Accrual Basis Income Statement

A. Revenues are recognized when the goods or service is provided to the customer, which means the earnings process is complete and the company does not owe anything else to the customer. When the customer orders or pays does not affect when revenue is recognized. Revenues are recognized when earned.

C. The only difference is in the format. The company will report the same items and the same amounts. Reporting the same items and the same amounts will result in the same total revenues, operating income and net income. A single-step income statement is used by service companies that may also provide goods to customers. A multi-step income statement reports the gross profit from selling goods to customers.

B. A customer that doesn’t pay is a common part of day to day business. It is very rare that all customers pay 100% and this is just a cost of doing business called bad debt expense. Expenses that are incurred that are part of day to day business are operating expenses. A company has discontinued operations only when they are no longer going to be in that particular business. Gross profit occurs from providing goods only.

C. The matching principle states that revenues must be recorded when earned and all expenses incurred to generate the revenue must be reported in the same period as the revenue. When cash is paid or received does not matter to the income statement. All other choices match the expense in the same period as the revenue.

Cost of Goods Sold = 234,000 + 22,000 depreciation on manufacturing equipment
which is a cost to make the product.

Administrative Expense = 144,000 + rent expense 12,000

Selling Expenses = 102,000 -17,000 moved to discontinued loss – 22,000 depreciation
moved to cost of goods sold

Other expenses was all moved to other categories: 71,352 tax expense, 2,800 loss,
12,000 rent expense

a. State any differences in the format of the two income statements.

Amazon is a single-step income statement. The company considers itself to be a service company. The service is shipping the goods to customers.

Ebay is a multi-step income statement. The company considers itself to be a seller of goods

The detail provided for operating expenses is about the same level of detail, with different categories of operating expenses. Each company groups the expenses in a way they believe best describes their business.

Amazon provides some detail of “other revenues and expenses” (interest) and Ebay does not provide detail and puts it all in one line items.

b. Which company earns more per share (basic) for 201x?

Amazon earns more at $2.58 (left column) than Ebay does at $1.38 (right column)

c. Compute operating income as a percent of sales for each company for 201x and compare? (Operating income divided by total revenues)

Amazon = 1,406,000,000 / 34,204,000,000 = 4.1%

Ebay = 2,053,571,000 / 9,156,274,000 = 22.4%

Ebay: 22.4% of each sales dollar is operating profit.
Amazon: 4.1% of each sales dollar is operating profit

Ebay will add more to operating profit for each additional sales dollar
The higher the % the faster operating income will grow as sales grow.

(Amazon is in millions, add 6 zeros and Ebay is in thousands, add 3 zeros)

d. Compute net income as a percent of sales for each company for 201x and compare? (Net income divided by total revenues)

Amazon: 1,152,000,000 / 34,204,000,000 = 3.37%

Ebay: 1,800,961,000 / 9,156,274,000 = 19.7%

Ebay, 19.7% of each sales dollar becomes net income after all expenses.
Amazon, 3.37% of each sales dollar becomes net income after all expenses.

The higher the percent, the better; net income will increase faster as sales increase.

e. Which company paid the most income taxes as a percent of income before income tax for 201x? (income tax expense / income before income tax)

Amazon: 352,000,000 / 1,497,000,000 = 23.5%

Ebay: 297,486,000 / 2,098,447,000 = 14.2%

Ebay: 14.2% of profit must be paid to the government for income taxes
Amazon: 23.5% of profit must be paid to the government for income taxes

A lower tax percent is better because the company can keep more of the profits.

f. Which company is growing revenue (sales) at the fastest rate?
(Current year total revenues less prior year total revenues / by prior year total revenues)

Amazon: (34,204 – 24,509) / 24,509 = 39.6%

Ebay: (9,156,274 – 8,727,362) / 8,727,362 = 4.9%

Amazon is growing sales revenue faster than Ebay. Generally, when sales grow faster, profits grow faster also.

g. Which company is growing net income at the fastest rate? (Current year net income less prior year net income divided by prior year net income)

Amazon: (1,152 – 902) / 902 = 27.7%

Ebay: (1,800,961 – 2,389,097) / 2,389,097 = (24.6%)

Sales at Ebay grew 4.9% and net income decreased by 24.6%
Sales at Amazon grew 39.6% and profits grew 27.7%

h. What types of revenue and expenses changed from 200x to 201x and caused Ebay to have a lower net income in 201x than in 200x?

The other income was almost $1.4 billion lower.
Loss of income was offset by higher profit on inventory sold and lower operating expenses and lower income tax.

Ebay earned $344,007 more gross profit (profit from selling inventory only) in 201x. Sales were higher and gross profit was higher.

Total operating expenses were $252,798 lower, mostly due to lower general and administrative and amortization expenses

Interest and other income was $1,377,509 less income in 201x.

Tax expense was 192,568 lower due to less income before tax.

An item not related to day to day primary business caused the biggest difference
in net income. The line item does not describe what happened and you can’t tell by looking at the income statement. The item that occurred in 200x to give income will be described in the footnotes to the financial statements.

i. State the items for each company that you think are the most important to your
decision relative to making an investment in one of the two companies.

Some important things to consider:
1) How fast sales and profits are increasing or decreasing.
2) The change in operating expenses compared to the change in sales.
3) Is profit increasing or decreasing and is this change caused by changes in the day to day primary business operations?
4) How much will profits change as sales change?
5) Earnings growth for one share of ownership (EPS).

A. How much does each company earn from selling goods to customers only?

B. Which company has the highest % of total operating expenses of total sales and revenues for 201x? Do not include cost of sales in total operating expenses.
(Total operating expenses / total sales and revenues)

A lower percentage means that it costs less to get income from each dollar of sales. Lower cost as a % of sales is better.

C. Which part of the income statement does each company report interest expense?

Caterpillar reports interest expense as part of operating expenses when it relates to financing provided to customers and as part of other revenues and expenses when it is not related to customers and is related to debt (amounts owed to banks).

Deere reports all interest expense as part of operating expenses.
This implies that interest is all related to providing to customers.

D. Which company has the highest earnings per common share (basic) in 201x?

Caterpillar:   $4.28
Deere:            $4.40

E. Which company’s sales are higher in 201x than in 20xx?

Both companies have lower sales in 201x than in 20xx.

F. Which company’s net income is higher in 201x than in 20xx?

Both companies earned less net income in 201x than in 20xx.

G. Which company will have to pay the most to the government for income earned in 201x?

Deere pays more in dollars and as a percent of income.

H. Which company is the largest in terms of the amount of goods and services provided to customers in 201x?

I. Which company earned the most from day to day primary business operations in 201x?

Deere does not have any other revenues and expenses.
Deere earns almost as much as Caterpillar on much lower sales.

Another way to look at this is operating income as a percent of sales.

Deere earns more operating income for every dollar of sales than Caterpillar.