operating decisions and the income statement · 2014. 5. 28. · 4. inventories (asset) determine...

Operating Decisions and the Income Statement

Chapter 3 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Slide 2 McGraw-Hill/Irwin Slide 2

Understanding the Business

How do business activities

affect the income statement?

How are these activities

recognized and measured?

How are these activities

reported on the

income statement?


The Operating Cycle

Purchase or

manufacture

products or

supplies on

credit.

Deliver product

or provide service

to customers on

credit.

Pay

suppliers.

Receive payment

from customers.

Begin


The Operating Cycle

Time Period: The long life of a company can be

reported over a series of shorter time periods.

Recognition Issues : When should the effects of

operating activities be recognized (recorded)?

Measurement Issues: What amounts should be

recognized?


Time Periods

Annual Time Periods

Calendar year

Year Ending December 31

Fiscal year

Year Ending June 30

Year Ending September 30

Year Ending January 31 (?)

Quarterly time periods

Publicly-trade companies

Monthly time periods

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The Operating Cycle






recognized?


© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison &

Horngren 3-7

When is Revenue Recognized (Earned)?

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recognized?

The Operating Cycle


The amount of revenue to record equals the cash value of

the goods or services transferred to the customer

Measurement

$44,725 MSRP

$ 5,651 Savings

$39,074 Jordan Way Price


Elements on the Income Statement

Losses Decreases in assets or increases in

liabilities from peripheral transactions.

Revenues Increases in assets or settlement of liabilities from ongoing operations.

Expenses Decreases in assets or increases in liabilities from ongoing operations.

Gains Increases in assets or settlement of

liabilities from peripheral transactions.


Revenues

Restaurant and commissary sales 884,000$

Franchise royalties and development fees 117,000

Total revenues 1,001,000

Costs and expenses

Cost of sales 425,000

Salaries and benefits expense 164,000

General and administrative expenses 314,000

Total costs and expenses 903,000

Operating income 98,000

Other revenues and gains (expense and losses)

Investment income 1,000

Interest expense (3,000)

Income before income taxes 96,000

Income tax expense 33,000

Net income 63,000$

Earnings per share 1.96$

Papa John's International, Inc. and Subsidiaries

Consolidated Statement of Income

For the Year Ended December 31, 2006

(dollars in thousands)

Papa John’s Primary

Operating Activity is

selling pizza and selling

franchises.

Operating Activities

Peripheral Activities


Papa John’s Primary

Operating Expenses

Revenues




Costs and expenses











Net income 63,000$






Cost of sales

(used inventory)

Salaries and

benefits to

employees

Other costs (like

advertising,

insurance, and

depreciation)


Revenues




Costs and expenses











Net income 63,000$






Earnings Per Share

Net Income Weighted Average

Number of Common Shares Outstanding


Revenues




Costs and expenses











Net income 63,000$






Corporations are taxable entities.

Income tax expense computed as Income Before Income Taxes × Tax Rate (Federal,

State, Local and Foreign).


Two Types of Accounting (and some others…)

Cash Basis Accrual Basis Others Tax Basis OCBOA Regulatory Traditional


Cash Basis Accounting

Revenue is recorded

when cash is received.

Expenses are recorded

when cash is paid.

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McGraw-Hill/Irwin Slide 17

Assets, liabilities, revenues, and expenses should be

recognized when the transaction that causes them

occurs, not necessarily when cash is paid or received.

Required by -

Generally

Acceptable

Accounting

Principles

Accrual Accounting


Revenue Principle

Recognize revenues when . . . Delivery has occurred or services have

been rendered.

There is persuasive evidence of an arrangement for customer payment.

The price is fixed or determinable.

Collection is reasonably assured.


Three Scenarios for Revenues


Revenue Principle

If cash is received before the company delivers goods or services, the liability

account UNEARNED REVENUE is recorded.

Cash received before revenue is earned -

Cash Received

Cash (+A) xxx Unearned revenue (+L) xxx


Revenue Principle

When the company delivers the goods or services UNEARNED REVENUE is reduced

and REVENUE is recorded.

Cash received before revenue is earned -

Cash Received

Company Delivers

Cash (+A) xxx Unearned revenue (+L) xxx

Revenue will be recorded when earned.


