Financial Statements

Once the adjusted trial balance is prepared, the financial statements can be prepared using such data. The Guitar Lessons Corporation's December income statement, statement of retained earnings, and balance sheet are shown below, prepared from the company's December 31 adjusted trial balance.

Financial Statements: Income Statement

Guitar Lessons Corporation
Income Statement
For the Month Ended December 31

Revenues

 

 

     Fees Revenue

$3,375

 

     Interest Revenue

20

 

Total Revenues

 

$3,395

Operating Expenses

 

 

     Supplies Expense

$400

 

     Wages Expense

1,400

 

     Insurance Expense

250

 

Total Operating Expenses

 

$2,050

Income Before Taxes

 

$1,345

Income Taxes Expense

 

425

Net Income

 

$920

 

Question: What did management do with the company's resources?

The income statement shows the company's management used the company's resources in December to generate additional resources of $920 (net income). Management brought in resources of $3,395 (revenues) and used up resources of $2,475 (operating expenses and income taxes expense).

The $920 net income calculated from the adjusted trial balance is different from the $2,300 net income calculated at the beginning of this chapter from the unadjusted trial balance. The $920 net income is more reasonable than the $2,300 because the $2,300 net income did not take into consideration all the company's December revenues and expenses. Specifically, the $2,300 net income did not include interest revenue, supplies expense, additional wages expense, insurance expense, or income taxes expense. Without the adjusting process, the Guitar Lessons Corporation's December income statement data would have been unreasonable. It would have been unwise for managers and others to base their decisions on unreasonable income statement data.

You should also notice the income statement format shown above. Note how revenues are reported separately from expenses. Notice also how operating expenses are reported separately from income taxes expense. Income taxes expense is reported as a separate line item primarily because income taxes are often quite large dollar amounts that are regulated by law and, thus, not controlled by management.

Financial Statements: Statement of Retained Earnings

Guitar Lessons Corporation
Statement of Retained Earnings
For the Month Ended December 31

Balance, December 1

$4,250

Plus: Net Income for December

920

Subtotal

$5,170

Less: Dividends in December

150

Balance, December 31

$5,020

 

Question : What did the company do with the resources generated by management?

The statement of retained earnings shows that of the $920 additional resources generated by management in December (net income), the company distributed $150 to the owner (dividends). By the end of December, the company retained in the business $5,020 of resources generated by management (retained earnings balance on December 31).

The $5,020 December 31 retained earnings balance calculated from the adjusted trial balance is different from the $6,400 retained earnings balance calculated at the beginning of this chapter from the unadjusted trial balance. The $5,020 retained earnings balance is more reasonable than the $6,400 because the $6,400 did not take into consideration all the company's December revenues and expenses. Remember, the unadjusted trial balance did not include interest revenue, supplies expense, additional wages expense, insurance expense, or income taxes expense. Without the adjusting process, the Guitar Lessons Corporation's December statement of retained earnings data would have been unreasonable. It would have been unwise for managers and others to base their decisions on unreasonable statement of retained earnings data.

Financial Statements: Balance Sheet

Guitar Lessons Corporation
Balance Sheet
December 31

Assets

 

     Cash

$9,750

     Notes Receivable

3,000

     Accounts Receivable

1,200

     Interest Receivable

20

     Supplies

200

     Prepaid Insurance

750

Total Assets

$14,920

Liabilities

 

     Accounts Payable

$1,350

     Unearned Fees Revenue

625

     Wages Payable

500

     Income Taxes Payable

425

Total Liabilities

$2,900

Stockholders' Equity

 

     Common Stock

$7,000

     Retained Earnings

5,020

Total Stockholders' Equity

$12,020

Total Liabilities and Stockholders' Equity

$14,920

 

Question: What are the company's resources?

The balance sheet shows that on December 31 the company has assets (resources) of $14,920. The assets consist of cash, notes receivable, accounts receivable, interest receivable, supplies, and prepaid insurance.

Question: Where did the company get its resources?

The balance sheet shows the company obtained $2,900 of assets through borrowing (liabilities). Resources of $7,000 were obtained from the owner (common stock) and $5,020 of resources were generated by management and kept in the business (retained earnings).

The December 31 balance sheet balances calculated from the adjusted trial balance are different from those calculated at the beginning of this chapter from the unadjusted trial balance. For example, based on adjusted balances the company reported total assets of $14,920, while based on unadjusted balances the company reported total assets of $15,550. Without the adjusting process, the Guitar Lessons Corporation's December balance sheet data would have been unreasonable. It would have been unwise for managers and others to base their decisions on unreasonable balance sheet data.


Practice Exercise

The following information was taken from the American Express Company's December 31, 2006 accounting records (all dollar amounts are in millions): assets = $127,853, liabilities = $117,342, common stock = $9,878, retained earnings, 12/31/05 = -$2,382, dividends = $692, revenues = $27,136, and expenses = $23,429.

1. Determine the dollar amount of the American Express Company's total resources on December 31, 2006.

 

Resources are called assets. The American Express Company's total assets on December 31, 2006 were $127,853 million.

 

2. Determine the dollar amount of the American Express Company's December 31, 2006 total resources that had been borrowed.

 

Sources of borrowed resources are called liabilities. The American Express Company's total liabilities were $117,342 million on December 31, 2006.

 

3. Determine the dollar amount of the American Express Company's December 31, 2006 total resources that had been invested by owners.

 

Sources of owner-invested resources are called common stock. The American Express Company's common stock was $9,878 million on December 31, 2006.

 

4. Determine the net dollar amount of the American Express Company's December 31, 2006 resources that had been generated by management in 2006.

 

Sources of management-generated resources during a specific time period are called net income. Net income is calculated by subtracting expenses from revenues. The American Express Company's net income for 2006 was $3,707 million ($27,136 revenues - $23,429 expenses).

 

5. Determine the dollar amount of the American Express Company's December 31, 2006 resources generated by management in 2006 and kept in the company at the end of 2006.

 

Sources of resources generated by management are called net income. Net income can be kept in the company or distributed to owners through dividends. American Express Company's 2006 net income was $3,707 million and it paid dividends of $692 million to owners. Thus, of the $3,707 million of resources generated by management in 2006, $3,015 million ($3,707 - $692) were kept in the company at the end of 2006.


** You now have the background to do text exercise 4.11 and text problems 4.1 and 4.2.

 

 

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