Accounting

What the Numbers Mean 11e

Demonstration Problem
Chapter 2 – Problem 20
Prepare an Income Statement, Balance Sheet,
and Statement of Changes in Stockholders’ Equity
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 Problem Definition
• The following information was obtained from the records of Shae, Inc.:

Merchandise $264,000
Notes Payable (long-term) 300,000
Sales 900,000
Buildings and equipment 504,000
Sales, general, and administrative expenses 72,000
Accounts receivable 120,000
Common stock (42,000 shares) 210,000
Income tax expense 84,000
Cash 192,000
Retained earnings, 1/1/16 129,000
Accrued liabilities 18,000
Cost of goods sold 540,000
Accumulated depreciation 216,000
Interest expense 48,000
Accounts payable 90,000
Dividends declared and paid during 2016 39,000

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 Problem Definition
a. Prepare an income statement and statement
of changes in stockholders’ equity for the year
ended December 31, 2016, and a balance
sheet at December 31, 2016, for Shae, Inc.
b. What is the company’s average income tax rate?
c. What interest rate is charged on long-term debt?
d. What is the par value per share of common
stock?
e. What is the company’s dividend policy?

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 Problem Solution
• Prepare an income statement for the year
ended December 31, 2016.
• Identify revenue and expense accounts:
Revenues: Sales
Expenses: Selling, general and
administrative expenses
Income tax expense
Cost of goods sold
Interest expense

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 Problem Solution
• Determine the order and presentation of the
revenue and expense accounts:

Include a
SHAE, INC. financial
Income Statement statement
For the Year Ended December 31, 2016 heading.

Gross Profit Sales $900,000

is the first Cost of goods sold (540,000)
subtotal
shown.
Gross profit $360,000

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 Problem Solution
SHAE, INC.
Income Statement
For the Year Ended December 31, 2016

Sales $900,000
Cost of goods sold (540,000)
Gross profit $360,000
Selling, general, and admin. exp. ( 72,000)
Income from operations $288,000

Income from operations (operating income) is a key measure of a

firm’s financial performance for a period of time.

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 Problem Solution
SHAE, INC.
Income Statement
For the Year Ended December 31, 2016

Sales $900,000
Cost of goods sold (540,000)
Gross profit $360,000
Selling, general, and admin. exp. ( 72,000)
Income from operations $288,000
Interest expense ( 48,000)
Income before taxes $240,000

Interest expense is a non-operating expense.

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 Problem Solution
SHAE, INC.
Income Statement
For the Year Ended December 31, 2016

Sales $900,000
Cost of goods sold (540,000)
Gross profit $360,000
Selling, general, and admin. exp. ( 72,000)
Income from operations $288,000
Interest expense ( 48,000)
Income before taxes $ 240,000
Income tax expense ( 84,000)
Net income $156,000
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 Problem Solution
• Prepare a Statement of Changes in Stockholders’ Equity
for the year ended December 31, 2016.
SHAE, INC. Include a
Statement of Changes in Stockholders’ Equity financial
For the Year Ended December 31, 2016 statement
Paid-in capital: heading.

Retained earnings:

Paid-in capital and retained earnings

are the two primary components of
stockholders’ equity.

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 Problem Solution
SHAE, INC.
Statement of Changes in Stockholders’ Equity
For the Year Ended December 31, 2016
Paid-in capital:
Common stock $210,000
Retained earnings:

Paid-in capital includes common

stock and additional funds paid-in,
or contributed, by stockholders.

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 Problem Solution
SHAE, INC.
Statement of Changes in Stockholders’ Equity
For the Year Ended December 31, 2016
Paid-in capital:
Common stock $210,000
Retained earnings:
Beginning balance $129,000
Net income for the year 156,000
Less: Dividends declared and paid during year (39,000)
Ending balance 246,000

Net income increases and dividends decrease retained earnings.

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 Problem Solution
SHAE, INC.
Statement of Changes in Stockholders’ Equity
For the Year Ended December 31, 2016
Paid-in capital:
Common stock $210,000
Retained earnings:
Beginning balance $129,000
Net income for the year 156,000
Less: Dividends declared and paid during year (39,000)
Ending balance 246,000
Total stockholders’ equity $456,000

Total stockholders’ equity is the sum of PIC and RE.

