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Lesson 10 (printer-friendly version)

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Chapter 1

Introduction

You're getting very close to the culmination of the accounting process. In just this lesson and two more, you'll have all
the knowledge of beginning bookkeepers. You should be very proud of your accomplishments in this course.

In Lesson 9, you learned how to prepare a worksheet for Children's Capers, showing its net income. This document is
the basis for the year-end reports you will be completing in this lesson.

In this lesson, you'll learn how to prepare four financial, end-of-the-year reports for Children's Capers. The first report is
an Income Statement, the second is a Distribution of Net Income, the third is an Owners' Equity Statement, and the
fourth and last is a Balance Sheet.

All of the information for the last three lessons of Accounting Fundamentals will be taken from the worksheet you
prepared in Lesson 9. This year-end work is, for the most part, simply a matter of copying figures from the worksheet
onto the various financial reports and the General Ledger accounts. While these reports are fairly easy to complete, I'm
going to give you an example of each of them in this lesson before you have to complete the report for Children's
Capers. That way, you'll have a model to follow as you prepare the various reports.

These reports are vital to the owners of Children's Capers and their financial advisor, their bank, and/or accountant. If
Children's Capers' financial reports are favorable for the year, Joan and Stacy, the owners, can purchase fixed assets
like their own building for the business, or expand their advertising territory. The owners can also withdraw more money
from the business for their personal use once they feel confident that Children's Capers is in good financial standing.

On the other hand, if Children's Capers' year-end financial records show that the
business only made a slight profit, the owners may wish to increase the prices on
their merchandise or try to reduce expenses in order to increase the net profit
during the next fiscal period.

Regardless of the reasons, every business needs to have its financial condition
evaluated at least once a year to regulate the activities mentioned in the
paragraphs above.

Now, let's get busy!

Chapter 2

Income Statement

An Income Statement is a report that shows the progress from the beginning of the year until the end of the year. This
report shows income, cost of merchandise sold, expenses, and net income or net loss. Once again, all of the figures
necessary to complete an Income Statement are taken from the worksheet for Children's Capers.

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Below is an example of an Income Statement for you to look at as I explain how to prepare one for Children's Capers.

Income Statement

First, as always, enter Children's Capers on the first line of the heading for the Income Statement. On the second line,
enter the words Income Statement, and on the third line enter For the Year Ended December 31, 200-.

Now, on the first line of the actual report, put the word Revenue. Below that, write Sales. Find the total amount of sales
by looking at the balance in the Sales account on the worksheet. Enter that amount in the second dollar-amount column
of the Income Statement form. Write 100% in the column labeled % of Sales. This shows that this amount is the total
amount of sales for the year.

Next, on the following line put the words Cost of Merchandise Sold. You're now going to figure out how much the total
merchandise sold for the year actually cost Children's Capers. This will be the wholesale amount Children's Capers paid
for merchandise that was purchased by their consumers during the year. This figure goes in the first column designated
for dollar amounts.

On the next line, enter Merchandise Inventory, January 1, 200-. Find the merchandise inventory value on January 1 in
column 1 of the worksheet. On the next line, enter Purchases and enter the amount of the Purchases account from
column 1 of the worksheet. Next, enter Total Cost of Merchandise Available for Sale and add those two numbers
together. This gives you the wholesale dollar amount of the total amount of merchandise available for consumers to
buy.

But not all of this merchandise was sold. On the next line, enter Less Merchandise Inventory, December 31, 200-. Find
this amount in the Merchandise Inventory account in column 7 of the worksheet. Then subtract this figure from the total
cost of merchandise available for sale, and you have the actual wholesale amount of the merchandise Children's
Capers sold in the 12-month period. Enter Cost of Merchandise Sold on the next line and put the number you found by
subtracting the ending merchandise inventory from the total merchandise available in the second column.

Now, subtract the Cost of Merchandise Sold from the Sales figure above. This gives you the Gross Profit on Sales for
Children's Capers for the year. This figure is simply the difference between the wholesale amount or the price Children's
Capers paid for the merchandise and the retail amount or the amount for which Children's Capers sold the

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merchandise.

Next, on the following line, enter the word Expenses. From column 5 of the worksheet, list all the expenses and their
balances. These balances go in the first column designated for numbers. When you've listed all the expenses, put Total
Expenses on the next line and total up the expenses. This total goes in the second column for figures.

Then, go ahead and subtract the Total Expenses from the Gross Profit on Sales. This
gives you the net income for the year. This figure should be the same number that is
showing for the net income on the worksheet. Amazing, huh?

You only have one more step to complete this report. You need to find the component
percentages for each component of the report. Businesses have minimum standards for
component percentages. These minimums are what a typical business would like to see to
be certain their business is thriving and headed in the right direction. These minimum
component percentages are:

z Cost of Merchandise Sold: Not more than 50.0%.

z Gross Profit on Sale: Not less than 50.0%.

z Total Expenses: Not more than 32.0%.

z Net Income: Not less than 18.0%.

