Financial Accounting Principles and Financial Statements Gapenski Chapter 3, the Income Statement

1
Financial Accounting Principles and Financial
Statements(Gapenski Chapter 3, the Income
Statement)

• Assignment Review
• Lecture 5

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The basic accounting equation

• Assets Liabilities Equity
• (uses) (sources)
• This equation simply reflects the fact that
  everything of value that an organization owns
  (assets) is the result of borrowing (liability)
  or investment of prior owned value (equity).
• This is an identity -- must balance.

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Graphic reference
Assets
Liability Owners Equity

Cash
A/P
Retained Earnings
DR
CR
DR
CR
DR
CR
_
_
_



Expense
Revenue
DR
CR
DR
CR
_
_


4
Debits and Credits

• The debit/ credit method allows the entry of only
  positive numbers whether this results in an
  increase or decrease in the account depends on
  the type of account.
• Left is a debit right is a credit purely a
  convention.
• Every accounting transaction affects at least two
  accounts with balancing debits and credits.
  Thats why it is termed double entry.

5
Terminology

• Accounts are info units used in tracking
  accounting events, e.g. A/R.
• All of the accounts used in the business make up
  the general ledger.
• The chart of accounts lists all accounts used in
  the general ledger along with reference numbers.
• A journal is a record of a transaction with
  related debits/ credits to accounts.

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Income accounts -- temporary

• Revenue examples
• Product A sales
• Product B sales
• Sales returns/ allowances
• Interest income
• Expenses examples
• Insurance expense
• Income tax expense
• Bad debt expense
• Cost of goods sold (COGS)
• What happens when the reporting period ends?

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Income accounts and closing
Assets
Liability Owners Equity

Cash
A/P
Retained Earnings
DR
CR
DR
CR
DR
CR
_
_
_



Expense
Revenue
On close, add income statement items to retained
earnings zero income accounts
DR
CR
DR
CR
_
_


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Extraordinary income gain/(loss)

• These items are both unusual and infrequent
  e.g.
• natural disasters (TS Allison)
• effect of discontinuing certain operations
  (Circuit City or Kmart store closures)
• major legal settlements (IBMs antitrust
  settlement)
• Extraordinary items should be non-recurring -- in
  fact that is one term for them.

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Questions Health care income concepts

• How do gross and net revenues differ?
• Is charity care a kind of bad debt?
• Where do you find charity care on a hospital
  income statement? Bad debt?
• What kinds of items are included in other as
  opposed to patient revenue?
• HMOs do not have patient revenues what do they
  have instead?
• When comparing FP and NFP hospitals, what is a
  good measure of expense control?
• How does depreciation affect taxes? Cash?

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Chapter 3 Problem 3.2 a,b

• 3.2 a. Key difference is in the listing of
  revenues. HMO revenues are listed as premiums
  earned and coinsurance -- not as net patient
  service revenue. Expense categories are about the
  same.
• b. No. The 367,000 depreciation expense
  recognizes wear and tear experienced during the
  year. Depreciation calculations may not reflect
  the actual change in asset market value.

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Chapter 3 Problem 3.2 c,d

• c. BestCare expects not all contract revenues
  will be collected. Estimated uncollectible
  revenues, 19,000, is listed as an expense item
  called provision for bad debts.
• d. Total profit margin net income/ total
  revenues.
• BestCares total profit margin for 2004 was
  1,218 / 28,613 0.043 4.3. Each of
  revenue produced 4.3 cents of earnings.
• The higher the total profit margin, the better
  the organizations expense control.

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Chapter 3 Problem 3.3 a, b
3.3 a. Lines are added that contain the operating
(taxable) income and provision for income taxes
entries -- Green Valley is a FP. Green Valleys
implied tax rate is 31,167 / 89,048 0.350
35.0. b. See above.
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Chapter 3 Problem 3.3 c
c. Green Valleys total profit margin was 57,881
/ 3,269,404 0.018 1.8, significantly lower
than the 2004 total profit margins of Sunnyvale
(4.5 percent) and BestCare (4.3 percent).
Profitability depends many things, but ceteris
paribus, FPs would have lower total profit
margins than NFPs.
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Chapter 3 Problem 3.3 d

• d. Green Valleys before-tax profit margin
• 89,048 / 3,269,404 0.027 2.7.
• Before-tax margin removes the influence of
  taxes, and is a better measure of expense control
  when comparing FPs and NFPs.

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Chapter 3 Problem 3.4
3.4 a. With net income of 2.4M on total revenues
of 30M, total expenses must be 30 2.4
27.6M. b. With 1 million in noncash expenses
(depreciation), cash expenses 26.6M. c.
Using only income statement data, cash flow can
be approximated as Net income Noncash expenses
Net income Depreciation. For Great Forks,
Cash flow 2.4 1.0 3.4M.
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Chapter 3 Problem 3.5 a
3.5 a. Brandywines 2004 IS (M)
Total revenues 12.0 Expenses
All but depreciation (75) 9.0
Depreciation expense 1.5
Total expenses 10.5
Net income 1.5
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Chapter 3 Problem 3.5 b,c,d
b. NI 12.0 9.0 1.5 1.5 M TPM NI
/ Tot rev 1.5 / 12.0 0.125 12.5 Cash
flow NI Depr 1.5 1.5 3.0M

• NI 12.0 9.0 3.0 0.
• TPM 0 / 12.0 0.
• Cash flow 0 3.0

d. NI 12.0 9.0 0.75 2.25 M TPM
2.25 / 12.0 0.188 18.8 Cash flow
2.25 0.75 3.0 M
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Chapter 3 Problem 3.6

• MainLines 2004 IS (M)
• Total revenues 12.0
• Expenses
• All but depreciation (75) 9.0
• Depreciation expense 1.5
• Total expenses 10.5
• Operating income 1.5
• Taxes (40) 0.6
• Net income 0.9

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Chapter 3 Problem 3.6 b,c,d
b. NI 12.0 9.0 1.5 (12-9-1.5)x 0.4
0.9M TPM NI / Tot rev 0.9 / 12.0
0.075 7.5 Cash flow NI Depr 0.9
1.5 2.4M

• NI 12.0 9.0 3.0 (12 9 3) x (0.4) 0
• TPM 0 / 12.0 0.
• Cash flow 0 3.0 3.0M

d. NI 12.09.00.75(12-9-.075) x 0.41.35M
TPM 1.35 / 12.0 0.112 11.2 Cash
flow 1.35 0.75 2.1 M
FP impact depr has on NI? cash flow?