Income Measurement and Profitability Analysis 5 Copyright © 2007 by The McGraw-Hill Companies, doc

1
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Income
Measurement
and Profitability
Analysis
5
5-2
Learning Objectives
Discuss the general objective of the timing of
revenue recognition, list the two general
criteria that must be satisfied before revenue
can be recognized, and explain why these
criteria usually are satisfied at a specific point
in time.
5-3
Revenue Recognition
Revenue should be recognized in the
period or periods that the revenue-
generating activities of the company are
performed.
2
5-4
Realization Principle
Record revenue when:
AND
There is
reasonable
certainty as to the
collectibility of the
asset to be

received (usually
cash).
The earnings
process is
complete or
virtually
complete.
5-5
SEC Staff Accounting Bulletin No. 101
Staff Accounting Bulletin
The SEC issued Staff Accounting Bulletin
No. 101 to crackdown on earnings
management. The bulletin provides
additional guidance to determine if the
realization principle is satisfied:
1. Persuasive evidence of an arrangement exists.
2. Delivery has occurred or services have been
performed.
3. The seller’s price to the buyer is fixed or
determinable.
4. Collectibility is reasonably assured.
5-6
Completion of the Earnings Process Within
a Single Reporting Period
delivered to the customer
When the product or
service has been
delivered to the customer
and cash has been
received or a receivable

has been generated that
has reasonable
assurance of
collectibility.
Recognize Revenue
3
5-7
Learning Objectives
Describe the installment sales and cost
recovery methods of recognizing revenues for
certain installment sales and explain the
unusual conditions under which these methods
might be used.
5-8
Significant Uncertainty of Collectibility
1. Installment Sales Method
2. Cost Recovery Method
When uncertainties about
collectibility exist, revenue
recognition is delayed.
5-9
Installment Sales Method
The installment sales method
recognizes the gross profit by
applying the gross profit
percentage on the sale to the
amount of cash actually collected.
4
5-10
2005 2006 2007

Installment sales $200,000 $250,000 $275,000
Cost of sales 155,000 190,000 220,000
Gross profit $45,000 $60,000 $55,000
Gross profit percentage 22.50% 24.00% 20.00%
Installment Sales Method
Clarke, Inc. had the following installment
sales in addition to its regular sales.
$45,000 ÷ $200,000 = 22.50%
5-11
Installment Sales Method
Clarke, Inc. had the following installment
sales in addition to its regular sales.
2005 2006 2007
Installment sale s 200,000$ 250,000$ 275,000$
Cash Collected:
From 2005 Sales (100,000) (50,000) (50,000)
From 2006 Sales (195,000) (25,000)
From 2007 Sales (200,000)
Cash Collections
At Dec. 31, 2007,
Clarke, Inc. is still
owed $30,000 from
the 2006 sales and
$75,000 from the
2007 sales.
2005 2006 2007
Installment sales $200,000 $250,000 $275,000
Cost of sales 155,000 190,000 220,000
Gross profit $45,000 $60,000 $55,000
Gross profit percentage 22.50% 24.00% 20.00%

5-12
Installment Sales Method
Description Debit Credit
Installment sales receivable 2005 200,000
Inventory 155,000
Deferred gross profit 2005 45,000
General Journal
Deferred gross profit is the difference
between the selling price and the cost of the
inventory.
5
5-13
Installment Sales Method
Description Debit Credit
Installment sales receivable 2005 200,000
Inventory 155,000
Deferred gross profit 2005 45,000
Cash 100,000
Installment sales receivable 2005 100,000
Deferred gross profit 2005 22,500
Realized gross profit 22,500
($100,000 collected x 22.50%)
General Journal
During 2005, Clarke collected $100,000
on its installment sales.
This entry records the Realized Gross Profit by
adjusting the Deferred Gross Profit account.
5-14
Installment Sales Method
Description Debit Credit

