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Operating Activities

Chapter F13. Operating Activities. Electronic Presentation by Douglas Cloud Pepperdine University. Objectives. 1. Identify the purpose and major components of the income statement. 2. Explain and apply rules for measuring revenues and receivables and reporting revenue transactions.

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Operating Activities

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  1. Chapter F13 Operating Activities Electronic Presentationby Douglas Cloud Pepperdine University

  2. Objectives 1.Identify the purpose and major components of the income statement. 2.Explain and apply rules for measuring revenues and receivables and reporting revenue transactions. 3. Describe reporting rules for inventories and cost of goods sold and compare reporting of inventories for merchandising and manufacturing companies. Once you have completed this chapter, you should be able to: Continued

  3. Objectives 4.Explain and apply rules for measuring cost of goods sold and inventories and describe the effects of income taxes on the choice of inventory estimation method. 5. Identify routine and nonroutine events that affect a company’s income statement.

  4. Objective 1 Identify the purpose and major components of an income statement.

  5. Basic Operating Activities The income statement reports the results of operating activities for a fiscal period on an accrual basis.

  6. Income Statement for Mom’s Cookie Company Exhibit 1 2005 2004 For the Year Ended December 31, Net sales revenue $3,235,600 $686,400 Cost of goods sold (1,954,300) (457,600) Gross profit 1,281,300 228,800 Selling, general and administrative expenses (1,094,700) (148,300) Operating income 186,600 80,500 Interest expense (20,400) (4,800) Pretax income 166,200 75,700 Income taxes (49,860) (22,710) Net income $ 116,340 $ 52,990 The first item on the income statement is net sales revenue. Earnings per share $ 0.29 $ 0.13

  7. Income Statement for Mom’s Cookie Company Exhibit 1 2005 2004 For the Year Ended December 31, Net sales revenue $3,235,600 $686,400 Cost of goods sold (1,954,300) (457,600) Gross profit 1,281,300 228,800 Selling, general and administrative expenses (1,094,700) (148,300) Operating income 186,600 80,500 Interest expense (20,400) (4,800) Pretax income 166,200 75,700 Income taxes (49,860) (22,710) Net income $ 116,340 $ 52,990 Cost of goods sold is subtracted from net sales revenue to compute gross profit. Earnings per share $ 0.29 $ 0.13

  8. Income Statement for Mom’s Cookie Company Exhibit 1 2005 2004 For the Year Ended December 31, Net sales revenue $3,235,600 $686,400 Cost of goods sold (1,954,300) (457,600) Gross profit 1,281,300 228,800 Selling, general and administrative expenses (1,094,700) (148,300) Operating income 186,600 80,500 Interest expense (20,400) (4,800) Pretax income 166,200 75,700 Income taxes (49,860) (22,710) Net income $ 116,340 $ 52,990 The expenses for marketing and distributing a company’s products and managing its operations are subtracted from gross profit to calculate operating income. Earnings per share $ 0.29 $ 0.13

  9. Income Statement for Mom’s Cookie Company Exhibit 1 2005 2004 For the Year Ended December 31, Non-operating expenses or losses, such as Interest Expense, are subtracted from operating income to compute pretax income. Net sales revenue $3,235,600 $686,400 Cost of goods sold (1,954,300) (457,600) Gross profit 1,281,300 228,800 Selling, general and administrative expenses (1,094,700) (148,300) Operating income 186,600 80,500 Interest expense (20,400) (4,800) Pretax income 166,200 75,700 Income taxes (49,860) (22,710) Net income $ 116,340 $ 52,990 Non-operating income or gains are added, to compute pretax income. Earnings per share $ 0.29 $ 0.13

  10. Income Statement for Mom’s Cookie Company Exhibit 1 2005 2004 For the Year Ended December 31, Net sales revenue $3,235,600 $686,400 Cost of goods sold (1,954,300) (457,600) Gross profit 1,281,300 228,800 Selling, general and administrative expenses (1,094,700) (148,300) Operating income 186,600 80,500 Interest expense (20,400) (4,800) Pretax income 166,200 75,700 Income taxes (49,860) (22,710) Net income $ 116,340 $ 52,990 Income tax expense is subtracted from pretax income to calculate net income. Earnings per share $ 0.29 $ 0.13

