Financial Statement

Fin Stmts 2
Overview
In this lesson, we will introduce the primary components of the

income statement, including: revenue, cost of goods sold, other
income and expenses, and net income. The lesson then focuses on
revenue and cost of goods sold. We will define “revenue” and explain
how revenue arises, then introduce the concept of “cost flow
assumptions” and how companies can make judgments that affect
cost of goods sold.
Suggested Readings
 Introduction to Income Statement. Accounting Coach. Income

Statement (Explanation).
 What is the inventory cost flow assumption? Accounting Tools.
Company Information
This module discusses financial statements from the following

companies:
 Under Armour
Goals and Objectives
Upon successful completion of this module, you will be able to:
 Understand what measurement question the income statement

seeks to answer.
 Identify the common components of an income statement.
 Explain what revenue represents and how it arises.
 Describe what cost of goods sold represents.
 Define the concept of “cost flow assumptions."
Key Phrases/Concepts
Keep your eyes open for the following key terms or phrases as you
interact with the lectures and complete the activities.
 Income statement
 Revenue
 Cost of goods sold
 Goods
 FIFO cost assumption
 LIFO cost assumption
 Average cost assumption
Guiding Questions
Develop your answers to the following guiding questions while

watching lectures and working on assignments throughout the lesson.
 What measurement question does the income statement

address?
 How does the income statement differ from the balance sheet?
 What is revenue and how is it generated?
 How can a company influence the amount of cost of goods sold
it reports in its income statement?
Module 1 Readings
Suggested Readings
 Introduction to Income Statement. Accounting Coach. Income

Statement (Explanation).
 What is the inventory cost flow assumption? Accounting Tools.
Company Information
This module discusses financial statements from the following

companies:
 Under Armour
Feel free to find other readings or resources and share them in the
forums.
As we begin this second course on understanding financial

