Inc. sold $12,500 of inventory on open accounts receivable. L O 1

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-5 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-5 Sales Revenue Sales Returns: Merchandise returned by the customer. Sales Allowances: A reduction in the amount owed by the customer as a result of defective merchandise received. Sales Discounts: A reduction in the amount owed by the customer to encourage prompt payment on account. L O 1

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-6 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-6 Shipping Terms FOB Shipping Point FOB Destination Seller Buyer Merchandise Carrier Ownership transfers to buyer when merchandise is passed to carrier, and the buyer pays the shipping costs. Ownership transfers to buyer when merchandise is passed to buyer, and the seller pays the shipping costs. L O 2

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-7 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-7 Gains/Losses Increases (gains) or decreases (losses) in an entity’s net assets resulting from nonoperating activities. Gains/losses are usually reported as other income and excluded from operating income. L O 8

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-8 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-8 Expenses Outflows or other using up of assets or incurring liabilities from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing central operations. 1.Some expenses are recognized concurrently with the revenues to which they relate (matching principle). 2.Some expenses are recognized in the period in which they are incurred (administrative salaries). 3.Some expenses result from an allocation of the cost of an asset to the period (depreciation). 1.Some expenses are recognized concurrently with the revenues to which they relate (matching principle). 2.Some expenses are recognized in the period in which they are incurred (administrative salaries). 3.Some expenses result from an allocation of the cost of an asset to the period (depreciation). L O 4

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-9 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 9-9 Cost of Goods Sold Calculation of Cost of Goods Sold in a Periodic Inventory System In a perpetual inventory system, cost of goods sold is determined for each sale. L O 2

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Recording Cost of Goods Sold On May 1, Matrix, Inc. sold merchandise inventory to a customer for $1,000 cash. The merchandise has a cost basis of $750 to Matrix. L O 2

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Gross Profit Gross profit is the excess of sales revenue over cost of goods sold. L O 3 Gross Profit Ratio = Gross Profit ÷ Net Sales

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Setting Sales Price with GP Ratio Selling Price = Cost of Product ÷ (1 – GP rate) Matrix, Inc. purchases a product for resale at a cost of $70 per unit. The company desires to earn a gross profit rate of 30% on all sales. What is the required selling price per unit? Selling Price = $70 ÷ (1 –.30) Selling Price = $100 per unit L O 3

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Operating Expenses Operating expenses usually are reported in the following classifications on the income statement: 1.Selling expenses. 2.General and administrative expenses. 3.Research and development expenses. L O 4

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Multiple-Step Income Statement L O 5

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Earnings Per Share BasicEPS = Income Available to Common Shareholders Weighted-Average Common Shares Outstanding Income Available to Common Shareholders Net Income − Preferred Stock Dividends = Matrix, Inc. reports net income of $128,387. Matrix has 1,000 shares of $100 par value, 8%, cumulative preferred stock outstanding. L O 6

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Weighted-Average Shares Basic EPS = $1.00 (rounded) = $128,387 − $8, ,250 L O 6

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Earnings Per Share When an entity has options, convertible debt, or convertible preferred stock, there is the potential for the dilution of basic earnings per share. When any of these securities are present, we test to see if, in fact, there is dilution. When dilution is determined, we report a second earnings per share statistic known as Diluted Earnings Per Share. L O 6

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Income Statement Alternatives Single-Step Multiple-Step L O 7

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Unusual Items Reported in Income  Discontinued operations  Extraordinary items  Cumulative effect of a change in accounting principle  Minority interest in earnings of subsidiaries  Discontinued operations  Extraordinary items  Cumulative effect of a change in accounting principle  Minority interest in earnings of subsidiaries L O 8

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Statement of Cash Flows Provides relevant information about the cash receipts and cash payments of an enterprise during a period. The statement shows why cash and cash equivalents changed during the period by reporting net cash provided or used by... Operating Activities  Investing Activities  Financing Activities  L O 9

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Investing Activities Operating Activities Financing Activities Sale of operational assets Sale of investments Collections of loans Cash received from revenues Issuance of stock Issuance of bonds and notes Enterprise Purchase of operational assets Purchase of investments Loans to others Cash paid for expenses Payment of dividends Repurchase of stock Repayment of debt L O 9 Cash Inflows Cash Outflows

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Items Not Affecting Cash You can see below that depreciation and similar items do not affect cash. Net income is reduced by depreciation expense, but cash flows remain unaffected. L O 9

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Cash Flows from Operating Activities Direct Presentation Supplemental Reconciliation L O 10 Net Cash Flow from Operations and Cash Flows from Operating Activities reconcile.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Statement of Cash Flows Indirect Presentation About 98% of major corporation use the Indirect Method of Presentation! L O 10

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Interpreting the Statement A business entity should have positive cash flows from operational activities. If operating activities do not generate cash, the entity must look to outside parties for funds to meet its day-to-day activities. L O 11

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved End of Chapter 9