Installment sales receivable 2006 250,000
Inventory 190,000
Deferred gross profit 2006 60,000
Cash 245,000
Installment sales receivable 2005 50,000
Installment sales receivable 2006 195,000
Deferred gross profit 2005 11,250
Deferred gross profit 2006 46,800
Realized gross profit 58,050
General Journal
During 2006, Clarke sold $250,000 on installments and
collected $50,000 on its 2005 installment sales and $195,000
on its 2006 installment sales.
Cash collections - 2005 50,000$ × 22.50% = 11,250$
Cash collections - 2006 195,000 × 24.00% = 46,800
58,050$
5-15
Description Debit Credit
Installment sales receivable 2007 275,000
Inventory 220,000
Deferred gross profit 2007 55,000
Cash 275,000
Installment sales receivable 2005 50,000
Installment sales receivable 2006 25,000
Installment sales receivable 2007 200,000
Deferred gross profit 2005 11,250
Deferred gross profit 2006 6,000
Deferred gross profit 2007 40,000
Realized gross profit 57,250
General Journal

2005 50,000$ × 22.50% = 11,250$
2006 25,000 × 24.00% = 6,000
2007 200,000 × 20.00% = 40,000
275,000$ 57,250$
Cash Collection on Installment Sales in 2007
Installment Sales Method
6
5-16
Installment Sales Method
2005 22,500 45,000 2005
2006 11,250
2007 11,250
-
Deferred Gross Profit 2005
2007 40,000 55,000 2007
15,000
Deferred Gross Profit 2007
2006 46,800 60,000 2006
2007 6,000
7,200
Deferred Gross Profit 2006
5-17
Installment Sales Method
Installment sales receivable 2006 30,000$
Installment sales receivable 2007 75,000
Installment accounts receivable 105,000$
Deferred gross profit 2006 7,200$
Deferred gross profit 2007 15,000
Deferred gross profit 22,200$
Balance Sheet

Installment accounts receivable 105,000$
Less: Deferred gross profit (22,200)
Net Installment accounts receivable 82,800$
5-18
Cost Recovery Method
Clarke, Inc. had the following installment Clarke, Inc. had the following installment
sales in addition to its regular sales. The sales in addition to its regular sales. The
company uses the company uses the cost recovery method to to
account for installment sales.account for installment sales.
2005 2006 2007
Installment sales $200,000 $250,000 $275,000
Cost of sales 155,000 190,000 220,000
Gross profit $45,000 $60,000 $55,000
Gross profit percentage 22.50% 24.00% 20.00%
$45,000 ÷ $200,000 = 22.50%
7
5-19
Cost Recovery Method
The following schedule shows the pattern of
cash collections for the three year period.
Year of Sale
2005 2006 2007
2005 $100,000 $50,000 $50,000
2006 195,000 25,000
2007 200,000
COGS 155,000$ 190,000$ 220,000$
Year of Collection
Under the cost recovery method
profit is not recognized until the
seller has recovered all of the cost of

the goods sold.
5-20
Cost Recovery Method
Description Debit Credit
Installment receivable 2005 200,000
Inventory 155,000
Deferred gross profit 2005 45,000
Cash 100,000
Installment receivable 2005 100,000
General Journal
The entries are exactly the same as under the Installment
Method—EXCEPT that there is not an entry to realize gross
profit. Since we have not collected cash in excess of COGS,
no gross profit is recognized in 2005.
5-21
Cost Recovery Method
In 2006, let’s concentrate on the
entries relating to 2005 sales only.
Description Debit Credit
Cash 50,000
Installment receivable 2005 50,000
General Journal
Cost of goods sold 155,000$
Cash collections - 2005 (100,000)
Cash collections - 2006 (50,000)
Unrecovered cost 5,000
We have not fully recovered the
cost, so no profit is recognized in 2006.
2005 Installment Sale
Now can we recognize some profit?

