Chapter_3_Lecture_Notes_4th_Edition_Libby_Student_Version

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Unformatted text preview: Chapter 3 Operating Decisions and the Income Statement 12/29/11 1 Learning Objectives After studying this chapter, you should be able to: 1. 2. 3. 4. 12/29/11 Understand the earning process of a merchandising companies Understand how to prepare a single-step and a multiple-step statement of earnings Highlight the accrual basis of accounting and apply the revenue recognition principle and the matching process to measure profit Compute and interpret net profit margin and earnings per share 2 The Income statements is the primary source of information for The Income statements is the primary source of information for aaccompany’scurrent profit performance: ompany’s current profit performance: financial statement readers use this and other information to: financial statement readers use this and other information to: Estimate the amount, timing, and uncertainty of the firm’s future Estimate the amount, timing, and uncertainty of the firm’s future income and cash flow income and cash flow Evaluate performance Evaluate performance Provide feedback Provide feedback Income from Continuing Operations Discontinued Operations Result from the disposal of a major segment of the business and are reported net of income tax effect. Net Income 12/29/11 3 Income from Continuing OperationsSingle Step Format: 2 broad classifications: Format: 2 broad classifications: ••All revenues and gains are listed first All revenues and gains are listed first ••All expenses and losses are listed next and All expenses and losses are listed next and subtracted from total revenues to compute net subtracted from total revenues to compute net iincome. ncome. ••Income from continuing operations is computed in Income from continuing operations is computed in one step, without intermediate subtotal one step, without intermediate subtotal 12/29/11 4 Income from ContinuingMultiple-Step Operating and non-operating activities are separated Expenses are classified by function (e.g. Selling and Administrative Expenses, Cost of Goods Sold) Advantages: • Highlighting regular and irregular activities allows for greater predictive value (assess future earnings) and feedback value (assess past earnings) • Provides better detail to compare companies • Allows for ratio analysis used to assess performance 12/29/11 5 Net Sales (gross sales less sales return and allowance gross and sales discount) and Operating Section Non-operating Section Income Tax 12/29/11 Less: Cost of Goods Sold Gross Profit Selling Expenses Administrative or General Expenses Operating Income Other Revenues and Gains Other Expenses and Losses Separate income tax section on Separate Income from Continuing Operations only Operations 6 Discontinued Operations Sale or abandonment of a segment off Sale or abandonment of a segment o a business. a business. Income or loss on the Income or loss on the segment’s operation for segment’s operation for ttheperiod. he period. Gain or loss on Gain or loss on disposal of the disposal of the segment. segment. Show net of tax effect. 12/29/11 7 12/29/11 8 International Perspective 12/29/11 9 How are Financial Statements Prepared and Analyzed? Income Statement Revenues – Expenses = Profit Beginning Equity Statement of + Profit Changes in - Dividends Declared Shareholders’ +/- Other Components Changes, net Equity Ending Equity Statement of Cash Flows 12/29/11 Assets = Liabilities + Shareholders’ Equity Cash Statement of Financial Position Change in Cash Share Capital Retained Earnings Other Components = Cash from Operating Activities + Cash from Investing Activities + Cash from Financing Activities 10 Cash vs. Accrual Accounting Cash basis: Revenue and expenses are recorded when cash is received. Accrual basis: Assets, liabilities, revenues, and expenses should be recognized when the transaction that causes them occurs, not necessarily when cash is paid or received. Accrual basis is required by GAAP 12/29/11 11 Revenue Principle Recognize revenues when .. .. .. Recognize revenues when The entity has transferred to the buyer the The entity has transferred to the buyer the significant risks and rewards of ownership. significant risks and rewards of ownership. The entity retains neither continuing managerial The entity retains neither continuing managerial iinvolvement nor effective control over the goods nvolvement nor effective control over the goods sold. sold. The amount of revenue can be reliably measured. The amount of revenue can be reliably measured. Collection is reasonably assured. Collection is reasonably assured. The costs in respect of the transaction can be The costs in respect of the transaction can be measured reliably. measured reliably. 12/29/11 12 The Matching Process Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid. 12/29/11 13 Gross Profit Percentage Gross Profit Percentage Gross Profit Net Sales = = $131,017 $459,208 = 28.5% All other things equal, a higher gross All other things equal, a higher gross profit results in higher net income. profit results in higher net income. Gildan 28.5% 12/29/11 2000 Gross Profit Comparisons Russell 28.0% Anvil 29.0% 14 Net Profit Margin gives an indication of how Net Profit Margin gives an indication of how effective management is at generating profit on effective management is at generating profit on every dollar of sales. every dollar of sales. 12/29/11 15 ...
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