Study: Part A: Prepare Financial Statements. Single-Step and Multi-Step Income Statements
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Slides 1-3 (0m:31s)
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Slide 1
Welcome to Introduction to Accounting Preparing for a User’s Perspective
Prepare financial statements
Slide 2
I bet you thought we would never get here but we are ready now to prepare the financial statements using the adjusted trial balance we just completed in the prior video.
Slide 3
We went through these five steps with the original accounting transactions then we went through them again with the adjusting entries and we just barely finished preparing the adjusted trial balance and are ready to prepare the financial statements.
Slides 4 & 5 (2m:35s)
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Slide 4
This is the adjusted trial balance we just barely completed. It actually is kind of long, so we put it on two different pages. What I wanted to do now is see if you can classify each of these listed accounts as one of the following: current assets, noncurrent assets, contra assets, current liability, noncurrent liability, equity accounts that will appear on the balance sheet, or equity accounts that appear on the income statement or it is a dividend account. The income statement accounts will be revenues and expenses.
So, stop the video, so if you can do that classification and then we’ll see how you did.
OK, here we go. Current assets, these are those assets expected to be converted into cash or save you from paying cash within the next year.
Noncurrent assets, those are those assets that are expected to be converted into cash or save you from spending cash in periods beyond one year.
Contra assets, those are the accounts that are deducted from the related asset on the balance sheet. For example, on the balance sheet, you would show accounts receivable minus the balance in the allowance for doubtful accounts to get the net receivables, the amount you really expect to realize out of those receivables and for equipment you have accumulated depreciation which is deducted to arrive at the book value of the equipment. Buildings deduct the accumulated depreciation to arrive at the book value of the buildings. That’s the amount of the building that has not yet been expensed.
Current liabilities, these are the liabilities that are expected to be paid off within the next year.
Going on to the next page.
Slide 5
Once again, stop the video and take a moment and see if you can classify these accounts. On this we’re only going to see one term for noncurrent liabilities, equity on the balance sheet as well as equity temporary accounts such as revenues expenses and dividends.
OK. Hopefully you have taken the time to classify those. Here we go.
Noncurrent liability, those liabilities expected to be paid off in periods beyond one year.
Equity, this is capital stock that will appear on the balance sheet. It is a permanent account which carries its balance forward from period to period.
Dividends is an equity account, but it actually is only a temporary equity account which gets deducted from retained earnings.
Revenues are equity accounts, but they are used to compute net income which is closed into retained earnings.
Expenses, expenses are deducted from revenues to arrive at net income which is closed into retained earnings.
I hope you got those [classifications] right, because that ability to classify these accounts is essential to preparing the financial statements properly.
Hopefully, you are ready to move on.
Let’s look at it from the big picture.
Slides 6-8 (2m:26s)
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Slide 6
The four financial statements we will be preparing are prepared in the following order.
- The Income Statement first to arrive at net income
- The Statement of Stockholders’ Equity which will include the Statement of Retained Earnings.
- The Balance Sheet which absolutely needs to have the ending retained earnings balance that they just computed on the Statement of Stockholders’ Equity [particularly the Statement of Retained Earnings], and then finally you will prepare
- The Statement of Cash Flows.
Slide 7
Looking at it from the big picture, these accounts here [Net Income Summary, Revenues, Expenses, Contra Revenues] are all used to prepare the Income Statement.
These accounts [Capital Contributions, Retained Earnings, Net Income and Dividends] are used to prepare your Statement of Stockholder Equity.
And finally, these accounts [Assets, Gross Assets, Contra Assets, Liabilities, Equity, Capital Contributions, and Retained Earnings] are all used to prepare the Balance Sheet.
The key thing you should see here is that these accounts circled in the green [Net Income, Revenues, Expenses, Contra Revenues] will all be closed into retained earnings, that makes them temporary.
Dividends gets closed into retained earnings. That makes it temporary. So, if I were to draw a line right through here all the accounts below that line are temporary accounts that get closed into retained earnings, which is a permanent account that carries its balance forward from period to period.
Slide 8
The financial statements articulate from one period to the next. What we do is we take our beginning balance sheet and then we have the other statements that help us explain how we get to the ending balance sheet. For example, the income statement tells us how retained earnings changed from one year to the next or from one period to the next. It [net income] gets added to retained earnings whose ending balance will then go on to the ending retained earnings. So we take our beginning retained earnings from the beginning of the year, add net income, take away dividends to get our ending retained earnings which goes on the ending balance sheet. Common stock [is] the same, we take the beginning common stock, we might have issuances of common stock for example, to get to our ending common stock which goes on the balance sheet.