8
5-22
Cost Recovery Method
Here are the entries we would make in
2007 relating to 2005 sales.
Description Debit Credit
Cash 50,000
Installment receivable 2005 50,000
Deferred gross profit 45,000
Realized gross profit 45,000
General Journal
We have fully recovered the $155,000 cost
during 2007, so the entire deferred gross
profit will be recognized.
5-23
Learning Objectives
Discuss the implications for revenue
recognition of allowing customers the right of
return.
5-24
Right of Return
In most situations, even though the right
to return merchandise exists, revenues
and expenses can be appropriately
recognized at point of delivery.
Estimate the
returns.
Reduce both
Sales and Cost of
Goods Sold.

9
5-25
Learning Objectives
Identify situations that call for the recognition of
revenue over time and distinguish between the
percentage-of-completion and completed
contract methods of recognizing revenue for
long-term contracts.
5-26
Completion of the Earnings Process Over
Multiple Reporting Periods
Completed
Contract Method
Percentage-of-
Completion
Method
Long-term
Contracts
5-27
Completed Contract Method
Recognizes revenue at a
point in time when the
earnings process is
complete
10
5-28
Completed Contract Method
Geller Construction entered into a three-year
contract to build a containment vessel for
Southeast Power Company for a contract price of

$1,400,000. Presented below is information
about the contract.
Let’s see how Geller will account for
the revenues and cost of this project
using the completed contract method.
2006 2007 2008
Construction costs incurred during they year 250,000$ 550,000$ 400,000$
Construction costs incurred in prior years - 250,000 800,000
Cumula tive construction costs 250,000 800,000 1,200,000
Estimated costs to complete at end of year 1,000,000 425,000 -
Total estimated and actual construction costs 1,250,000$ 1,225,000$ 1,200,000$
Billings made during the year 250,000$ 525,000$ 625,000$
Cash collections during year 225,000 470,000 405,000
5-29
Description Debit Credit
Construction in progress 250,000
Cash, materials, etc. 250,000
Accounts receivable 250,000
Billings on construction contract 250,000
Cash 225,000
Accounts receivable 225,000
General Journal
Completed Contract Method
Gross
profit is
not
recognized
until
project is
complete.

2006
Construction costs incurred during they year 250,000$
Construction costs incurred in prior years -
Cumulative construction costs 250,000
Estimated costs to complete at end of year 1,000,000
Total estimated and actual construction costs 1,250,000$
Billings made during the year 250,000$
Cash collections during year 225,000
5-30
Description Debit Credit
Construction in progress 250,000
Cash, materials, etc. 250,000
Accounts receivable 250,000
Billings on construction contract 250,000
General Journal
Completed Contract Method
Construction in Progress
-
Billings on Construction Contract
Debit Balance (Unbilled Receivable)
Classified as
an asset
Construction in Progress
-
Billings on Construction Contract
Credit Balance (Overbilled Receivable)
Classified as
a liability
11
5-31

Description Debit Credit
Construction in progress 550,000
Cash, materials, etc. 550,000
Accounts receivable 525,000
Billings on construction contract 525,000
Cash 470,000
Accounts receivable 470,000
General Journal
Completed Contract Method
2006 2007
Construction costs incurred during they year 250,000$ 550,000$
Construction costs incurred in prior years - 250,000
Cumulative construction costs 250,000 800,000
Estimated costs to complete at end of year 1,000,000 425,000
Total estima ted a nd actual construction costs 1,250,000$ 1,225,000$
Billings made during the year 250,000$ 525,000$
Cash collections during year 225,000 470,000
Gross
profit is
not
recognized
until
project is
complete.
5-32
Completed Contract Method
Description Debit Credit
Construction in progress 400,000
Cash, materials, etc. 400,000
Accounts receivable 625,000

