1. Demonstration Problem
Accounting
What the Numbers Mean 6e
Demonstration Problem
Chapter 2 – Problem 14
Prepare an Income Statement, Balance Sheet,
and Statement of Changes in Owners’ Equity

2. Problem Definition
The following information was obtained from the records of Shae, Inc.:
Merchandise inventory $ 44,000
Notes Payable (long term) ,000
Sales ,000
Buildings and equipment ,000
Sales, general, and administrative expenses ,000
Accounts receivable ,000
Common stock (7,000 shares) ,000
Income tax expense ,000
Cash ,000
Retained earnings, 1/1/ ,500
Accrued liabilities ,000
Cost of goods sold ,000
Accumulated depreciation ,000
Interest expense ,000
Accounts payable ,000
Dividends declared and paid during ,500

3. balance sheet items reflect account balances at
Problem Definition
Except as otherwise indicated, assume that all
balance sheet items reflect account balances at
December 31, 2004, and that all income state-
ment items reflect activities that occurred
during the year ended December 31, 2004.
There were no changes in paid-in-capital
during the year.

4. Problem Definition
Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2004, and a balance sheet at December 31, 2004.
What is the company’s average tax rate?
What interest rate is charged on long-term debt?
What is the par value per share of common stock?
e. What is the company’s dividend policy?

5. Problem Solution
Prepare an income statement for the year ended December 31, 2004.
Identify revenue an expense accounts:
Revenues: Sales
Expenses: Selling, general and administrative expenses
Income tax expense
Cost of goods sold
Interest expense

6. Problem Solution
Determine the order and presentation of the revenue and expense accounts:
Include a
Financial
Statement
heading.
SHAE, INC.
Income Statement
For the Year Ended December 31, 2004
Sales $150,000
Cost of goods sold (90,000)
Gross profit $ 60,000
Gross Profit is the first subtotal shown.

7. Problem Solution SHAE, INC. Sales $150,000 Cost of goods sold (90,000)
Income Statement
For the Year Ended December 31, 2004
Sales $150,000
Cost of goods sold (90,000)
Gross profit $ 60,000
Selling, general, and admin. exp ( 12,000)
Income from operations $ 48,000
Income from operations (operating income) is a key measure of a firm’s financial performance for a period of time.

8. Problem Solution SHAE, INC. Sales $150,000 Cost of goods sold (90,000)
Income Statement
For the Year Ended December 31, 2004
Sales $150,000
Cost of goods sold (90,000)
Gross profit $ 60,000
Selling, general, and admin. exp ( 12,000)
Income from operations $ 48,000
Interest expense ( 8,000)
Income before taxes $ 40,000
Interest expense is a non-operating expense.

9. Problem Solution SHAE, INC. Sales $150,000 Cost of goods sold (90,000)
Income Statement
For the Year Ended December 31, 2004
Sales $150,000
Cost of goods sold (90,000)
Gross profit $ 60,000
Selling, general, and admin. exp ( 12,000)
Income from operations $ 48,000
Interest expense ( 8,000)
Income before taxes $ 40,000
Income tax expense ( 14,000)
Net income $ 26,000

10. Problem Solution
Prepare a Statement of Changes in Owners’ Equity for the year ended December 31, 2004.
SHAE, INC.
Statement Changes in Owner’s Equity
For the Year Ended December 31, 2004
Paid-in capital:
Retained earnings:
Include a
Financial
Statement
heading.
Paid-in capital and retained earnings are the two primary components of owners’ equity.

11. Problem Solution SHAE, INC.
Statement Changes in Owner’s Equity
For the Year Ended December 31, 2004
Paid-in capital:
Common stock $ 35,000
Retained earnings:
Paid-in capital includes common stock and additional funds paid-in, or contributed, by owners.

12. Problem Solution SHAE, INC. Paid-in capital: Common stock $ 35,000
Statement Changes in Owner’s Equity
For the Year Ended December 31, 2004
Paid-in capital:
Common stock $ 35,000
Retained earnings:
Beginning balance $21,500
Net income for the year ,000
Less: Dividends declared and paid during year ( 6,500)
Ending balance ,000
Net income increases and dividends decrease retained earnings.

13. Problem Solution SHAE, INC. Paid-in capital: Common stock $ 35,000
Statement Changes in Owner’s Equity
For the Year Ended December 31, 2004
Paid-in capital:
Common stock $ 35,000
Retained earnings:
Beginning balance $21,500
Net income for the year ,000
Less: Dividends declared and paid during year ( 6,500)
Ending balance ,000
Total owners’ equity $ 76,000
Total owners’ equity is the sum of PIC and RE.

14. Problem Solution Prepare a balance sheet at December 31, 2004.
SHAE, INC.
Balance Sheet
December 31, 2004
Assets:
Liabilities:
Owners’ Equity:
The report format of the balance sheet shows assets above liabilities and owners’ equity.