Changes on the cash account can be explained by the statement of cash flows. We take the beginning cash add to it all the changes in cash from the year to get to the ending cash which goes on the balance sheet. This here on the middle is called articulation. The balance sheet from one period articulates to the balance sheet at the end of the period using these other statements that explain the changes.
Slides 9-13 (2m:16s)
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Slide 9
We will now prepare the four financial statements referred to in this course. Please take out a scratch piece of paper and use the adjusted account balances on the following page to prepare a single-step income statement.
Here is a formatting hint. Put the name of the company at the top. Specify that it is the income statement. Specify the accounting period being reported on. Normally it is a year, but since this company started March 1st of X1, it will just be from March 1st, X1 to December 31st, X1.
Then list all revenues and their balances and total them up. List all expenses and their balances and total them up. Take the total revenues less total expenses and you get net income.
Also compute earnings per share which will be net income divided by the 1,000 shares that are currently issued and outstanding.
Slide 10
Here is the full adjusted trial balance. The accounts to be used to prepare the single-step income statement are revenues and expenses. Good luck.
Slides 11-13
This is the single-step income statement. You title it with the name of the company; name the statement, income statement [and] you indicate the period. In this case it’s a brand new company we started on March 1st. Normally, it would be for the year ended December 31st, but we only started in March so that will be our period. I know it’s unusual but I thought you would at least want to see that.
This is a single-step income statement, and all we did is we took all the revenues, added them up to get total revenues [took] all the expenses, added them up to get total expenses. Revenues minus expenses gave us net income of $71,696.
To get the earnings per share, we took that net income and divided by the number of shares issued and outstanding, which from prior videos you would know were 1,000 shares issued and outstanding. Which means, each share effectively earned $71.70.
Because the font in the video may be a little small, I broke this out into two pages, just so you could see it a little better.
Slide 12
Here’s the revenue part. [see single-step income statement above]
Slide 13
And here’s the expenses part. [see single-step income statement above]
Slides 14-18 (3m:03s)
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Slide 14
Slide 15
An alternative format of the income statement is called the multi-step income statement. You can use either one, but the one you would normally expect to see out in industry would be the multi-step income statement.
Please take out a scratch piece of paper and use the adjusted account balances on the following page to prepare a multi-step income statement.
Here’s a formatting hint.
Do the labeling at the top just like you did with a single-step income statement, but when you get down into revenues and expenses you are going to need to break them out in relation to how they relate to the operating activities of the company.
At the very top you are going to have your net sales revenues, minus your cost of goods sold equals your gross profit. Then deduct your operating expenses to get your operating income, add your other revenues less your other expenses to get your income before taxes, then deduct your income taxes to arrive at net income which will be the same number as on the single-step income statement. Then compute your earnings per share.
Slides 16-18
The multi-step income statement groups revenues and expenses in some logical manner. For example, sales revenues minus the cost of goods sold gives us our gross profit on those products that we sold, then we have the operating expenses that support this process of selling the inventory to customers. We have our selling expenses which I have subtotaled, our administrative expenses which I have subtotaled to get the total operating expenses of $24,640.
Our gross profit was sufficiently large to cover the operating expenses of running the business arriving at income from operations of $125,360. Then we have some other revenues and expenses that aren’t really our core business so we call them other and it appears that we have a net expense of $5,867. We take our income from operations deduct that net other expense to get income before income tax expense of $119,493.
If you recall from the prior video, our income tax rate was 40% arriving at $47,797 of income tax expense which is deducted from income before income tax to get our net income and as you can see, it is the same answer as the single-step. We have just provided more useful groupings of information so you can better analyze the health of the business.
On the next slides I went and broke this out so you can just
Slide 17
read them a little bit better. It’s the same statement, [see multi-step income statement above]
Slide 18
I just wanted you to be able to see the numbers a little bit easier. [see multi-step income statement above]
Now that we know what our income is, that was our first financial statement, the income statement. Now we are going on to the statement of shareholder equity, that is number two.
That’s the end of part 1 in which we prepared the income statement, in part 2 we will prepare the statement of stockholders’ equity, the balance sheet and the statement of cash flows.
Good luck on the income statement quiz.