Financial Statement Preparation: A Tutorial Prepared by – Dr. Angela H. Sandberg Professor of Accounting – Jacksonville State University

Financial Statements This tutorial illustrates how to prepare three basic financial statements

Financial Statements This tutorial illustrates how to prepare three basic financial statements The Income Statement

Financial Statements This tutorial illustrates how to prepare three basic financial statements The Income Statement The Statement of Retained Earnings

Financial Statements This tutorial illustrates how to prepare three basic financial statements The Income Statement The Statement of Retained Earnings The Balance Sheet

Financial Statements This tutorial illustrates how to prepare three basic financial statements The Income Statement The Statement of Retained Earnings The Balance Sheet The purpose of these statements is to help users make better decisions.

The Income Statement

Income Statement The first statement prepared is the Income Statement.

Income Statement The first statement prepared is the Income Statement. The Income Statement reports a business’ performance for the period.

Income Statement A simple format for an income statement is:

Income Statement A simple format for an income statement is: Revenues – Expenses = Net Income

Income Statement A simple format for an income statement is: Revenues – Expenses = Net Income We will look at a more complex format later.

Income Statement Revenues are earned for the sale of goods or services. Note that revenues occur when the sale is made. The payment may or may not have been received.

Income Statement Revenues are earned for the sale of goods or services. Note that revenues occur when the sale is made. The payment may or may not have been received. Examples of revenues include sales, service revenue and interest revenue.

Income Statement Expenses are incurred when a business receives goods and services. Like revenues, payment may or may not have been made.

Income Statement Expenses are incurred when a business receives goods and services. Like revenues, payment may or may not have been made. Examples of expenses include salaries expense, utility expense and interest expense.

Income Statement Most businesses require more information from their businesses than a simple income statement can provide. Therefore, they use a multi-step income statement format.

Income Statement Most businesses require more information from their businesses than a simple income statement can provide. Therefore, they use a multi-step income statement format. A format for a multi-step income statement is:

Income Statement Sales revenue - Cost of goods sold Gross profit - Operating expenses Income from operations +/- Non-operating items Income before taxes - Income taxes Net income

Income Statement Cost of goods sold represents the expense a business incurred to buy or make a product for resale.

Income Statement Cost of goods sold represents the expense a business incurred to buy or make a product for resale. Example - a book store buys a book for $25 and then sells it for $32. The cost of goods sold is $25.

Income Statement Operating expenses are the usual expenses incurred in operating a business.

Income Statement Operating expenses are the usual expenses incurred in operating a business. Accounts such as salaries expense, utility expense, and depreciation expenses are all shown in this section.

Income Statement Non-operating items are revenue, expenses, gains and losses that do not relate to the company’s primary operations.

Income Statement Non-operating items are revenue, expenses, gains and losses that do not relate to the company’s primary operations. Accounts include interest expense and gains and losses of the sale of equipment and investments.

Income Statement Income taxes are computed by multiplying Income before taxes by the income tax rate.

Income Statement Income taxes are computed by multiplying Income before taxes by the income tax rate. Example – Income before taxes is $50,000. The income tax rate is 30%. Income taxes = $50,000 * 30% = $15,000.

The Statement of Retained Earnings

Statement of Retained Earnings The Statement of Retained Earnings reports how net income and dividends affected a company’s financial position during the period.

Statement of Retained Earnings The format of the statement is: 19 19

Statement of Retained Earnings The format of the statement is: Beg. balance, retained earnings + Net income - Dividends End. balance, retained earnings 19 19

Statement of Retained Earnings Note that the Income Statement must be prepared before the Statement of Retained Earnings.

Statement of Retained Earnings Note that the Income Statement must be prepared before the Statement of Retained Earnings. This is because you have to know the amount of net income in order to compute the ending balance of retained earnings.

The Balance Sheet

Balance Sheet The purpose of the balance sheet is to report the financial position of an accounting entity at a particular point in time.

Balance Sheet The purpose of the balance sheet is to report the financial position of an accounting entity at a particular point in time. The basic format for the balance sheet is: Assets = Liabilities + Equity

Balance Sheet Assets are economic resources owned by a company.

Balance Sheet Assets are economic resources owned by a company. Examples include cash, accounts receivable, supplies, buildings and equipment.

Balance Sheet Liabilities are the company’s debt or obligations.

Balance Sheet Liabilities are the company’s debt or obligations. Examples are accounts payable, unearned revenues and bonds payable.