Billings on construction contract 625,000
Cash 405,000
Accounts receiva ble 405,000
General Journal
2006 2007 2008
Construction costs incurred during they year 250,000$ 550,000$ 400,000$
Construction costs incurred in prior years - 250,000 800,000
Cumula tive construction costs 250,000 800,000 1,200,000
Estimated costs to complete at end of year 1,000,000 425,000 -
Total estimated and actual construction costs 1,250,000$ 1,225,000$ 1,200,000$
Billings made during the year 250,000$ 525,000$ 625,000$
Cash collections during year 225,000 470,000 405,000
5-33
Completed Contract Method
Description Debit Credit
Construction in progress 400,000
Cash, materials, etc. 400,000
Accounts receivable 625,000
Billings on construction contract 625,000
Cash 405,000
Accounts re ceivable 405,000
Cost of construction 1,200,000
Construction in progress 200,000
Revenue from long-term contract 1,400,000
Revenue from long-term contract 1,400,000
Cost of construction 1,200,000
Retained earnings 200,000
General Journal
Gross
profit is

recognized
in year 3
since
project is
complete.
2006 2007 2008
Construction costs incurred during they yea r 250,000$ 550,000$ 400,000$
Construction costs incurred in prior yea rs - 250,000 800,000
Cumulative construction costs 250,000 800,000 1,200,000
Estimated costs to complete at end of year 1,000,000 425,000 -
Total estimated and actual construction costs 1,250,000$ 1,225,000$ 1,200,000$
Billings ma de during the year 250,000$ 525,000$ 625,000$
Cash collections during year 225,000 470,000 405,000
Remember that
the contract price
was $1,400,000.
12
5-34
Completed Contract Method
Description Debit Credit
Billings on construction contract 1,400,000
Construction in progress 1,400,000
General Journal
Entry to transfer title to the customer.
2006 250,000
2007 550,000
2008 400,000
2008 200,000
1,400,000
Construction in Progress

250,000 2006
525,000 2007
625,000 2008
1,400,000
Billings on Construction Contract
5-35
Percentage-of-Completion Method
Cost incurred to date
Gross profit estimate
Measuring Progress Toward Completion
Estimate of project’s total
cost
5-36
Percentage-of-Completion Method
Total costs incurred to date
Percent complete =
Most recent estimate of total
project cost
Let’s look at an
example.
13
5-37
Percentage-of-Completion Method
Geller Construction entered into a three-year
contract to build a containment vessel for
Southeast Power Company for a contract price of
$1,400,000. Presented below is information
about the contract.
Let’s see how Geller will account for the
revenues and cost of this project using the

percentage-of-completion method.
2006 2007 2008
Construction costs incurred during they year 250,000$ 550,000$ 400,000$
Construction costs incurred in prior years - 250,000 800,000
Cumula tive construction costs 250,000 800,000 1,200,000
Estimated costs to complete at end of year 1,000,000 425,000 -
Total estimated and actual construction costs 1,250,000$ 1,225,000$ 1,200,000$
Billings made during the year 250,000$ 525,000$ 625,000$
Cash collections during year 225,000 470,000 405,000
5-38
Percentage-of-Completion Method
2006
Contract price 1,400,000$
Actual costs to date $250,000
Estimated costs to complete 1,000,000
Total project cost $1,250,000
Total gross profit (Contract price - total costs) 150,000$
Percentage-of-completion (actual costs to date) 250,000$
Divided by the estimated total project cost 1,250,000$
Equals percentage complete to date 20.00%
Total project gross profit 150,000$
Multiplied by the estimated % of completion 20.00%
Gross profit earned to date 30,000$
Less gross profit recognized in previous periods -
Gross profit recognized currently 30,000$
5-39
Description Debit Credit
Construction in progress 250,000
Cash, materials, etc. 250,000
Accounts receivable 250,000

Billings on construction contract 250,000
Cash 225,000
Accounts receivable 225,000
General Journal
Percentage-of-Completion Method
Contra account to CIP
Entries are identical
to the entries for the
completed contract
method.
2006
Construction costs incurred during they year 250,000$
Construction costs incurred in prior years -
Cumulative construction costs 250,000
Estimated costs to complete at end of year 1,000,000
Total estimated and actual construction costs 1,250,000$
Billings made during the year 250,000$
Cash collections during year 225,000
14
5-40
Description Debit Credit
Construction in progress 250,000
Cash, materials, etc. 250,000
Accounts receivable 250,000
Billings on construction contract 250,000
Cash 225,000
Accounts receivable 225,000
General Journal
Percentage-of-Completion Method
Construction in Progress