Revenue Principle

CASH COLLECTED

(Goods or services due to

customers)

over time will

become

REVENUE

(Earned when goods

or services provided)

Rent collected in advance Rent revenue

Unearned air traffic revenue Air traffic revenue

Deferred subscription revenue Subscription revenue

Typical liabilities that become

revenue when earned include . . .


Revenue Principle

When cash is received on the date the revenue is earned, the following

entry is made:

Cash Received

Company Delivers

Cash (+A) xxx Revenue (+R) xxx

AND


Revenue Principle

If cash is received after the company delivers goods or services, an asset ACCOUNTS RECEIVABLE is recorded.

Cash received after revenue is earned -

Accounts receivable (+A) xxx Revenue (+R) xxx

Company Delivers


Revenue Principle

Cash Received

Accounts receivable (+A) xxx Revenue (+R) xxx

Cash received after revenue is earned -

Company Delivers

When the cash is received the ACCOUNTS RECEIVABLE is reduced.

Cash will be collected.


Revenue Principle

CASH TO BE

COLLECTED

(Owed by

customers)

and already

earned as

REVENUE

(Earned when

goods or services

provided)

Interest receivable Interest revenue

Rent receivable Rent revenue

Royalties receivable Royalty revenue

Assets reflecting revenues earned but

not yet received in cash include . . .


The Matching Principle

Resources consumed to

earn revenues in an

accounting period should be recorded in that period, regardless of when cash is

paid.

Three Scenarios for Expenses



If cash is paid before the company receives goods or services, an asset account,

PREPAID EXPENSE is recorded.

Cash is paid before expense is incurred -

$ Paid

Prepaid expense (+A) xxx Cash (-A) xxx



Expense Incurred

When the expense is incurred PREPAID EXPENSE is reduced and an EXPENSE is

recorded.

Cash is paid before expense is incurred -

$ Paid

Prepaid expense (+A) xxx Cash (-A) xxx

Expense will be recorded when incurred.



When cash is paid on the date the

expense is incurred, the following entry

is made:

Cash Paid

Expense Incurred

Expense (+E) xxx Cash (-A) xxx

AND



If cash is paid after the company receives goods or services, a liability PAYABLE is

recorded.

Cash paid after expense is incurred -

Expense (+E) xxx Payable (+L) xxx

Expense Incurred



Cash Paid

When cash is paid the PAYABLE is reduced.

Cash paid after expense is incurred -

Expense Incurred

Expense (+E) xxx Payable (+L) xxx

Cash will be paid.



CASH PAID FOR

as used over

time becomes EXPENSE

Supplies inventory Supplies expense

Prepaid insurance Insurance expense

Buildings and equipment Depreciation expense

Typical assets and their related

expense accounts include. . .


A = L + SE ASSETS

Debit

for

Increase

Credit

for

Decrease

LIABILITIES

Debit

for

Decrease

Credit

for

Increase

RETAINED

EARNINGS

Debit

for

Decrease

Credit

for

Increase

CONTRIBUTED

CAPITAL

Debit

for

Decrease

Credit

for

Increase

Next, let’s see how

Revenues and

Expenses affect

Retained Earnings.


EXPENSES

Debit

for

Increase

Credit

for

Decrease

REVENUES

Debit

for

Decrease

Credit

for

Increase

RETAINED

EARNINGS

Debit

for

Decrease

Credit

for

Increase

Expanded Transaction Analysis Model

Dividends decrease

Retained Earnings. Net Income increases

Retained Earnings.


Identify & Classify the Accounts

1. Cash (asset)

2. Franchise fee revenue

(revenue)

3. Unearned franchise fees

(liability)

Determine the Direction of the Effect

1. Cash increases.


increases.


increases.

Papa John’s sold franchises for $400 cash. The company earned

$100 immediately. The rest will be earned over several months.


1. Cash (asset).


(revenue).


(liability).


1. Cash increases.


increases.


increases.


= +

Cash 400 Unearned franchise

revenue

300 Franchise fees

revenue

100

Stockholders' EquityLiabilitiesAssets

Debit Credit

Cash (+A) 400

Unearned franchise revenue (+L) 300

Franchise fees revenue (+R, +SE) 100

Description

General Journal

Papa John’s sold franchises for $400 cash. The company earned

$100 immediately. The rest will be earned over several months.



