| Chapter 5 The Income Statement aka: earnings statement, statement of operations, profit & loss statement Summarizes the operating results of a business by matching the revenue earned during a given period of time with the expenses incurred in generating that revenue. The Statement of Retained Earnings Retained earnings is that portion of stockholders� (owner�s) equity created by earning net income and retaining the related resources in the business Retained Earnings at the beginning of the period +Net Income (or � Net Loss) -Dividends =Retained Earnings at the end of the period *Dividends are not an expense, so they aren�t included in �net income� The Balance Sheet Lists the amounts of the company�s assets, liabilities, and owner�s equity at the end of the accounting period. * Separate Balance Sheet Subtotals Current Asset- cash or capable of being converted to cash within a year Current Liability- existing debt or obligation that a company expects to satisfy relatively soon using its current assets. These are useful when evaluating a company�s ability to pay its debts as they come due. The Financial Statements are all related to one another. 1. Balance Sheets include amount of Retained Earnings at the respective dates 2. Statement or Retained Earnings summarize the factors that have caused the amount of retained earnings to change between balance sheets. 3. Income Statement explains in greater detail, including expenses. Adequate Disclosure- most important accounting principle * This principle means that financial statements must be accompanied by any information necessary for the statements to be interpreted properly. * Notes � supplemental disclosures that accompany financial statements. They provide users with various types of information * Information that must be disclosed�any facts that an intelligent person would consider necessary for the statements to be interpreted properly. -accounting methods in use, due dates of major liabilities, lawsuits, plant closings, investigations, etc * Good Faith Effort � is demanded by management to keep the users of financial statements informed about the company�s operations. The Temporary Equity Accounts * Separate ledger accounts measure each type of revenue and expense, and the dividends distributed. * These are temporary (or nominal) b/c they accumulate the transactions of only one accounting period. Closing Entries * Transferring the balances of the temporary accounts into the retained earnings account 1. updates the balance of the retained earnings account for changes in retained earnings occurring during the accounting period. 2. returns the balances of the temporary accounts to zero, so that they are ready to measure the revenue, expenses, and dividends of the next accounting period. * How To: 1. Close revenue and expense account balances to the Income Summary account -Revenue Accounts: Dr Revenue, Cr Income Summary -Expense Accounts: Dr Income Summary, Cr Expenses 2. Close the Income Summary account to Retained Earnings -If Net Income: Dr Income Summary, Cr Retained Earnings -If Net Loss: Dr Ret Earn, Cr Inc Sum 3. Close the Dividends account to Retained Earnings -Dr Retained Earnings, Cr Dividends After-Closing Trial Balance Prepared after all closing entries have been made. Consists only of Balance Sheet Accounts (Assets, Liabilities, Owner�s Equity) Financial Analysis Evaluating Profitability * The real question is not how the business did, but how it is likely to do in the future * Net Income as a percentage: Net Income/Total Revenue -indicator of management�s ability to control costs Evaluating Liquidity * A company�s ability to meet its cash obligations as they become due * Working Capital = Current Assets � Current Liabilities -measure of short-term debt paying ability expressed in dollars *Current Ration = Current Assets / Current Liabilities -measure of short-term debt paying ability expressed as a ratio *Quick Ratio = (Cash + Accounts Receivables) / Current Liabilities Interim Financial Statements financial statements prepared for periods of less than one year (such as monthly or quarterly) The Accounting Cycle 1. Journalize (record) transactions � creating a chronological record of events. 2. Post to Ledger Accounts � creating a record classified by accounts. 3. Prepare a Trial Balance � prove equality of debits and credits 4. End-of-period Adjustments � make adjusting entries in journal and post to ledger accounts. 5. Prepare Adjusted Trial Balance � prove equality of debits and credits 6. Prepare Financial Statements & appropriate Disclosures � Income Statement, Statement of Retained Earnings, Balance Sheet 7. Closing Entries � to �zero� the revenue, expense, and dividend accounts 8. Prepare After-Closing Trial Balance |