Balance Sheet Equity is the residual balance. Assets – liabilities = equity. Equity is commonly called stockholders’ equity if the business is a corporation as it represents the financing provided by the stockholders along with the earnings from the business not paid out as dividends.

Balance Sheet There are two different types of assets shown on a balance sheet. These are current assets and non-current assets.

Balance Sheet There are two different types of assets shown on a balance sheet. These are current assets and non-current assets. Current assets + Non-current assets Total assets

Balance Sheet Current assets are assets that will be used or turned into cash within one year.

Balance Sheet Current assets are assets that will be used or turned into cash within one year. Examples include cash, accounts receivable, inventory, short-term investments, supplies and prepaids.

Balance Sheet Non-current assets comprise the remainder of the assets.

Balance Sheet Non-current assets comprise the remainder of the assets. These include accounts such as: long-term investments, land, building, equipment and patents.

Balance Sheet There are two different types of liabilities shown on a balance sheet – current liabilities and long-term liabilities.

Balance Sheet There are two different types of liabilities shown on a balance sheet – current liabilities and long-term liabilities. Current liabilities + Long-term liabilities Total liabilities

Balance Sheet Current liabilities are obligations that will be paid in cash (or other services) or satisfied by providing service within the coming year.

Balance Sheet Current liabilities are obligations that will be paid in cash (or other services) or satisfied by providing service within the coming year. Examples include accounts payable, short-term notes payable, and taxes payable.

Balance Sheet Long-term liabilities are obligations that will not be paid or satisfied within the year.

Balance Sheet Long-term liabilities are obligations that will not be paid or satisfied within the year. Examples include mortgage payable and bonds payable.

Balance Sheet Stockholders’ Equity is divided into two categories: contributed capital and retained earnings. Contributed capital + Retained earnings Total stockholders’ equity

Balance Sheet Contributed capital is the amount of cash (or other assets) provided by the shareholders.

Balance Sheet Contributed capital is the amount of cash (or other assets) provided by the shareholders. Common Stock and Additional Paid in Capital are accounts in this section.

Balance Sheet Retained earnings is the total earnings that have not been distributed to owners as dividends.

The Balance Sheet Current assets + Non-current assets Total assets Current liabilities + Long-term liabilities + Stockholders’ equity Total liabilities and stockholders’ equity 5 7 7

Balance Sheet The Balance Sheet must be prepared after the Statement of Retained Earnings in order to have calculated the ending balance of Retained Earnings.

Order of Preparation Income Statement Net income Statement of Retained Earnings Beginning Retained Earnings + Net income – Dividends Ending retained earnings Balance Sheet Ending Balance Retained Earnings

Review Income statement—A summary of the revenue and expenses for a specific period of time. Statement of retained earnings – a summary of the changes in the retained earnings that have occurred during a specific period of time. Balance sheet—A list of the assets, liabilities, and owner’s equity as of a specific date.

Example Problem Cash 5,000 Sales 100,000 Utility Expense 8,000 Buildings 65,000 Common Stock 45,000 Accounts Payable 12,000 Supplies 4,000 Cost of Goods Sold 58,000 Interest Expense Additional Paid in Capital 20,000 Bonds Payable 40,000 Supplies Expense 3,000 Salaries Expense 16,000 Accounts Receivable 10,000 Inventories Retained Earnings 5,000 (beg. bal.) Income Tax Rate 30%

Step One Classify the accounts as assets, liabilities, equity, revenue or expenses.

Assets Cash 5,000 Sales 100,000 Utility Expense 8,000 Buildings 65,000 Common Stock 45,000 Accounts Payable 12,000 Supplies 4,000 Cost of Goods Sold 58,000 Interest Expense Additional Paid in Capital 20,000 Bonds Payable 40,000 Supplies Expense 3,000 Salaries Expense 16,000 Accounts Receivable 10,000 Inventories Retained Earnings 5,000 (beg. bal.) Income Tax Rate 30%

Assets, Liabilities, Cash 5,000 Sales 100,000 Utility Expense 8,000 Buildings 65,000 Common Stock 45,000 Accounts Payable 12,000 Supplies 4,000 Cost of Goods Sold 58,000 Interest Expense Additional Paid in Capital 20,000 Bonds Payable 40,000 Supplies Expense 3,000 Salaries Expense 16,000 Accounts Receivable 10,000 Inventories Retained Earnings 5,000 (beg. bal.) Income Tax Rate 30%