-
Billings on Construction Contract
Debit Balance (Unbilled Receivable)
Classified as
an asset
Construction in Progress
-
Billings on Construction Contract
Credit Balance (Overbilled Receivable)
Classified as
a liability
5-41
Description Debit Credit
Construction in progress 250,000
Cash, materials, etc. 250,000
Accounts receivable 250,000
Billings on construction contract 250,000
Cash 225,000
Accounts receivable 225,000
Cost of construction 250,000
Construction in progress 30,000
Revenue from long-term contract 280,000
General Journal
Percentage-of-Completion Method
2006
Contract price 1,400,000$
Actual costs to date $250,000
Estimated costs to complete 1,000,000
Total project cost $1,250,000
Total gross profit (Contract price - total costs) 150,000$

Percentage-of-completion (actual costs to date) 250,000$
Divided by the estimated total project cost 1,250,000$
Equals percentage complete to date 20.00%
Total project gross profit 150,000$
Multipl ied by the estimated % of completion 20.00%
Gross profit earned to date 30,000$
Less gross profit recognized in previous periods -
Gross profit recogni zed currently 30,000$
5-42
Percentage-of-Completion Method
Description Debit Credit
Construction in progress 250,000
Cash, materials, etc. 250,000
Accounts receivable 250,000
Billings on construction contract 250,000
Cash 225,000
Accounts receivable 225,000
Cost of construction 250,000
Construction in progress 30,000
Revenue from long-term contract 280,000
Revenue from long-term contract 280,000
Cost of construction 250,000
Retained earnings 30,000
General Journal
Closing Entry
15
5-43
Percentage-of-Completion Method
2006 2007
Contract price 1,400,000$ 1,400,000$

Actual costs to date $250,000 $800,000
Estimated costs to complete 1,000,000 425,000
Total project cost $1,250,000 $1,225,000
Total gross profit (Contract price - total costs) 150,000$ 175,000$
Percentage-of-completion (actual costs to date) 250,000$ 800,000$
Divided by the estimated total project cost 1,250,000$ 1,225,000$
Equals percentage complete to date 20.00% 65.31%
Total project gross profit 150,000$ 175,000$
Multiplied by the estimated % of completion 20.00% 65.31%
Gross profit earned to date 30,000$ 114,286$
Less gross profit recognized in previous periods - (30,000)
Gross profit recognized currently 30,000$ 84,286$
5-44
Description Debit Credit
Construction in progress 550,000
Cash, materia ls, etc. 550,000
Accounts receivable 525,000
Billings on construction contract 525,000
Cash 470,000
Accounts receivable 470,000
General Journal
Percentage-of-Completion Method
2006 2007
Construction costs incurred during they year 250,000$ 550,000$
Construction costs incurred in prior years - 250,000
Cumula tive construction costs 250,000 800,000
Estimated costs to complete at end of year 1,000,000 425,000
Total estimated and actual construction costs 1,250,000$ 1,225,000$
Billings made during the year 250,000$ 525,000$
Cash collections during yea r 225,000 470,000

5-45
Percentage-of-Completion Method
Description Debit Credit
Construction in progress 550,000
Cash, materials, etc. 550,000
Accounts receivable 525,000
Billings on construction contract 525,000
Cash 470,000
Accounts receivable 470,000
Cost of construction 550,000
Construction in progress 84,286
Revenue from long-term contract 634,286
Revenue from long-term contract 634,286
Cost of construction 550,000
Retained earnings 84,286
General Journal
2006 2007
Contract price 1,400,000$ 1,400,000$
Actual costs to date $250,000 $800,000
Estimated costs to complete 1,000,000 425,000
Total project cost $1,250,000 $1,225,000
Total gross profit (Contract price - total costs) 150,000$ 175,000$
Percentage-of-completion (actual costs to date) 250,000$ 800,000$
Divided by the estimated total project cost 1,250,000$ 1,225,000$
Equals percentage complete to date 20.00%
65.31%
Total project gross profit 150,000$ 175,000$
Multiplied by the estimated % of completion 20.00%
65.31%
Gross profit earned to date 30,000$ 114,286$