statements,
I hope most of you completed the first course.
Just in case, let's highlight a few ideas before we get started.
In the first course you were introduced to the idea that financial
statements are representations or substitute attributes meant to
measure attributes of the company.
We saw that the balance sheet as a substitute attribute to the
company's position, helped answer two measurement questions,
what does the company own and what does the company owe.
However, there's a third measurement question that the balance
sheet does not
address, and that's where we'll begin our conversation about the
income statement.
Play video starting at 1 minute 4 seconds and follow transcript1:04
When we spoke about the balance sheet, we illustrated the balance
sheet as
a photograph taken of the company on some particular date.
Let's say that the date of the photograph is the first day of the year,
January 1st.
Now, let's imagine we took the second photograph of the same
company, but
we take the photo on December 31st.
If we compare the two photographs taken a year apart,
it probably won't look the same.
In other words,
the company's position on December 31st will have changed since
January 1st.
What's the difference in the company's position and what caused this
difference?
Well, that's what the income statement captures.
It depicts what occurred during the period that changed the
company's financial
position from the beginning of the period to its position at the end of
the period.
The income statement answers the measurement question,
how did the company perform, because it shows how the company's
activities during
the period impacted its assets and liabilities.
Let's take a look at the simple income statement from the apparel
manufacturer,
Under Armour to see how it's organized.
Play video starting at 2 minutes 11 seconds and follow transcript2:11
The first line item you see is an item called revenue, or net sales.
Then you see something called cost of goods sold, or cost of sales.
Notice that the cost of goods sold is subtracted from revenue to arrive
at
gross profit.
Then, you run into an item that is selling general and administrative
expenses.
Under Armour uses this line item to aggregate several types of
expenses
that are subtracted from gross profit to yield net income before
income taxes.
We then subtract the line item for income taxes to arrive at net
income.
With some new information to process, it's time to see what we've
learned so far.
Here are a few check questions.
With a broad overview of the income statement complete,
let's take a closer look at the first line item, revenue.
And to do that, let's take a road trip.
Here we are at my favorite bakery in Champaign, Sweet Indulgence.
I love walking into the bakery and seeing all the fantastic treats that
the owner,
Missy, has prepared that day.
Of course, the point of the bakery is not to give people like me
something to look at.
No way.
She wants someone to buy something.
And, today, I am going to oblige.
Ladies and gentlemen, Missy has just earned revenue.
Why?
Because revenue is an increase in Missy's asset or a decrease in
her
liabilities brought about by activities that are center to her normal
operations.
Let's break this down.
Missy's business is to provide food and drink to customers.
I took delivery of the most delicious cookie sandwich,
Missy received cash from me, which increases her assets.
Yep, that's revenue.
Let's see what else I might try to buy.
Yeah, the monster mixer that I told my wife about.
Boy, I'd be a hero if I brought home that baby.
I wonder if Missy would sell it to me.
Much for showing us the back room, all the things that you have, but
by the way, how much would you charge me for the monster mixer?
>> [LAUGH] Well if you could get it out of here, I don't know.
Probably about 13,000, or 14,000, and that's a used one, so.
>> Okay, I don't know.
Okay, truthfully.
I can't afford that mixer and if I bring it home to my wife,
I wouldn't be much of a hero if she found out how much it costs.
But let's pretend I did, and somehow I got the mixer in my car and
drove it home.
Would Missy have revenue?
Let's have a look.
Missy received cash from me, which increases her assets, check.
I took delivery of the monster mixer, check.
But wait a minute.
Is Missy in business to sell monster mixers?
Of course not.
This last example suggests an important idea.
A transaction that represents revenue for one company, may not
represent revenue for
a different company.
If Jed at Body and
Sole sells me a cupcake, then that wouldn't be revenue for Jed.
Or if rather than going to Regent Dance for dance lessons, I pay one
of Missy's employees for lessons, Sweet Indulgence would not
increase its revenue.
So, why is it so important to distinguish between
what transaction represents revenue versus not being revenue?
If the company's assets are increasing, who cares if it's revenue?
Well, let's think about this.
Let's say you are considering whether or not to lend $100,000 to Jed
at Body and
Sole or one of Jed's competitors, we'll call him Fred.
Remember Jed's business is to sell athletic shoes and
clothing and Fred has a similar business.
So, what is your concern if you're a lender.
Your concern is whether your loan will be repaid and
you'd like to see evidence that your debtor can pay you back.
Now, consider that both Jed and
Fred have income statements that show each earned net income of
$50,000.
There's a difference however, Jed's net income is driven mostly by
the revenue
associated by his selling shoes and clothing, but Fred's net income is
driven
mostly by his selling an old treadmill he kept in the store and
several display cases that remained empty during the last year.
So who would you lend money to Jed or Fred?
If it's me making the loan decision, I'm making the loan to Jed.
Jed's net income is driven by revenue.
He's earning income by doing what he's in business to do.
As a result, I expect Jed's net income to look similar next year and
the year after that, and maybe even the year after that,
because his net income is associated with his normal business.
Fred, on the other hand, I'm not so
sure what his net income will look like next year.
After all, Fred's net income came from selling off equipment,
not from his normal business.
So, if I want to lend money with the best hope of being repaid,
I have to go with Jed because Jed's net income, being driven by
revenue,
suggests his net income performance will persist in the future.
Well, this ends our lesson on revenue.
