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Accounting What the Numbers Mean 9e. Demonstration Problem. Chapter 2 – Problem 14 Prepare an Income Statement, Balance Sheet, and Statement of Changes in Owners’ Equity . Problem Definition. The following information was obtained from the records of Shae, Inc.:.

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Accounting

What the Numbers Mean 9e

### Demonstration Problem

Chapter 2 – Problem 14

Prepare an Income Statement, Balance Sheet,

and Statement of Changes in Owners’ Equity

Problem Definition
• The following information was obtained from the records of Shae, Inc.:

Merchandise inventory \$264,000

Notes Payable (long term) 300,000

Sales 900,000

Buildings and equipment 504,000

Sales, general, and administrative expenses 72,000

Accounts receivable 120,000

Common stock (42,000 shares) 210,000

Income tax expense 84,000

Cash 192,000 Retained earnings, 1/1/10 129,000

Accrued liabilities 18,000

Cost of goods sold 540,000

Accumulated depreciation 216,000

Interest expense 48,000

Accounts payable 90,000

Dividends declared and paid during 2010 39,000

Problem Definition

Except as otherwise indicated, assume that all

balance sheet items reflect account balances at

December 31, 2010, and that all income state-

ment items reflect activities that occurred

during the year ended December 31, 2010.

There were no changes in paid-in-capital

during the year.

Problem Definition
• Prepare an income statement and statement of changes in owners’ equityfor the year ended December 31, 2010, and a balance sheet at December 31, 2010.
• 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?

Problem Solution
• Prepare an income statement for the year ended December 31, 2010.
• Identify revenue an expense accounts:

Revenues: Sales

Expenses: Selling, general and administrative expenses

Income tax expense

Cost of goods sold

Interest expense

Problem Solution
• Determine the order and presentation of the revenue and expense accounts:

Gross Profit is the first subtotal shown.

SHAE, INC.

Income Statement

For the Year Ended December 31, 2010

Sales \$900,000

Cost of goods sold (540,000)

Gross profit \$360,000

Problem Solution

SHAE, INC.

Income Statement

For the Year Ended December 31, 2010

Sales \$900,000

Cost of goods sold (540,000)

Gross profit \$360,000

Selling, general, and admin. exp. ( 72,000)

Income from operations \$288,000

Income from operations (operating income) is a key measure of a firm’s financial performance for a period of time.

Problem Solution

SHAE, INC.

Income Statement

For the Year Ended December 31, 2010

Sales \$900,000

Cost of goods sold (540,000)

Gross profit \$360,000

Selling, general, and admin. exp. ( 72,000)

Income from operations \$288,000

Interest expense ( 48,000)

Income before taxes \$240,000

Interest expense is a non-operating expense.

Problem Solution

SHAE, INC.

Income Statement

For the Year Ended December 31, 2010

Sales \$900,000

Cost of goods sold (540,000)

Gross profit \$360,000

Selling, general, and admin. exp. ( 72,000)

Income from operations \$288,000

Interest expense ( 48,000)

Income before taxes \$240,000

Income tax expense ( 84,000)

Net income \$ 156,000

Problem Solution
• Prepare a Statement of Changes in Owners’ Equity for the year ended December 31, 2010.

SHAE, INC.

Statement Changes in Owner’s Equity

For the Year Ended December 31, 2010

Paid-in capital:

Retained earnings:

Paid-in capital and retained earnings are the two primary components of owners’ equity.

Problem Solution

SHAE, INC.

Statement Changes in Owner’s Equity

For the Year Ended December 31, 2010

Paid-in capital:

Common stock \$210,000

Retained earnings:

Paid-in capital includes common stock and additional funds paid-in, or contributed, by owners.

Problem Solution

SHAE, INC.

Statement Changes in Owner’s Equity

For the Year Ended December 31, 2010

Paid-in capital:

Common stock \$210,000

Retained earnings:

Beginning balance \$129,000

Net income for the year 156,000

Less: Dividends declared and paid during year (39,000)

Ending balance 246,000

Net income increases and dividends decrease retained earnings.

Problem Solution

SHAE, INC.