  11. Income Statement for Mom’s Cookie Company Exhibit 1 2005 2004 For the Year Ended December 31, Net sales revenue $3,235,600 $686,400 Cost of goods sold (1,954,300) (457,600) Gross profit 1,281,300 228,800 Selling, general and administrative expenses (1,094,700) (148,300) Operating income 186,600 80,500 Interest expense (20,400) (4,800) Pretax income 166,200 75,700 Income taxes (49,860) (22,710) Net income $ 116,340 $ 52,990 Earnings per share is reported on a corporate income statement. Earnings per share $ 0.29 $ 0.13

  12. Objective 2 Explain and apply rules for measuring revenues and receivables and reporting revenue transactions.

  13. The Effect of Sales and Services on the Financial Statements Exhibit 2 Statement of Cash Flows Income Statement Balance Sheet Activity Sales of Goods and Services to Customers Cash Received from Customers Operating Revenues Cash Accounts Receivable

  14. Revenue should be recognized when four criteria have been met. Revenues and Receivables 1. The selling company has completed most of the activities necessary to produce and sell the goods or services. 2. The selling company has incurred the costs associated with producing and selling the goods or services or can reasonably measure those costs. 3. The selling company can measure objectively the amount of revenue it has earned. 4. The selling company is reasonably sure that it is going to collect cash from the purchaser.

  15. Recognizing Revenue for Long-Term Contracts Constructo, Inc. contracts to construct a new building for $20 million. For the fiscal period ending in 2004, Constructo, Inc. will recognize revenue of $4 million (20% of $20 million). The project will take three years. Constructo, Inc. estimates at the end of 2004, the first year of the contract, 20 percent of the work has been completed.

  16. Sales Discounts and Returns Revenues are reported on the income statement net of discounts and expected returns. A discount is a reduction in the normal sales price to encourage customers to buy large quantities of goods (a quantity discount) or to pay their accounts early (a sales discount).

  17. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 11/4 Accounts Rec. 5,000 Sales Revenue 5,000 Sales Discounts and Returns Mom’s Cookie Company sells goods priced at $5,000 to a customer on November 4, 2004, and offers a 2% discount if the customer pays in full within 10 days of the purchase.

  18. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 11/4 Cash 4,900 Sales Discount –100 Accounts Rec. –5,000 Sales Discounts and Returns If the customer pays within the discount period, the company reduces the revenue by $100 ($5,000 x 2%) and records the discount.

  19. Returns Sales Discounts and Returns Like sales discounts, sales returns are subtracted from sales revenues in reporting net operating revenues on the income statement.

  20. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 12/31 Sales Returns –500,000 Allowance for Returns –500,000 Sales Discounts and Returns From past experience, the company estimates that $500,000 of its 2004 sales will be returned in 2005. Textbook Publishing Company sells $5 million of books during fiscal year 2004.

  21. MATCHING Sales Discounts and Returns A major principle of accounting is the matching principle.

  22. Sales Discounts and Returns The matching principle is an effort to match revenues and expenses in the period in which they occur so that revenues, expenses, and net income are not misstated.

  23. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 1/12 Allowance for Returns 100,000 Accounts Rec. –100,000 Sales Discounts and Returns Textbook Publishing received a return of $100,000 (sales price) on January 12, 2005, from a credit customer. The goods cost the company $75,000. Continued

  24. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 1/12 Merchandise Inventory 75,000 Cost of Goods Sold 75,000 Sales Discounts and Returns Textbook Publishing received a return of $100,000 (sales price) on January 12, 2005, from a credit customer. The goods cost the company $75,000.

  25. Uncollectible Accounts Mom’s Cookie Company has a balance in Allowance for Doubtful Accounts of $1,000 at the end of its 2004 fiscal year before adjustments are made for the year. Management evaluates the company’s credit sales and outstanding receivables and determines that the amount of the allowance account should be $5,000.

  26. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 12/31 Doubtful Accounts Exp. –4,000 Allowance for Doubtful Accts. –4,000 Uncollectible Accounts Since the current allowance balance is $1,000, the allowance account needs to be increased by $4,000. Doubtful AccountsExpenseis a selling expense

  27. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 2/12 Accounts Receivable –800 Allowance for Doubtful Accts. 800 Uncollectible Accounts On February 12, 2005, Mom’s Cookie Company determines that $800 owed by Home Goods Company cannot be collected.

  28. Warranty Costs Products under warranty allow the customer to return a defective product for replacement or refund.

  29. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 3/31 Warranty Expense –12,000 Warranty Obligations 12,000 Warranty Costs From sales in March, 2004, Harris Company estimates warranty costs of $12,000 will be incurred in April, May, and June.

