CHAPTER
9
The Income Statement and the
Statement of Cash Flows
CHAPTER OUTLINE:
I. Income Statement
A. Revenues
1. Revenue recognition
2. Revenue from sales
4. Unusual revenue recognition methods
a. Percentage of completion
B. Expenses
1. Expense recognition
a. Matching principle, objectivity, and conservatism applied
2. Cost of goods sold
a. Under perpetual inventory system
b. Under periodic inventory system
c. Purchases returns and allowances
C. Gross Profit or Gross Margin
2. Effect of sales mix
4. Use of target gross profit ratio to set selling price
D. Operating Expenses
E. Income from Operations
F. Other Income and Expense
1. Interest income and interest expense
2. Other gains and losses
G. Income Before Income Taxes and Income Tax Expense
H. Net Income and Earnings Per Share
2. Net income available for common stock
3. Basic versus diluted earnings per share
Chapter 9 The Income Statement and the Statement of Cash Flows
I. Summary of Income Statement Presentation Alternatives
2. Multiple-step format
J. Unusual or Infrequently Occurring Items Sometimes Seen on the Income Statement
1. Discontinued operations
3. Net income attributable to noncontrolling (minority) interests
II. Statement of Cash Flows
A. Content and Format of the Statement
1. Cash providing/using activities
2. Net income—the beginning point for cash generated from operations, but adjustments
are required for non-cash elements of net income
3. Changes in other current assets and current liabilities affect cash generated from
operating activities
5. Summary of financing activities
6. Statement illustrated
a. Direct method
b. Indirect method
B. Interpreting the Statement of Cash Flows
2. Operating activities—should generate cash
4. Financing activities
a. Debt transactions—borrowings and repayments
Instructor’s Manual / Solutions Manual
TEACHING/LEARNING OBJECTIVES:
Primary:
1. To have the student integrate the material learned during the study of the balance sheet with the
impact of those issues on net income and cash flows.
3. To prepare the student to interpret a relatively straightforward statement of cash flows.
Supporting:
5. To have the student understand that there are some alternatives to recognizing revenue at the
point of sale of a product or service, and that these alternatives must be evaluated carefully.
7. To have the student understand the significance of gross profit / gross margin, and how to use an
estimated gross profit / gross margin ratio to estimate net income.
9. To have the student understand the basic earnings per share calculation, and the reasons for
adjustments sometimes required in this calculation.
11. To have the student understand the purpose of the statement of cash flows.
12. To have the student understand how the statement of cash flows relates to the income
Chapter 9 The Income Statement and the Statement of Cash Flows
TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS:
2. It should be emphasized that during discussion of the balance sheet components, the income
statement impact of transactions was described. This chapter focuses on the presentation
3. The net sales, gross profit / gross margin, and operating income amounts on the income
4. The significance of the price/earnings ratio as a common stock valuation model is explained in
5. The difference between the accrual basis income statement and statement of cash flows should
6. Use examples of statements of cash flows to help students understand the interpretation process.
Instructor’s Manual / Solutions Manual
ASSIGNMENT OVERVIEW:
NO.
DIFFICULTY &
TIME ESTIMATE
OTHER
COMMENTS
M9.1.
Easy, 5-8 min.
In-class demonstration of gross profit calculations.
M9.2.
Easy, 5-8 min.
In-class demonstration of income statement relationships.
M9.3.
Easy, 3-5 min.
In-class demonstration of basic EPS.
M9.4.
Easy, 5-8 min.
In-class demonstration of cash flows from operations—indirect.
E9.5.
Easy, 5-8 min.
Straight-forward revenue recognition exercise.
E9.6.
Easy, 5-8 min.
Good in-class demonstration exercise.
E9.7.
Med., 5-8 min.
Review the cost of goods sold model, and refer students to
the “inventory errors” discussion Chapter 5.
E9.8.
Med., 5-8 min.
See E9.7.
E9.9.
Easy, 5-8 min.
Use to clarify relationships: sales, cost of goods sold, gross
profit.
E9.10.
Easy, 5-8 min.
Good homework assignment.
E9.11.
5
Easy, 5-8 min.
Good discussion starter. Refer students to Exhibit 9.7.,Part II.
E9.12.
Easy, 5-8 min.
See E9.11. Good in-class demonstration exercise.
E9.13.
Easy, 5-8 min.
Straight-forward application of the basic EPS equation.
E9.14.
Med., 7-10 min.
Group learning exercise. An easy way to get students to think
about the EPS effects of potentially dilutive securities.
E9.15.
Med.-Hard, 10-15
min.
Group learning exercise. Walk through the solution using
T-accounts to solve for the missing amounts.
E9.16.
quite challenging. Good homework assignment.
Med.-Hard
Group learning exercise. Students find this exercise to be
E9.17.
Easy, 3-5 min.
Straight-forward Campbell’s income statement exercise.
E9.18.
Med., 7-10 min.
Use this exercise as a discussion starter. Ask students, “What
kinds of information does the SCF communicate that cannot be
easily determined by looking at the BS and IS alone?”
P9.20.
Med., 7-10 min.