Statement Changes in Owner’s Equity

For the Year Ended December 31, 2010

Paid-in capital:

Common stock \$210,000

Retained earnings:

Beginning balance \$129,000

Net income for the year 156,000

Less: Dividends declared and paid during year (39,000)

Ending balance 246,000

Total owners’ equity \$456,000

Total owners’ equity is the sum of PIC and RE.

Problem Solution
• Prepare a balance sheet at December 31, 2010.

SHAE, INC.

Balance Sheet

December 31, 2010

Assets:

Liabilities:

Owners’ Equity:

The report format of the balance sheet shows assets above liabilities and owners’ equity.

Problem Solution

SHAE, INC.

Balance Sheet

December 31, 2010

Assets:

Cash \$192,000

Accounts receivable 120,000

Merchandise inventory 264,000

Total current assets \$576,000

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.

Problem Solution

SHAE, INC.

Balance Sheet

December 31, 2010

Assets:

Cash \$192,000

Accounts receivable 120,000

Merchandise inventory 264,000

Total current assets \$576,000

Buildings and equipment 504,000

Less: Accumulated depreciation (216,000) 288,000

Total assets \$864,000

Liabilities:

Owners’ Equity:

Total liabilities and owners’ equity

Accumulated depreciation is a contra asset account.

Problem Solution

SHAE, INC.

Balance Sheet

December 31, 2010

Assets:

Total assets \$864,000

Liabilities:

Accounts payable \$ 90,000

Accrued liabilities 18,000

Notes payable (long term) 300,000

Total liabilities \$408,000

Owners’ Equity:

Total liabilities and owners’ equity

As with assets, liabilities are often classified as current and non-current.

Problem Solution

SHAE, INC.

Balance Sheet

December 31, 2010

Assets:

Total assets \$864,000

Liabilities:

Total liabilities \$408,000

Owners’ Equity:

Common stock \$210,000

Retained earnings 246,000

Total owners’ equity 456,000

Total liabilities and owners’ equity

CS, RE, and Total OE are taken from the Statement of Changes in OE.

Problem Solution

SHAE, INC.

Balance Sheet

December 31, 2010

Assets:

Total assets \$864,000

Liabilities:

Total liabilities \$408,000

Owners’ Equity:

Total owners’ equity 456,000

Total liabilities and owners’ equity \$864,000

Total assets = Total liabilities + Total owners’ equity

Problem Solution

SHAE, INC.

Balance Sheet

December 31, 2010

Assets:

Cash \$192,000

Accounts receivable 120,000

Merchandise inventory 264,000

Total current assets \$456,000

Buildings and equipment 504,000

Less: Accumulated depreciation (216,000) 288,000

Total assets \$864,000

Liabilities:

Owners’ Equity:

Total liabilities and owners’ equity

Completed asset side of balance sheet.

Problem Solution

SHAE, INC.

Balance Sheet

December 31, 2010

Assets:

Total assets \$864,000

Liabilities:

Accounts payable \$ 90,000

Accrued liabilities 18,000

Notes payable (long term) 300,000

Total liabilities \$408,000

Owners’ equity:

Common stock \$210,000

Retained earnings 246,000

Total owners’ equity 456,000

Total liabilities and owners’ equity \$864,000

Completed liability and owners’ equity side.

Problem Solution
• Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2010, and a balance sheet at December 31, 2010.
• 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?

Problem Solution

The company’s average income tax rate would be computed by dividing income tax expense by earnings before taxes:

\$84,000 / \$240,000 = 35% average tax rate

Problem Solution
• Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2010, and a balance sheet at December 31, 2010.
• 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?

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.

\$48,000 / \$300,000 = 16% interest rate

Problem Solution
• Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2010, and a balance sheet at December 31, 2010.
• 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?

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:

\$210,000 / 42,000 shares = \$5 par value per share

Problem Solution
• Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2010, and a balance sheet at December 31, 2010.
• 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?

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:

\$39,000 / \$156,000 = 25% dividend payout policy

Accounting

What the Numbers Mean 9e

You should now have a better understandingof how to prepare financial statements.

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