The Mathematics of Money

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490 Chapter 12 Financial Statements


Example 12.1.4 At the start of last year, Cattarauqua Ginseng Enterprises had
inventory that cost $37,923. Over the course of the year it made purchases of $48,923
before taking into account $1,850, which it received as a refund for a returned shipment
and $1,175 of savings from cash discounts for early payment. At the end of the year,
they had inventory whose total cost was $21,321. Calculate the company’s cost of goods
sold for the year.

We fi rst determine the net cost of the company’s purchases for the year:

Gross purchases  Returns  Cash discounts  Net purchases
$48,923  $1,850  $1,175  $45,898

To calculate the cost of goods:

Starting inventory  Net purchases  Ending inventory  Cost of goods sold
$37,923  $45,898  $21,321  $62,500

Expenses: We have already seen that a business may break down its expenses into subcat-
egories; these subcategories are often grouped together into certain groupings as well.
Operating expenses (also known as overhead ) include most of the expenses of operat-
ing the business. Operating expenses include costs like rent, utilities, wages and salaries,
insurance, and other similar costs. Operating expenses could also include depreciation,
an amount used to recognize the expense of equipment and other property used, not pur-
chased, during the period in question. For example, a company that bought $500,000 worth
of equipment that is expected to last 10 years might recognize this expense by claiming
$50,000 of depreciation in each of those 10 years. (Depreciation is discussed in more detail
in Section 8.4) Depreciation is intended to match up the cost of property and equipment
with the time period in which it is actually used.
The two major expenses not generally included as operating expenses are taxes and
interest paid by the company. Since the total income tax for the year cannot be known until
the company completes its tax filings, the amount of taxes is often a projection listed as a
“provision for taxes.”
By subtracting the operating expenses from the gross profit we arrive at the business’s
earnings before interest and taxes, not surprisingly often abbreviated as EBIT. Subtract-
ing all expenses from the gross profit gives the company’s net income.

Example 12.1.5 Cattarauqua Ginseng Enterprises had net sales of $176,530 last
year, and the cost of goods sold was $62,500. Expenses for the year included $35,000
for salaries, $5,000 for depreciation, $23,000 for rent and utilities, an $8,500 provision
for taxes, and $7,095 of interest expenses. Calculate the company’s gross profi t, total
operating expenses, EBIT, and net income for the year.

First, we fi nd the gross income:

Net sales  Cost of goods sold  Gross income
$176,530  $62,500  $114,030

Next, we total up the operating expenses, which in this case include salaries, depreciation,
rent, and utilities:

Sum of operating expense subcategories  Total operating expenses
$35,000  $5,000  $23,000  $63,000

The EBIT can be found by subtracting these operating expenses from the gross income:

Gross income  Operating expenses  EBIT
$114,030  $63,000  $51,030

Finally, to arrive at the net income we subtract the taxes and interest:

EBIT  Taxes  Interest  Net income
$51,030  $8,500  $7,095  $35,435

Before moving on, let’s put all of this together to complete a fairly detailed income statement
example.
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