Financial Accounting Principles and Financial Statements Gapenski Chapter 3, the Income Statement

1. Financial Accounting Principles and Financial Statements(Gapenski Chapter 3, the Income Statement) Assignment Review Lecture 5

2. The basic accounting equation Assets = Liabilities + Equity (uses) (sources) This equation simply reflects the fact that everything of value that an organization owns (assets) is the result of borrowing (liability) or investment of prior owned value (equity). This is an identity -- must balance.

3. Graphic reference

4. Debits and Credits The debit/ credit method allows the entry of only positive numbers � whether this results in an increase or decrease in the account depends on the type of account. Left is a debit; right is a credit � purely a convention. Every accounting transaction affects at least two accounts � with balancing debits and credits. That�s why it is termed �double entry.�

5. Terminology Accounts are info units used in tracking accounting events, e.g. A/R. All of the accounts used in the business make up the general ledger. The chart of accounts lists all accounts used in the general ledger along with reference numbers. A journal is a record of a transaction with related debits/ credits to accounts.

6. Income accounts -- temporary Revenue examples: Product A sales Product B sales Sales returns/ allowances Interest income Expenses examples: Insurance expense Income tax expense Bad debt expense Cost of goods sold (COGS) What happens when the reporting period ends?

7. Income accounts and closing

8. Extraordinary income gain/(loss) These items are both unusual and infrequent: e.g.: natural disasters (TS Allison) effect of discontinuing certain operations (Circuit City or Kmart store closures) major legal settlements (IBM�s antitrust settlement) Extraordinary items should be non-recurring -- in fact that is one term for them.

9. Questions: Health care income concepts How do gross and net revenues differ? Is charity care a kind of bad debt? Where do you find charity care on a hospital income statement? Bad debt? What kinds of items are included in �other� as opposed to �patient� revenue? HMOs do not have �patient revenues;� what do they have instead? When comparing FP and NFP hospitals, what is a good measure of expense control? How does depreciation affect taxes? Cash?

10. Chapter 3: Problem 3.2 a,b 3.2 a. Key difference is in the listing of revenues. HMO revenues are listed as premiums earned and coinsurance -- not as net patient service revenue. Expense categories are about the same. b. No. The $367,000 depreciation expense recognizes �wear and tear� experienced during the year. Depreciation calculations may not reflect the actual change in asset market value.

11. Chapter 3: Problem 3.2 c,d c. BestCare expects not all contract revenues will be collected. Estimated uncollectible revenues, $19,000, is listed as an expense item called �provision for bad debts.� d. Total profit margin = net income/ total revenues. BestCare�s total profit margin for 2004 was $1,218 / $28,613 = 0.043 = 4.3%. Each $ of revenue produced 4.3 cents of earnings. The higher the total profit margin, the better the organization�s expense control.

13. Chapter 3: Problem 3.3 c

14. Chapter 3: Problem 3.3 d d. Green Valley�s before-tax profit margin: $89,048 / $3,269,404 = 0.027 = 2.7. Before-tax margin removes the influence of taxes, and is a better measure of expense control when comparing FPs and NFPs.

18. Chapter 3: Problem 3.6 MainLine�s 2004 IS ($M) Total revenues $12.0 Expenses: All but depreciation (75%) $ 9.0 Depreciation expense 1.5 Total expenses $10.5 Operating income $ 1.5 Taxes (40%) 0.6 Net income $ 0.9