To arrive at the component percentages, you would divide each of the components by the Sales number. For example,
to find the Cost of Merchandise Sold component percentage, divide the Cost of Merchandise figure by the Sales figure.
In this example, J & J Auto Repair's sales for the year were $172,000.00. The Cost of Merchandise Sold was
$90,170.00. To arrive at the component percentage, divide $90,170.00 by $172,000.00. Change the decimal number
arrived at into a percent by moving the decimal point two places to the right. Then, round the percent to one place after
the decimal point. On the calculator, $90,170.00 divided by $172,000.00 is .5242. Change this to a percent, which
would be 52.42%. Then, round it to one place after the decimal point, which would give you 52.4%.

To find the Gross Profit on Sales figure, divide that number by the Sales number. To determine the Expenses
component percentage, divide the Total Expenses number by the Sales figure. And, to find the Net Income Component
Percentage, divide the Net Income by the Sales number.

You need to round each of these percentages to one place following the decimal point. For example, a component
percentage of 32.67% would be 32.7%. A component percentage of 45.32% would be 45.3%.

Sometimes when dividing one category into two separate categories using percents rounded to one tenth of a percent, it
is necessary to add one tenth of a percent to make the two add back up to the total. So it is in the case of the percent
for the net income. The calculation comes out to 19.8%, but you need to make it 19.9% so that this percent and the
Total Expenses percent add back up to the Gross Profit on Sales percent. When you determine the percent of the Net
Income, you will have to add one tenth of a percent, which will make it 19.9% rather than the 19.8% your calculator will
show.

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To check your work, the Cost of Merchandise Sold percentage and the Gross Profit percentage should add up to 100%.
The Total Expenses component percentage and the Net Income percentage should add up to the Gross Profit on Sales
number.

Once you've completed the Income Statement, put two double lines under both columns to show that all the numbers
are correct and in agreement with the worksheet.

Chapter 3

Distribution of Net Income and Owners' Equity Statement

In this chapter, you'll be preparing two financial reports, a Distribution of Net Income and an Owners' Equity Statement.
Once again, below are models of these two financial reports.

The Distribution of Net Income Statement will be the first report you make out. This is a financial statement showing how
the net income or net loss is distributed to the partners.

Distribution of Net Income

Once again, fill in the three-line heading. Children's Capers goes on the first line, Distribution of Net Income Statement
on line 2 and For the Year Ended December 31, 200- on the third line.

Children's Capers has two partners, Joan Caldwell and Stacy Hall. These two partners have agreed to share net
income or net loss equally. This means that Joan will receive 50% of the net income and Stacy will receive 50%.
Partners may decide to share net income and net loss any way they desire. Partners don't have to be equal or 50/50
partners, but Joan and Stacy are.

On the first line of the report, enter Joan Caldwell. On the line below her name, put 50.0% of Net Income and enter the
dollar amount in the column to the right. To find Joan's dollar amount of the net income, simply multiply the net income
found on the worksheet by 50%.

On the next line, write Stacy Hall, and on the line under her name, write 50.0% of Net Income. In the dollar column,
enter her share of the net income, which would be the same as Joan's share since they share the net income equally.

Next, on the following line, write Net Income and total the two partners' dollar amounts. This figure should equal the net
income showing on the worksheet. If it does, double rule the total. That's all there is to that report!

Completing the Owners' Equity Statement

You'll now complete the Owners' Equity Statement. This report updates the owners' equity in the business. Remember
that the owners' equity is in an account titled Capital. The two things that change the owners' equity are their share of
the net income and their drawing. The net income will increase the balances in the owners' capital accounts and the
drawing account balances will decrease the owners' capital accounts. These two figures change the capital accounts of
the owners at the end of the year. Obviously, the owners want their capital account balances to increase. That shows
that the business is thriving and making them money.

So, let's go ahead and complete this financial report for the partners of Children's Capers.

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Use the following sample of an Owners' Equity Statement as a model as you complete Children's Capers Owners'
Equity Statement.

Owners' Equity Statement

Fill in the three-line heading, only this time the second line will be Owners' Equity Statement.

The first partner in Children's Capers is Joan Caldwell. Enter her name on the first line. On the line under her name,
indent a little and write Capital, January 1, 200-. This figure is shown in column 2 of the worksheet, Trial Balance Credit.
Enter this figure in the second dollar-amount column of the form.

On the next line, put Share of Net Income. Since Joan and Stacy are equal partners in Children's Capers, each will
receive one half of the net income, which is $713.50. Enter this amount in the first dollar-amount column.

Next, on the following line, write Less Withdrawals. This is the account balance in Joan's drawing account. You'll get this
number from column 1 of the worksheet in the account Joan Caldwell, Drawing. Enter this amount in the first dollar-
amount column.

Now, because the drawing is greater than Joan's share of the net income, you will put Net Decrease in Capital on the
next line. Subtract the net income figure from the drawing balance. This amount is a decrease in capital. Enter the net
decrease figure in the middle or second dollar-amount column.