Assets, Liabilities, Equity Cash 5,000 Sales 100,000 Utility Expense 8,000 Buildings 65,000 Common Stock 45,000 Accounts Payable 12,000 Supplies 4,000 Cost of Goods Sold 58,000 Interest Expense Additional Paid in Capital 20,000 Bonds Payable 40,000 Supplies Expense 3,000 Salaries Expense 16,000 Accounts Receivable 10,000 Inventories Retained Earnings 5,000 (beg. bal.) Income Tax Rate 30%

Assets, Liabilities, Equity, Revenues Cash 5,000 Sales 100,000 Utility Expense 8,000 Buildings 65,000 Common Stock 45,000 Accounts Payable 12,000 Supplies 4,000 Cost of Goods Sold 58,000 Interest Expense Additional Paid in Capital 20,000 Bonds Payable 40,000 Supplies Expense 3,000 Salaries Expense 16,000 Accounts Receivable 10,000 Inventories Retained Earnings 5,000 (beg. bal.) Income Tax Rate 30%

Assets, Liabilities, Equity, Revenues, Expenses Cash 5,000 Sales 100,000 Utility Expense 8,000 Buildings 65,000 Common Stock 45,000 Accounts Payable 12,000 Supplies 4,000 Cost of Goods Sold 58,000 Interest Expense Additional Paid in Capital 20,000 Bonds Payable 40,000 Supplies Expense 3,000 Salaries Expense 16,000 Accounts Receivable 10,000 Inventories Retained Earnings 5,000 (beg. bal.) Income Tax Rate 30%

Step Two Prepare the Income Statement. Sales revenue - Cost of goods sold Gross profit - Operating expenses Income from operations +/- Non-operating items Income before taxes - Income taxes Net income

Income Statement Sales 100,000 - Cost of Goods Sold -58,000 Gross Margin 42,000 - Operating Expenses -27,000 Income from Operations 15,000 - Non-operating Items -5,000 Income before Taxes 10,000 - Income Taxes -3,000 Net Income 7,000

Income Statement Operating expenses include: Utility expense 8,000 Sales 100,000 - Cost of Goods Sold -58,000 Gross Margin 42,000 - Operating Expenses -27,000 Income from Operations 15,000 - Non-operating Items -5,000 Income before Taxes 10,000 - Income Taxes -3,000 Net Income 7,000 Operating expenses include: Utility expense 8,000 Salaries expense 16,000 Supplies expense 3,000

Income Statement Non-operating items include: Interest expense 5,000 Sales 100,000 - Cost of Goods Sold -58,000 Gross Margin 42,000 - Operating Expenses -27,000 Income from Operations 15,000 - Non-operating Items -5,000 Income before Taxes 10,000 - Income Taxes -3,000 Net Income 7,000 Non-operating items include: Interest expense 5,000

Income Statement Income taxes = Income before taxes * Income tax rate Sales 100,000 - Cost of Goods Sold -58,000 Gross Margin 42,000 - Operating Expenses -27,000 Income from Operations 15,000 - Non-operating Items -5,000 Income before Taxes 10,000 - Income Taxes -3,000 Net Income 7,000 Income taxes = Income before taxes * Income tax rate 10,000 * 30% = 3,000

Step Three Prepare the Statement of Retained Earnings. + Net income Beg. balance, retained earnings + Net income - Dividends End. balance, retained earnings

Statement of Retained Earnings Beginning Balance, Retained Earnings 5,000 + Net Income +7,000 - Dividends -0 Ending Balance, Retained Earnings 12,000 Net Income is brought forward from the Income Statement.

Step Four Current assets Prepare the Balance Sheet. + Non-current assets Total assets Current liabilities + Long-term liabilities + Stockholders’ equity Total liabilities and stockholders’ equity

Balance Sheet Current Assets: Current Liabilities: Cash 5,000 Accounts Payable 12,000 Accounts Receivable 10,000 Long-term liabilities: Inventories 45,000 Bonds Payable 40,000 Supplies 4,000 Stockholders’ Equity: Non-Current Assets: Common Stock Buildings 65,000 Additional Paid in Capital 20,000 Retained Earnings Total Assets 129,000 Total Liabilities and Equity

Balance Sheet Current Assets: Current Liabilities: Cash 5,000 Accounts Payable 12,000 Accounts Receivable 10,000 Long-term liabilities: Inventories 45,000 Bonds Payable 40,000 Supplies 4,000 Stockholders’ Equity: Non-Current Assets: Common Stock Buildings 65,000 Additional Paid in Capital 20,000 Retained Earnings Total Assets 129,000 Total Liabilities and Equity End. Bal. is brought forward from the Statement of Retained Earnings

The End