Next time we meet, we'll spend some time at Jed's store
as we discuss revenue's unpleasant little brother.
Until then, be well.
In our last lesson, we completed our overview
of the income statement.
Remember, the income statement helps us
answer the third measurement question, how did you perform? And as
such, it represents a substitute
attribute for the company's performance. Last time, we focused on the
income
statement line item revenue. In this lesson, our focus will be on
the line that typically follows revenue, cost of goods sold. The concept of
cost of goods
sold isn't complicated. We can start by asking the question,
what are goods? Goods are assets either manufactured or purchased
with the intent
to be sold to customers. Let's visit the athletic apparel store,
Body n' Sole, in search for the goods. Here we are at Body n' Sole, you
may
remember Jed's store from an earlier lesson, and
we are going to take another look around. Out on the floor of the store,
we see the apparel, and as we move to the back of
the store we see shelves of shoes, all of which Jed has purchased with
the intent to sell them to customers. Well ladies and gentlemen,
these are goods. I know what you're thinking. Isn't this just the
inventory
we saw in an earlier lesson? Of course it is. So, when we think about
cost of goods sold, you can also think about it
as cost of inventory sold. Let's go back to the studio and
dig a little deeper. We see now that there's a relationship
between cost of goods sold and inventory. We can formalize this a bit by
introducing the term, total cost of goods available for sale, where
Jed's total cost of goods available for sale represents the cost of
inventory that
Jed held at the beginning of the period. We'll say the period began
January 1st,
plus the cost of all the inventory Jed purchased and received during
the period, which ended December 31st. The maximum amount of
inventory
Jed can sell during the year is the inventory he started with,
and the inventory he added. Now, at the end of the year,
the cost of total goods available for sale is divided between two buckets.
The cost of inventory that
was sold during the year goes into the cost of goods sold bucket,
while the cost of inventory that wasn't sold remains on the balance
sheet as the cost of inventory. Okay, it's time to see
what we've learned so far. Try these two questions and
see how you do. With a conceptual understanding of cost
of goods sold reported on the income statement, we're ready to
introduce
a little more complexity to the issue. Consider this scenario, Jed receives
several shipments of a popular model of athletic shoes throughout the
year that
he stores on shelves in the back room. Each time he receives a shipment
of shoes
his cost to purchase the shoes increases. The first shipment cost $50 for
each pair of shoes. The shipment costs $60 per pair of shoes, the third
shipment costs $65 for
each pair of shoes and so on. Because all of the shoes look alike,
when Jed sells a pair of shoes, he doesn't know if that pair came from
the
first shipment, or the second shipment, or the third shipment. So, if Jed
has 200 pairs of
the popular shoe available for sale during the year and
he actually sells 150 pairs of the shoes, what cost should he associate
with the shoes that were sold? $50, $60, or $65? [MUSIC] This question
introduces the idea
of cost flow assumptions. The three cost flow assumptions
are first in first out, or FIFO, last in first out, or
LIFO, or average cost. If Jed adopts the first in, first out
assumption, he's assuming that the shoes he purchased for $50 were the
first
shoes he sold to customers. If Jed adopts the last in,
first out assumption, he assumes the $65 shoes were
the first shoes he sold to customers. While using the average cost
assumption, Jed calculates the weighted average cost
for the pairs of shoes available for sale during the year, and assigns that
cost to each pair of shoes actually sold. With respect to cost flow
assumptions,
there are two things you should remember. First, the cost flow
assumption chosen can affect the cost of goods sold
reported on the income statement. For example, if Jed adopts FIFO, his
reported cost of good flow would
be lower than if he adopts LIFO. Second, the cost flow assumption
that a company adopts need not match the physical flow of goods. Jed
could very well sell
the shoes he sees first, but adopt the cost flow assumption
other than first in, first out. Well, we've now tackled the first two
line items on the income statement, revenue and costs of goods sold.
What's unique about these two line
items is that they're used to calculate an important summary amount.
By subtracting the company's cost
of goods sold from it's revenue, we see the summary amount of gross
profit.
Gross profit is an important indicator
of a company's performance and future prospects. If gross profit is large
it might suggest
that the company is less at risk to small changes in the price of
manufacturing or
purchasing their inventory. Before closing out this lesson,
I'll point out one final thing. The line item cost of goods sold is
common in income statements, but you may see a slightly different
name like cost of sales. Don't let that confuse you. Often the different
label is related
to the company being a service provider rather than a provider of
goods. If a company sells dance lessons
rather than athletic shoes then there's little in
the way of inventory, so cost of goods sold would be a less
accurate characterization of a line item. Okay, we're not yet
done with the income statement. As we move to the next module, we'll
continue answering our measurement
question about how the company performed, but we'll add a new twist
to the conversation. Until then friends, be well.

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Fin Stmts 2

In this lesson, we will introduce the primary components of the

 Introduction to Income Statement. Accounting Coach. Income

This module discusses financial statements from the following

Goals and Objectives

Upon successful completion of this module, you will be able to:

 Understand what measurement question the income statement

Develop your answers to the following guiding questions while

 What measurement question does the income statement

 Introduction to Income Statement. Accounting Coach. Income

This module discusses financial statements from the following

As we begin this second course on understanding financial

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