Less gross profit recognized in previous periods - (30,000)
Gross profit recognized currently 30,000$ 84,286$
16
5-46
Percentage-of-Completion Method
2006 2007 2008
Contract price 1,400,000$ 1,400,000$ 1,400,000$
Actual costs to date $250,000 $800,000 $1,200,000
Estimated costs to complete 1,000,000 425,000 0
Total project cost $1,250,000 $1,225,000 $1,200,000
Total gross profit (Contract price - total costs) 150,000$ 175,000$ 200,000$
Percentage-of-completion (actual costs to date) 250,000$ 800,000$
(project is
complete)
Divided by the estimated total project cost 1,250,000$ 1,225,000$
Equals percentage complete to date 20.00% 65.31% 100.00%
Total project gross profit 150,000$ 175,000$ 200,000$
Multiplied by the estimated % of completion 20.00% 65.31% 100.00%
Gross profit earned to date 30,000$ 114,286$ 200,000
Less gross profit recognized in previous periods - (30,000) (114,286)
Gross profit recognized currently 30,000$ 84,286$ 85,714$
5-47
Percentage-of-Completion Method
Description Debit Credit
Construction in progress 400,000
Cash, materials, etc. 400,000
Accounts receivable 625,000
Billings on construction contract 625,000
Cash 405,000
Accounts receivable 405,000

Cost of construction 400,000
Construction in progress 85,660
Revenue from long-term contract 485,660
Revenue from long-term contract 485,660
Cost of construction 400,000
Retained earnings 85,660
General Journal
2006 2007 2008
Construction costs incurred during they year 250,000$ 550,000$ 400,000$
Construction costs incurred in prior years - 250,000 800,000
Cumula tive construction costs 250,000 800,000 1,200,000
Estimated costs to complete at end of year 1,000,000 425,000 -
Total estimated and actual construction costs 1,250,000$ 1,225,000$ 1,200,000$
Billings made during the year 250,000$ 525,000$ 625,000$
Cash collections during year 225,000 470,000 405,000
5-48
Percentage-of-Completion Method
Description Debit Credit
Construction in progress 400,000
Cash, materials, etc. 400,000
Accounts receivable 625,000
Billings on construction contract 625,000
Cash 405,000
Accounts receivable 405,000
Cost of construction 400,000
Construction in progress 85,714
Revenue from long-term contract 485,714
Revenue from long-term contract 485,714
Cost of construction 400,000
Retained earnings 85,714

General Journal
2006 2007 2008
Contract price 1,400,000$ 1,400,000$ 1,400,000$
Actual costs to date $250,000 $800,000 $1,200,000
Estimate d costs to complete 1,000,000 425,000 0
Total proje ct cost $1,250,000 $1,225,000 $1,200,000
Total gross profit (Contract price - total costs) 150,000$ 175,000$ 200,000$
Percentage-of-completion (actual costs to date) 250,000$ 800,000$
(project is
complete)
Divided by the estimated total project cost 1,250,000$ 1,225,000$
Equals percentage complete to date 20.00% 65.31% 100.00%
Total proje ct gross profit 150,000$ 175,000$ 200,000$
Multiplied by the estimated % of completion 20.00% 65.31% 100.00%
Gross profit earned to date 30,000$ 114,286$ 200,000
Less gross profit recognized in previous periods - (30,000) (114,286)
Gross profit recognized currently 30,000$ 84,286$ 85,714$
17
5-49
Percentage-of-Completion Method
Description Debit Credit
Billings on construction contract 1,400,000
Construction in progress 1,400,000
General Journal
Entry to transfer title to the customer.
2006 250,000
30,000
2007 550,000
84,286
2008 400,000