See P9.19.
P9.21.
Med.-Hard, 10-12
min.
Analytical problem. Emphasize the IS/BS sheet linkage between
sales, cost of goods sold, gross profit, and ending inventory.
P9.22.
Med., 7-10 min.
Excel problem. See P9.21. Good homework assignment.
P9.23.
Med., 5-8 min.
Straight-forward in-class demonstration of cash flows from
operations using the indirect method.
P9.24.
Med., 10-12 min.
Excel problem. See P9.23. Good in-class demonstration of the
Statement of Cash Flows—indirect method.
P9.25.
Med., 10-12 min.
Provided for instructors wishing to emphasize the direct method
presentation of the Statement of Cash Flows.
P9.26.
Med., 7-10 min.
See P9.25.
P9.27.
Med.-Hard, 12-15
min.
Excel problem. Excellent problem for self-study / review.
P9.28.
Med.-Hard, 12-15
min.
See P9.27. Good homework assignment.
P9.29.
Med.-Hard, 20-25
min.
Group learning problem. Be careful not to consume too much
P9.30.
Med.-Hard, 22-35
min.
Excel problem. See P9.29. Group learning problem.
C9.31.
Med., 10-12 min.
Focus company case assignment. Generates class discussion.
C9.32.
Med., 10-12 min.
See C9.31.
C9.33.
Hard, 25-35 min.
Group learning case. Great for MBA classes!
Chapter 9 The Income Statement and the Statement of Cash Flows
SOLUTIONS:
M9.2.
a.
Income tax expense …. ……….. ……….. ……….. ……….. ……….. ……….. ……….. (7,600)
Net income ….. ……….. ……….. ……….. ……….. ……….. ……….. ……….. ……….. $ 22,800
Net sales ……… ……….. ……….. ……….. ……….. ……….. ……….. ……….. ……….. $300,000
Cost of goods sold…… ……….. ……….. ……….. ……….. ……….. ……….. ……….. (165,000)
Gross profit …. ……….. ……….. ……….. ……….. ……….. ……….. ……….. ……….. $135,000
M9.1.
a.
Net sales …….. ……….. ……….. ……….. ……….. ……….. ……….. $450,000 100.0%
Cost of goods sold…… ……….. ……….. ……….. ……….. ……….. 297,000 66.0%.
Gross profit …. ……….. ……….. ……….. ……….. ……….. ……….. $153,000 34.0%
b.
Selling price … ……….. ……….. ……….. ……….. ……….. ……….. $75.00 100.0%
Cost to manufacture … ……….. ……….. ……….. ……….. ……….. ? 66.0%.
Gross profit …. ……….. ……….. ……….. ……….. ……….. ……….. $ ? 34.0%
M9.3.
Net income ….. ……….. ……….. ……….. ……….. ……….. ……….. ……….. ……….. $659,250
E9.5.
6/9/16 21 days 6/30/16 28 days 7/28/16
a.
For the year end June 30, 2016, recognize 21/49 of summer school tuition, because that
portion of the summer session occurs within the first fiscal year. Summer session
M9.4.
Cash flows from operating activities:
Net income ….. ……….. ……….. ……….. ……….. ……….. ……….. ……….. $ 89,400
E9.6.
a.
Season ticket price ….. ……….. ……….. ……….. ……….. ……….. ……….. ……….. $180
Price of first program event … ……….. ……….. ……….. ……….. ……….. ……….. (45)
E9.7.
Solution approach: Use the cost of goods sold model with assumed amounts that are the
same except for the item in error:
“Error” “Correct”
Beginning inventory .. ……….. ……….. ……….. ……….. ……….. $100,000 $100,000
E9.8.
a.
“Error” “Correct”
Beginning inventory .. ……….. ……….. ……….. ……….. ……….. $100,000 $100,000
Add: Purchases ………. ……….. ……….. ……….. ……….. ……….. 300,000 300,000
Goods available for sale ……… ……….. ……….. ……….. ……….. $400,000 $400,000
E9.9.
a.
(in millions)
E9.9.
(continued)
b.
Using the gross profit ratio for 2014 of 35.1%:
Net sales ($ millions) . ……….. ……….. ……….. ……….. ……….. ……….. $2,700
Cost of goods sold (64.9%) … ……….. ……….. ……….. ……….. ……….. (1,752)
E9.10.
a.
Sales (in millions) ….. ……….. ……….. ……….. ……….. ……….. ……….. $600.0 100.0%
Cost of goods sold…… ……….. ……….. ……….. ……….. ……….. ……….. ? ? .
Gross profit …. ……….. ……….. ……….. ……….. ……….. ……….. ……….. $ ? 31.2%
$600.0 million sales * (100% – 31.2%) or 68.8% cost of goods sold ratio = $412.8 million
b.
Selling price … ……….. ……….. ……….. ……….. ……….. ……….. ……….. $ ? 100.0%
Cost to manufacture … ……….. ……….. ……….. ……….. ……….. ……….. 1,634 ? .
Gross profit …. ……….. ……….. ……….. ……….. ……….. ……….. ……….. $ ? 31.2%