15. Problem Solution SHAE, INC.
Balance Sheet
December 31, 2004
Assets:
Cash $ 32,000
Accounts receivable ,000
Merchandise inventory ,000
Total current assets $ 96,000
Non-current assets
Total assets
Liabilities:
Owners’ Equity:
Total liabilities and owners’ equity
Current assets are listed in order of liquidity, or nearness to cash.

16. Problem Solution SHAE, INC.
Balance Sheet
December 31, 2004
Assets:
Cash $ 32,000
Accounts receivable ,000
Merchandise inventory ,000
Total current assets $ 96,000
Buildings and equipment ,000
Less: Accumulated depreciation (36,000) ,000
Total assets $144,000
Liabilities:
Owners’ Equity:
Total liabilities and owners’ equity
Accumulated depreciation is a contra asset account.

17. Problem Solution SHAE, INC.
Balance Sheet
December 31, 2004
Assets:
Total assets $144,000
Liabilities:
Accounts payable $ 15,000
Accrued liabilities ,000
Notes payable (long term) ,000
Total liabilities $ 68,000
Owners’ Equity:
Total liabilities and owners’ equity
As with assets, liabilities are often classified as current and non-current.

18. Problem Solution SHAE, INC.
Balance Sheet
December 31, 2004
Assets:
Total assets $144,000
Liabilities:
Total liabilities $ 68,000
Owners’ Equity:
Common stock $ 35,000
Retained earnings ,000
Total owners’ equity ,000
Total liabilities and owners’ equity
CS, RE, and Total OE are taken from the Statement of Changes in OE.

19. Problem Solution SHAE, INC.
Balance Sheet
December 31, 2004
Assets:
Total assets $144,000
Liabilities:
Total liabilities $ 68,000
Owners’ Equity:
Total owners’ equity ,000
Total liabilities and owners’ equity $144,000
Total assets = Total liabilities + Total owners’ equity

20. Problem Solution SHAE, INC. Completed asset side of balance sheet.
December 31, 2004
Assets:
Cash $ 32,000
Accounts receivable ,000
Merchandise inventory ,000
Total current assets $ 96,000
Buildings and equipment ,000
Less: Accumulated depreciation (36,000) ,000
Total assets $144,000
Liabilities:
Owners’ Equity:
Total liabilities and owners’ equity
Completed asset side of balance sheet.

21. Problem Solution SHAE, INC.
Balance Sheet
December 31, 2004
Assets:
Total assets $144,000
Liabilities:
Accounts payable $ 15,000
Accrued liabilities ,000
Notes payable (long term) ,000
Total liabilities $ 68,000
Owners’ equity:
Common stock $ 35,000
Retained earnings ,000
Total owners’ equity ,000
Total liabilities and owners’ equity $144,000
Completed liability and owners’ equity side.

22. Problem Solution
Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2004, and a balance sheet at December 31, 2004.
What is the company’s average tax rate?
What interest rate is charged on long-term debt?
What is the par value per share of common stock?
e. What is the company’s dividend policy?

23. Problem Solution
The company’s average income tax rate would be computed by dividing income tax expense by earnings before taxes:
$14,000 / $40,000 = 35% average tax rate

24. Problem Solution
Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2004, and a balance sheet at December 31, 2004.
What is the company’s average tax rate?
What interest rate is charged on long-term debt?
What is the par value per share of common stock?
e. What is the company’s dividend policy?

25. Problem Solution
The interest rate charged on long-term debt is a function of interest expense divided by long-term debt:
This assumes that the year-end balance of long-term debt is representative of the average long-term debt account balance throughout the year.
$8,000 / $50,000 = 16% interest rate

26. Problem Solution e. What is the company’s dividend policy?
Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2004, and a balance sheet at December 31, 2004.
What is the company’s average tax rate?
What interest rate is charged on long-term debt?
What is the par value per share of common stock?
e. What is the company’s dividend policy?

27. $35,000 / 7,000 shares = $5 par value per share
Problem Solution
The par value per share of common stock can be determined simply by dividing the dollar amount for common stock by the number of common shares outstanding:
$35,000 / 7,000 shares = $5 par value per share

28. Problem Solution
Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2004, and a balance sheet at December 31, 2004.
What is the company’s average tax rate?
What interest rate is charged on long-term debt?
What is the par value per share of common stock?
e. What is the company’s dividend policy?

29. $6,500 / $26,000 = 25% dividend payout policy
Problem Solution
Shae, Inc. appears to have a policy of paying a fixed percentage of net income as a dividend to shareholders, computed as the dividends declared and paid divided by net income:
$6,500 / $26,000 = 25% dividend payout policy

30. Accounting What the Numbers Mean 6e David H. Marshall Wayne W. McManus
You should now have a better understanding of how to prepare an income statement, balance sheet, and statement of changes in owners’ equity.
Remember that there is a demonstration problem for each chapter that is here for your learning benefit.
David H. Marshall
Wayne W. McManus
Daniel F. Viele