85,714
1,400,000
Construction in Progress
250,000 2006
525,000 2007
625,000 2008
1,400,000
Billings on Construction Contract
5-50
Long-term Contract Losses
Periodic Loss for
Profitable
Projects
Determine periodic
loss and record loss
as a credit to the
Construction in
Progress account.
Loss Projected
for Entire Project
Estimated loss is
fully recognized in
the first period the
loss is anticipated
and is recorded by a
credit to
Construction in
Progress account.
5-51
Learning Objectives

Discuss the revenue recognition issues
involving software and franchise sales.
18
5-52
Software Revenue Recognition
Statement of Position 97-2
If a sale includes multiple elements (software,
future upgrades, postcontract customer
support, etc.), the revenue should be allocated
to the various elements based on the relative
fair value of the individual elements.
This will likely result in a portion of the
proceeds received from the sale of software
being deferred and recognized as revenue in
future periods.
5-53
Franchise Sales
Source: SFAS 45
Initial Franchise
Fees
Generally are
recognized at a
point in time when
the earnings
process is virtually
complete.
Continuing
Franchise Fees
Recognized over
time as the services

are performed.
5-54
Learning Objectives
Identify and calculate the common ratios used
to assess profitability.
19
5-55
Receivables Turnover Ratio
Whenever a ratio divides an income statement
balance by a balance sheet balance, the average
for the year is used in the denominator.
Net Sales
Average Accounts Receivable
Receivables
Turnover
Ratio
=
This ratio measures how many
times a company converts its
receivables into cash each year.
5-56
Average Collection Period
This ratio is an approximation of the
number of days the average accounts
receivable balance is outstanding.
365
Receivables Turnover Ratio
Average
Collection
Period

=
5-57
Inventory Turnover Ratio
This ratio measures the number
of times merchandise inventory
is sold and replaced during the year.
Cost of Goods Sold
Average Inventory
Inventory
Turnover
Ratio
=
20
5-58
Average Days in Inventory
This ratio indicates the number
of days it normally takes to sell inventory.
365
Inventory Turnover Ratio
Average
Days in
Inventory
=
5-59
Asset Turnover Ratio
This ratio measures how efficiently a
company utilizes all of its assets to
generate revenue.
Net Sales
Average Total Assets

Asset
Turnover
Ratio
=
5-60
Profit Margin on Sales
Profit Margin
on Sales
Net Income
Net Sales
=
This ratio indicates the portion of
each dollar of revenue that is
available to cover expenses.
21
5-61
Return on Total Assets
Return on
Total Assets
Net Income
Average Total Assets
=
This ratio measures how well assets
have been employed.
5-62
Return on Equity
Return on
Equity
Net Income
Average Shareholders’ Equity

=
This ratio measures the ability of
management to generate net income from
the resources the owners provide.
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Appendix 5
Interim
Reporting
22
5-64
Interim Reporting
Issued for periods of less than
a year, typically as quarterly
financial statements.
Serves to enhance the
timeliness of financial
information.
Fundamental debate centers
on the choice between the
discrete and integral part
approaches.
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Interim Reporting
Reporting Revenues
and Expenses
With only a few exceptions, the
same accounting principles
applicable to annual reporting are
used for interim reporting.
Reporting Unusual

Items
Discontinued operations and
extraordinary items are reported
entirely within the interim period in
which they occur.
Earnings Per Share
Quarterly EPS calculations follow
the same procedures as annual
calculations.
Reporting Accounting
Changes
Accounting changes made in an
interim period are reported by
retrospectively applying the changes
to prior financial statements.
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Minimum Disclosures
Sales, income taxes,
and net income
Earnings per share
Seasonal revenues,
costs, and expenses
Significant changes
in estimates for
income taxes
Discontinued operations,
extraordinary items, and
unusual or infrequent
items
Contingencies

Changes in
accounting principles
or estimates
Significant changes
in financial position
23
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End of Chapter 5