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Comparing Financial Statements by Entity & Industry CHAPTER 10 Comparing Financial Statements by Entity & Industry

PERFORMANCE OBJECTIVES 1 PO30: Distinguish among sole proprietorship, partnership & corporate forms of entity PO31: describe key differences in financial statements of merchandisers, manufacturers, construction companies, nonfinancial service companies

PERFORMANCE OBJECTIVES 2 PO32: Calculate net income; prepare income statements, balance sheets under percentage of completion & completed contract methods

USER FOCUS Not all assets are reported at cost How construction in progress & progress billings reported on balance sheet

INSIGHTS Corporations take many forms All income methods recognize same income over time

SOLE PROPRIETORSHIPS Characteristics of sole proprietorship Owned, managed by 1 person Easy to establish Owner receives income/losses; liable for business obligations

PARTNERSHIPS Characteristics of partnership Owned by 2 or more people Access to additional financing Mutual agency, co-ownership of assets, division of income

COMMON CHARACTERISTICS Characteristics common to sole proprietorships & partnerships Unlimited liability for business debts Easy to form Commonly used for small business Require distinction between business, personal transactions Legally, business & owners same Limited life Owners taxed

WHY DID CMU CONVERT TO PARTNERSHIP? To attract additional financing Reduced work load Conversion easy

INITIAL PARTNERSHIP TRANSACTION Transaction analysis Fundamental accounting equation Account title Assets = Liabilities + Equity Inventory Contributed Cap 10,000

INITIAL PARTNERSHIP TRANSACTION Journal entry Account titles Debit Credit Inventory 10,000 Contributed Capital

DIVISION OF NET INCOME Net income/weeks 30,000/52 = $576.92 per week Susan = ($576.92 * 51) + (.75 * $576.92) = $29,855.77 Martha = $30,000 - $29,855.77 = $144.23

CMU Partnership Capital For Year ended 12/31 Susan, 1/2 + Investments Share income Withdrawals $0 30,000 29,856 <8,100> $51,756 Martha 12/24 Investments Total partners’ capital 10,000 144 10,144 $61,900

CMU Balance Sheet 12/31 Assets Current assets Investments Property, plant, Equipment - Accumulated Depreciation $56,300 2,000 19,000 <2,300> Liabilities Current Noncurrent Owner’s Equity Partners’ Capital Accounts $9,100 4,000 61,900 Total assets $75,000 Total liabilities & Equity

CHARACTERISTICS OF CORPORATIONS Owned by shares of stock Legally separate from owners Limited liability

WHY CHOOSE CORPORATE FORM OF BUSINESS ? To raise large amounts of capital Unlimited life Changes in ownership easily implemented Limited liability

WHAT IF? CMU Corporate Transactions 1 Journal entry Sale of stock Account Title Debit Credit Cash Inventory Investment in stock Capital Stock 30,000 9,200 5,600 44,800

WHAT IF? CMU Corporate Transactions 2 Journal entry Corporation declares, pays dividends Account Title Debit Credit Dividends declared Dividends payable Cash 12,900

WHAT IF? CMU Corporate Transactions 3 Journal entry Federal income tax incurred Account Title Debit Credit Income tax expense Income tax payable 4,500

CMU Income Statement For year ending 12/31 Revenues Expenses Income tax expense Net Income $87,500 57,500 4,500 $25,500

CMU Statement of Retained Earnings For year ending 12/31 Balance 1/1 Net income Deduct: dividends declared Balance 12/31 $0 25,500 12,900 $12,600

CMU Balance Sheet 12/31 Assets Current assets Investments Property, plant, Equipment - Accumulated Depreciation $50,700 7,600 19,000 <2,300> Liabilities Current Noncurrent Owner’s Equity Capital stock Retained Earnings $13,600 4,000 44,800 12,600 Total assets $75,000 Total liabilities & Equity

INSIGHT 10-1: Corporations Take Many Forms C-Corporation Taxed under subchapter C of Internal Revenue Code S-Corporation Closely held: < 30 stockholders Taxed as partnership Nonprofit Corporation Limited liability company

EXPLORING DIFFERENT TYPES OF INDUSTRY Merchandising Manufacturing Construction Service companies

MERCHANDISING Operating activities Buys, resells products Accounts receivable & Sales Inventory, Cost of Goods Sold Account titles Debit Credit Bad debt expense Allowance for bad debts 500

MERCHANDISING: Investing Activities Recognizing Depreciation Account title Primary Contra Land, Building, Equipment Accumulated depreciation Net book value $xxx,xxx <x,xxx>

MANUFACTURING: Operating Activities Raw materials Direct labor Manufacturing overhead Total manufacturing costs Raw materials + Direct labor + Overhead Cost of goods manufactured Work in process 1/1 + Total manufacturing costs – work in process 12/31

CONSTRUCTION: Operating Activities Long term construction Aircraft, bridges, dams, skyscrapers, etc. 2 revenue recognition methods Completed contract Revenues not recognized until work completed Percentage of completion Revenues & expenses recognized in proportion to project completion

COMPLETED CONTRACT Statement Retained Earnings Year 1 Year 2 Retained earnings, beginning + Net income Subtotal Dividends Retained earnings, ending $0 1,000,000

PERCENTAGE OF COMPLETION: Statement of Retained Earnings Year 1 Year 2 Retained earnings, beginning + Net income Subtotal Dividends Retained earnings, ending $0 800,000 $800,000 200,000 1,000,000 $1,000,000

INSIGHT 10-2 Same Income Why is total retained earnings the same at the end of the project for both methods of revenue recognition? Same income earned Allocated to time periods differently

USER FOCUS 10-1: Reporting Assets Accounts receivable Do not reported historical cost Do represent uncollected sales revenue

USER FOCUS 10-2: Construction Accounts Construction in progress Current account Measured by value of work done Progress billings Contra asset Measured by amount billed

SERVICE COMPANIES Sales of services Financial services companies Banks Insurance companies Stock, real estate brokerages

Reading Consolidated Financial Statements APPENDIX 10-1 Reading Consolidated Financial Statements

PERFORMANCE OBJECTIVES PO33: Prepare consolidated balance sheet

BASIC CONCEPT Case 1 P Company buys 100% of S Company Journal entry Account Titles Debit Credit Investment in Subsidiary S Cash 200

BASIC CONCEPT Case 1 Explanation To avoid double counting, P Company Eliminates investment in S subsidiary Eliminates capital stock, retained earnings S subsidiary P company adds remaining assets, liabilities, equity accounts of P & S

CONCEPT OF GOODWILL: Case 2 P Company buys 100% of S Company for $10 above book value Journal entry Account Titles Debit Credit Investment in S Company Cash 210

CONCEPT OF GOODWILL: Case 2 Explanation Intangible asset Excess of purchase price over book value of individual assets To avoid double counting, P Company Eliminates investment in S subsidiary, Goodwill Eliminates capital stock, retained earnings S subsidiary P company adds remaining assets, liabilities, equity accounts of P & S

CONCEPT OF MINORITY INTEREST: Case 3 P Company buys 90% of S Company, paying $10 over book value Journal entry Account Titles Debit Credit Goodwill Capital Stock Retained earnings Investment in S 10 90 190

CONCEPT OF MINORITY INTEREST: Case 3 Explanation Nonparent ownership of voting stock in less than wholly owned subsidiary company To avoid double counting, P Company Eliminates investment in S subsidiary, Goodwill Eliminates 90% capital stock, retained earnings S subsidiary Establishes minority interest equal to 10% P company adds remaining assets, liabilities, equity accounts of P & S