1. Cash (asset)

2. Restaurant sales revenue

(revenue)

3. Cost of sales- restaurant

(expense)

4. Inventories (asset)


1. Cash increases.


increases.


increases.

4. Inventories decrease.

The company sold $36,000 of pizzas for cash. The costs of the

pizza ingredients for those sales were $9,600.


1. Cash (asset).


(revenue).


(expense).

4. Inventories (asset).


1. Cash increases.


increases.


increases.

4. Inventories decrease.


Debit Credit

Cash (+A) 36,000

Restaurant sales revenue (+R, +SE) 36,000

Cost of sales - restaurant (+E, -SE) 9,600

Inventories (-A) 9,600

Description

General Journal

= +

Cash 36,000 Restaurant sales

revenue

36,000

Inventory (9,600) Cost of sales (9,600)

Stockholders' EquityLiabilitiesAssets

The company sold $36,000 of pizzas for cash. The costs of the

pizza ingredients for those sales were $9,600.


How are Financial Statements Prepared?

Income

Statement Revenues – Expenses = Net Income

Statement of

Retained

Earnings

Beginning Retained Earnings

+ Net Income

- Dividends Declared

Ending Retained Earnings

Balance

Sheet

Assets = Liabilities + Stockholders’ Equity

Contributed Capital

Retained Earnings

Statement

of Cash Flows

Change

in

Cash

= Cash from Operating Activities

+ Cash from Investing Activities

+ Cash from Financing Activities


Income Statement

Revenues

Restaurant sales revenue 66,000$

Franchise fee revenue 2,800

Total revenues 68,800

Costs and expenses








Gain on sale of land 3,000


Income tax expense -

Net income 21,800$




For the Month Ended January 31, 2007



Beginning balance, December 28, 2006 147,000$

Net income 21,800

Dividends (3,000)

Ending balance, January 31, 2007 165,800$

PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES

Consolidated Statement of Retained Earnings

For the Month Ended Janaury 31, 2007

(Dollars in thousands)

Statement of Retained Earnings

The net income comes from the Income

Statement just prepared.


Balance Sheet

Assets Jan. 31, 2007

Current assets:

Cash 43,900$

Accounts receivable 19,200

Supplies 26,000

Prepaid expenses 17,000

Other current assets 14,000

Total current assets 120,100

Long-term investments 2,000

Property and equipment, net of depreciation 207,000

Long-term notes receivable 15,000

Intangibles 67,000

Other assets 17,000

Total assets 428,100$

Liabilities and Stockholders' Equity

Current liabilities:

Accounts payable 39,000$

Dividends payable 3,000

Accrued expenses payable 73,000

Total current liabilities 115,000

Unearned franchise fees 7,300

Long-term notes payable 110,000

Other long-term liabilities 27,000

Total liabilities 259,300

Stockholders' equity:

Contributed capital 3,000

Retained earnings 165,800

Total stockholders' equity 168,800

Total liabilities and stockholders' equity 428,100$

PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Dollars in thousands)

The ending balance from

the Statement of Retained

Earnings flows into the

equity section of the

Balance Sheet.


Focus on Cash Flows

Effect on

Cash Flows

Cash received from: Customers +

Investments +

Cash paid to: Suppliers -

Employees -

Interest paid -

Income taxes paid -

Nature of Operating Activity

Cash Inflows

Cash Outflows

Current

Ratio

Current Assets

Current Liabilities =

Current

Ratio

$18,000

$12,931 = = 1.39 to 1

This ratio measures the ability

of the company to pay current

debts as they become due.

Is 2.00 the magic number ?

Past Trends Industry

Standards


Key Ratio Analysis

Measures the sales

generated per dollar

of assets.

Creditors and analysts use

this ratio to assess a

company’s effectiveness at

controlling current and

noncurrent assets.

Total Asset

Turnover

Ratio

Sales (or Operating) Revenues

Average Total Assets =


Key Ratio Analysis

Creditors and analysts use this ratio to assess a company’s effectiveness at controlling current and

noncurrent assets.

Total Asset

Turnover

Ratio

Sales (or Operating) Revenues

Average Total Assets =

operating decisions and the income statement · 2014. 5. 28. · 4. inventories (asset) determine...

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