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 Problem Solution
• Prepare a balance sheet at December 31, 2016.
SHAE, INC.
Balance Sheet
December 31, 2016
Assets:

Liabilities:

Stockholders’ Equity:

The report format of the balance sheet shows

assets above liabilities and stockholders’ equity.
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 Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2016
Assets:
Cash $192,000
Accounts receivable 120,000
Merchandise inventory 264,000
Total current assets $576,000
Noncurrent assets
Total assets
Current assets are listed in order
Liabilities: of liquidity, or nearness to cash.
Stockholders’ Equity:
Total liabilities and stockholders’ equity

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 Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2016
Assets:
Cash $192,000
Accounts receivable 120,000
Merchandise inventory 264,000
Total current assets $576,000
Buildings and equipment 504,000
Less: Accumulated depreciation (216,000) 288,000
Total assets $864,000

Liabilities: Accumulated depreciation is a

Stockholders’ Equity: contra asset account.
Total liabilities and stockholders’ equity

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 Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2016
Assets:
Total assets $864,000

Liabilities:
Accounts payable $ 90,000
Accrued liabilities 18,000
Notes payable (long-term) 300,000
Total liabilities $408,000

Stockholders’ Equity: As with assets, liabilities are

Total liabilities and stockholders’ equity often classified as current and
noncurrent.
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 Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2016
Assets:
Total assets $864,000
Liabilities:
Total liabilities $408,000
Stockholders’ Equity:
Common stock $210,000
Retained earnings 246,000
Total stockholders’ equity 456,000
Total liabilities and stockholders’ equity

CS, RE, and Total SE are taken from the Statement of Changes in SE.

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 Problem Solution
SHAE, INC.
Balance Sheet
December 31, 2016
Assets:
Total assets $864,000
Liabilities:
Total liabilities $408,000
Stockholders’ Equity:
Total stockholders’ equity 456,000
Total liabilities and stockholders’ equity $864,000

Total assets = Total liabilities + Total stockholders’ equity

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 Problem Solution
SHAE, INC. Completed asset
Balance Sheet side of balance
December 31, 2016 sheet.
Assets:
Cash $192,000
Accounts receivable 120,000
Merchandise inventory 264,000
Total current assets $576,000
Buildings and equipment 504,000
Less: Accumulated depreciation (216,000) 288,000
Total assets $864,000

Liabilities:
Stockholders’ Equity:
Total liabilities and stockholders’ equity

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 Problem Solution
SHAE, INC. Completed liability
Balance Sheet and stockholders’
December 31, 2016 equity side.
Assets:
Total assets $864,000
Liabilities:
Accounts payable $ 90,000
Accrued liabilities 18,000
Notes payable (long-term) 300,000
Total liabilities $408,000
Stockholders’ equity:
Common stock $210,000
Retained earnings 246,000
Total stockholders’ equity 456,000
Total liabilities and stockholders’ equity $864,000
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 Problem Solution
a. Prepare an income statement and statement of
changes in stockholders’ equity for the year
ended December 31, 2016, and a balance sheet at
December 31, 2016.
b. What is the company’s average income tax
rate?
c. What interest rate is charged on long-term debt?
d. What is the par value per share of common
stock?
e. What is the company’s dividend policy?

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 Problem Solution
The company’s average income tax rate
would be computed by dividing income tax
expense by earnings before taxes:

$84,000 / $240,000 = 35% average tax rate

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 Problem Solution
a. Prepare an income statement and statement of
changes in stockholders’ equity for the year
ended December 31, 2016, and a balance sheet
at December 31, 2016.
b. What is the company’s average income tax rate?
c. What interest rate is charged on long-term
debt?
d. What is the par value per share of common
stock?
e. What is the company’s dividend policy?

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 Problem Solution
The interest rate charged on long-term debt
is a function of interest expense divided by
long-term debt:

$48,000 / $300,000 = 16% interest rate

This assumes that the year-end balance of long-term debt

is representative of the average long-term debt account
balance throughout the year.

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 Problem Solution
a. Prepare an income statement and statement of
changes in stockholders’ equity for the year
ended December 31, 2016, and a balance sheet
at December 31, 2016.
b. What is the company’s average income tax rate?
c. What interest rate is charged on long-term debt?
d. What is the par value per share of common
stock?
e. What is the company’s dividend policy?

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 Problem Solution
The par value per share of common stock
can be determined simply by dividing the
dollar amount for common stock by the
number of common shares outstanding:

$210,000 / 42,000 shares = $5 par value per share

Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 Problem Solution
a. Prepare an income statement and statement of
changes in stockholders’ equity for the year
ended December 31, 2016, and a balance sheet
at December 31, 2016.
b. What is the company’s average income tax rate?
c. What interest rate is charged on long-term debt?
d. What is the par value per share of common
stock?
e. What is the company’s dividend policy?

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 Problem Solution
Shae, Inc. appears to have a policy of
paying a fixed percentage of net income as
a dividend to shareholders, computed as the
dividends declared and paid divided by net
income:

$39,000 / $156,000 = 25% dividend payout policy

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 Accounting
What the Numbers Mean 11e

You should now have a better understanding

of how to prepare financial statements.

Remember that there is a demonstration problem for

each chapter that is here for your learning benefit.

David H. Marshall
Wayne W. McManus
Daniel F. Viele
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