Page 437 - Introduction to Business

CHAPTER 12 Financial Reporting 411

The fifth item on the income statement (line 6) is other operating expenses. This
is a broad category for other expenses directly associated with the Cathy’s Candy
Company operations, which consist of selling candies. Interest expense (line 7) is
the expense associated with debt. Earnings before income tax (line 8) amounted to
$3,957 million in 2004 and $2,547 million in 2003. Income tax expense (line 9)
reduced net income (profits) by $1,482 million in 2004 and $960 million in 2003.
Cathy’s Candy Company earned $2,475 million in 2004 and $1,587 million in 2003
after paying all expenses.
Cathy’s Candy Company’s income statement shows percentages for the
amounts of each item. Each amount was divided by net sales revenue. Thus, in
2004, depreciation expense was computed to be 3.6 percent of net sales
(978/27,162); in 2003, depreciation was 4.1 percent of net sales (807/19,524). Is this
a good trend or a bad trend? This is a good trend. The proportionate expense of
buildings, equipment, and other depreciable assets increased at a lower rate than
revenues. This contributed to a higher profit margin in 2004 than in the previous profit margin The ratio of net income
year, 9.1 versus 8.1 percent. to net sales
The Financial Accounting Standards Board requires that in addition to net
income, business firms report an income amount called comprehensive income.
Comprehensive income includes net income plus several additional items. There is
some debate among financial statement users whether comprehensive income is
helpful for making financial decisions.

Statement of Retained Earnings

The Cathy’s Candy Company statement of retained earnings is shown in Exhibit statement of retained earnings The
12.3. As shown on the income statement, the firm earned net income of $2,475 mil- financial statement that shows
the change in retained earnings from
lion in 2004. This amount from the income statement also appears on the state-
the beginning of the period to the end
ment of retained earnings (line 2). Thus, net income is the link between the income of the period
statement and the statement of retained earnings. The net income in each year
increases retained earnings.
When a firm has net income, the board of directors must decide whether to pay
a cash dividend to the owners, that is, the stockholders. In both 2004 and 2003,
Cathy’s Candy Company declared dividends (line 3). Dividends decrease retained
earnings. As shown, the ending balance in one year (2003) becomes the starting
balance in the subsequent year (2004).

EXHIBIT 12.3
Cathy’s Candy Company
Consolidated Statement of Retained Earnings

Year Ended Year Ended
Dec. 31, Dec. 31,
2004 2003
Retained Earnings ($ millions) ($ millions)
1. Balance, beginning of year 7,176 5,826
2. Net income for the year 2,475 1,587
3. Less cash dividends declared (288) (237)
4. Balance, end of year 9,363 7,176

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