Demonstration Problem

1
Demonstration Problem
Accounting What the Numbers Mean 6e

• 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)
50,000 Sales 150,000 Buildings
and equipment
84,000 Sales, general, and
administrative expenses
12,000 Accounts receivable
20,000 Common stock (7,000 shares)
35,000 Income tax
expense 14,000 Cash
32,000 Retained earnings, 1/1/04
21,500 Accrued liabilities 3,000 Cost
of goods sold 90,000 Accumulated
depreciation 36,000 Interest expense
8,000 Accounts payable
15,000 Dividends declared and paid during 2004
6,500
3
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 companys 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 companys 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. 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 firms financial performance for
a period of time.
8
Problem Solution
SHAE, INC. 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. 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 Owners 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 Owners 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.
Statement Changes in Owners 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
26,000 Less Dividends declared and paid during
year ( 6,500) Ending balance
41,000

Net income increases and dividends decrease
retained earnings.
13
Problem Solution
SHAE, INC.
Statement Changes in Owners 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
26,000 Less Dividends declared and paid during
year ( 6,500) Ending balance
41,000 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 Own
ers 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
20,000 Merchandise inventory 44,000 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
20,000 Merchandise inventory 44,000 Total
current assets 96,000 Buildings and
equipment 84,000 Less Accumulated
depreciation (36,000) 48,000 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
3,000 Notes payable (long term)
50,000 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
41,000 Total owners equity 76,000 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 76,000 Total liabilities and
owners equity 144,000
Total assets Total liabilities Total owners
equity
20
Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2004 Assets Cash
32,000 Accounts receivable
20,000 Merchandise inventory 44,000 Total
current assets 96,000 Buildings and
equipment 84,000 Less Accumulated
depreciation (36,000) 48,000 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
3,000 Notes payable (long term)
50,000 Total liabilities 68,000 Owners
equity Common stock 35,000 Retained
earnings 41,000 Total owners equity
76,000 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 companys 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 companys dividend policy?

23
Problem Solution

• The companys 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 companys 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 companys 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

• 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 companys 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 companys dividend policy?

27
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 companys 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 companys dividend policy?

29
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
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