The capital account will be smaller because Joan withdrew more money during the year than Children's Capers made
for her. Obviously, the goal of any business is to make more money than its owners withdraw, but the opposite happens
at times.

So, subtract the Net Decrease in Capital from the January 1 capital balance. This gives you the capital balance on
December 31, 200-. This new capital balance goes in the third dollar-amount column. Write Capital, December 31, 200-,
on the line next to this figure. The December 31 capital account balance will be smaller than the January 1 capital
account balance. This is so because Joan withdrew more from Children's Capers throughout the year than her share of
the net income. This will make her capital account balance less at the end of the year than it was at the beginning of the
year.

Stacy will have a net increase in her capital account balance, as she withdrew less than her share of the net income.

Now you need to go through the same process for Stacy Hall, the other partner in Children's Capers. Remember to take
the January 1 capital balance and Stacy's drawing account balance from columns 1 and 2 of the worksheet. They are
not necessarily the same figures as Joan's.

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When owners' capital account balances decrease from one year to the next, they may wish to make some changes for
the coming year. They could decrease the amount of money they withdraw from the business. They might mark up their
merchandise a little more to increase their net income. They also could cut down on their expenses, which would make
the net income larger. These are all options that owners of a business have when looking over the financial reports.

Chapter 4

Balance Sheet

The fourth financial report in this lesson is a Balance Sheet. The Balance Sheet shows the financial condition of a
business on a specific date. It is used to make financial decisions for the ensuing fiscal period. An example Balance
Sheet is shown below:

Balance Sheet

Using the Balance Sheet form you printed at the beginning of this lesson, please fill in the three-line heading. Enter
Children's Capers on the first line, Balance Sheet on the second, and December 31, 200- on the third line.

On the first line following the heading, enter Assets, centered on the line. On the next and continuing lines, list each and
every asset account and its balance from column 7 of the worksheet. Enter these dollar amounts in the first column of
the report form. Notice that this section of the worksheet is the Balance Sheet section; thus, you are preparing a
Balance Sheet. Makes sense, huh?

On the line after the last asset account name and balance, enter Total Assets and add the asset account balances. This
total goes in the second column.

Next, center the word Liabilities on the next line. After that line, enter each liability account name and its balance from
column 8 of the worksheet. These figures are entered in the first column designated for numbers. On the following blank
line, put Total Liabilities and enter the total of all the liability account balances in the second column.

Now, center Owners' Equity on the next line. Enter Joan Caldwell, Capital on the following line. You can't use the capital
account balance that is showing in column 8 of the worksheet. This is the January 1 capital balance. The balance in the

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owners' capital account has changed from January 1 to December 31. You need to use the updated capital account
balances. These are found on the Owners' Equity Statement that you completed earlier in this lesson.

When you've entered both partners' new capital balances, add the two amounts together and enter Total Owners'
Equity on the next line. Write the total in the second column.

Now, you must check your work to make sure everything is in balance. The total assets must equal the sum of the total
liabilities plus the sum of the total owners' equity. If these two totals agree, double rule both columns below the last used
line. This double ruling shows that the report is in agreement.

Chapter 5

Conclusion

Once again, I want to congratulate you on your accomplishments in this lesson. You've learned how to prepare four
very important financial reports at the end of an accounting cycle. These reports are the basis for some extremely
important financial decisions that Children's Capers and all businesses have to make.

With only two lessons to go, you're very close to the finishing touches of Children's Capers' accounting cycle. Please
take a few minutes to reflect on the new knowledge and skills you've acquired so far in this course and give yourself a
pat on the back. You deserve it.

As usual, when you feel you are ready and are comfortable with the concepts presented in this lesson, I'd like you to
take a quick, multiple-choice quiz. Good luck!

Supplementary Material

Lesson 10 Forms
/crs/pix/fun/L10-Forms.pdf
Here are the four new forms you will need for this lesson.

Lesson 10 Solutions
/crs/pix/fun/L10-Solutions.pdf
All finished? Click here to check your work against this lesson's
solution forms. You can either print them or check the amounts
online. Unfortunately, some of the wider forms can only appear
sideways, so printing may be your better option. If you don't mind
tilting your head, you'll be able to see what you need to see on the
screen while saving some printer ink and paper!

Note: Only those forms and accounts with new entries in them will
appear in each lesson's solutions. If you're curious about a
transaction in a previous lesson, you'll have to go back to that
lesson's Solutions link.

FAQs

Q: Why are financial reports necessary at the close of the fiscal period?

A: Financial reports are necessary at the close of the fiscal period to show how the business
progressed during the year. These reports are used to project business profits and the future
success of the business.

Q: If a business shows a net loss for the year rather than a net income, what can be done to
correct the situation?

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A: If a business shows a net loss for the year, the owner(s) might consider: 1) looking at
expenses to determine where they could be cut and 2) increasing the markup of
merchandise they sell.

Q: Why is it important that the owner's capital account balance increase from the beginning
of the year to the end?

A: The owner's capital account balance should increase because this shows that the
business is making the owner money and also his equity in the business is increasing.

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