  30. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 5/15 Warranty Obligations –400 Parts Inventory –300 Wages Payable 100 Warranty Costs On May 15, Harris replaces a faulty motor on an appliance. The cost of the motor is $300 and the cost of labor to install the motor is $100.

  31. Objective 3 Describe reporting rules for inventories and cost of goods sold and compare reporting of inventories for merchandising and manufacturing companies.

  32. The Effect of Inventory Transactions on the Financial Statements Exhibit 3

  33. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 5/4 Merchandise Inventory 10,000 Accounts Payable 10,000 Reporting Inventories and Cost of Goods Sold On May 4, 2004, Mom’s Cookie Company purchased $10,000 of inventory on credit.

  34. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 5/6 Cost of Goods Sold –4,000 Merchandise Inventory –4,000 Reporting Inventories and Cost of Goods Sold On May 6, Mom’s Cookie Company sold $4,000 of that inventory.

  35. Reporting Inventories and Cost of Goods Sold On May 12, Mom’s Cookie Company pays for half of the inventory purchase. ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Contributed Capital Retained Earnings Other Assets Date Accounts 5/12 Accounts Payable –5,000 Cash –5,000

  36. Reporting Inventories and Cost of Goods Sold Purchase discounts for paying for goods and services within the discount period should result in both Inventory and Accounts Payable being reduced.

  37. Components of Manufacturing Inventory Exhibit 4 Work-in-Process Finished Goods Labor and Overhead Costs Inventories Raw Materials

  38. Reporting Inventories and Cost of Goods Sold Manufacturing Raw materials inventory includes the costs of component parts or ingredients that become part of the product being manufactured.

  39. Reporting Inventories and Cost of Goods Sold Manufacturing Work-in-process inventory includes the costs of materials, labor, and overhead that have been applied to products that are in the process of being manufactured.

  40. Reporting Inventories and Cost of Goods Sold Manufacturing Finished goods inventory includes the costs of products that have been completed in the manufacturing process and are available for sale to customers.

  41. Computation of Manufacturing Inventory Costs Exhibit 5

  42. Objective 4 Explain and apply rules for measuring cost of goods sold and inventories and describe the effects of income taxes on the choice of inventory estimation method.

  43. Measuring Inventory Hydro Company sells and services agricultural irrigation equipment. On March 20, 2004, Hydro purchased 20 pump motors at $200 each. Hydro already had 8 identical motors on hand, for which it had paid $175.

  44. Measuring Inventory On March 22, 2004, a customer purchased one motor. Should the company record the cost of goods sold for the motor as $175 or as $200?

  45. Sold 1 Mar. 20 20 units @ $200 per unit Measuring Inventory First-In, First-Out Method Mar. 1 8 units @ $175 per unit 7 units @ $175 per unit Using the first-in, first-out method, the cost of the motor sold would be recorded as $175 because $175 is the cost of the oldest item in Hydro’s inventory.

  46. Sold 1 Mar. 20 20 units @ $200 per unit Measuring Inventory Last-In, First-Out Method Mar. 1 8 units @ $175 per unit 19 units @ $200 per unit Using last-in, first-out, Hydro would record the cost of the motor sold on March 22 as $200 because $200 is the cost of the most recent item in Hydro’s inventory.

  47. Measuring Inventory Weighted-Average Method Mar. 1 8 units @ $175 per unit = $1,400 Mar. 20 20 units @ $200 per unit = 4,000 28 units $5,400 $192.86 per unit $5,400 ÷ 28 units Using the weighted-average method, Hydro would record the cost of the motor sold on March 22 as $192.86.

  48. Measuring Inventory Mom’s Cookie Company has finished goods inventory of $3,000 at the end of February 2005. The inventory includes 150 cases of cookies at a cost of $20 per case. Exhibit 6 (Slide 49) summarizes unit costs and sales for the company for March.

  49. Unit Costs and Sales for Mom’s Cookie Company for March Exhibit 6 March 1 Inventory 150 $20.00 $ 3,000 March 8 Batch 3,000 20.30 60,900 March 18 Batch 3,000 20.60 61,800 March 20 Sales 5,200 March 28 Batch 3,000 20.90 62,700 March 31 Sales 3,600 Total Cost of Goods Available for Sale $188,400

  50. 3,000 units @ $20.30 per unit Mar. 8 Mar. 18 3,000 units @ $20.60 per unit Measuring Inventory First-In, First-Out Method Perpetual Inventory System Beg. Inv. 150 units @ $20.00 per unit Inventory purchased on March 8 and March 18

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