The format of the fi nancial statements introduced so far has been quite simple only with account titles introduced. Although simplicity helps to grasp the concept easy, it may be insuffi cient to use effectively for many different purposes. This chapter also introduces a standardized format of fi nancial statements that is commonly used in the industry,
presenting the same information. Later in this chapter, more advanced examples will be introduced to help readers to develop better knowledge to consolidate the business performance and its status.
3.4.1 Advanced Format of the Income Statement
The Income Statement introduced in the Table 3.2 shows a simplifi ed list of accounts. For small operations, it may work fi ne with no diffi cul- ties. However, there is another way to present the same information for better analysis. Compare the format of the Income Statement introduced in the following Table 3.3 with the previous one presented in Table 3.2.
Table 3-03 The Income Statement in a Revised Format The Income Statement
The R&B Grill
For the month of January, 2xx1
Amounts V.A.%*
Revenues 115,000 100.0%
Cost of Sales 45,200 39.3%
Gross Profi t 69,800 60.7%
Operating Expenses
Labor Expense 38,000 33.0%
Rent Expense 15,000 13.0%
Utility Expense 5,000 4.3%
Insurance Expense 1,500 1.3%
Depreciation Expense 6,000 5.2%
Total Operating Expenses 65,500 57.0%
Operating Profi ts (EBIT) 4,300 3.7%
Interest Expense (Income) 1,500 1.3%
Income before Income Taxes (EBT) 2,800 2.4%
Income Tax (35%)* 980
Net Income (loss) 1,820 1.6%
* V.A.% = Vertical Analysis %.
The report in the new format provides more specifi c and refi ned information. The Gross Profi t line shows the amount left over after the Cost of Sales is deducted from the Revenues. The term Gross Profi t
indicates that the amount must be large enough to cover all other expenses that follow. The amount of all expenses spent in the oper- ations, without the Cost of Sales, was $65,500. The vertical analysis column shows the percentage of individual expenses and profi ts of the revenues. This information will enable operators to enhance their cost control by taking appropriate actions on individual expenses by keeping track of them.
The restaurant industry has been updating their own reporting sys- tem, called “the Uniform Systems of Accounts for Restaurant.” It is very similar to the format introduced above. The system is designed to max- imize the usefulness of the fi nancial information for the practitioners and other stakeholders. It still follows the generally accepted account principles (GAAP) for details. The Uniform Systems of Accounts for Restaurant (simply, “the uniform system” from now in this book) pro- vides more specifi c information by separating revenues into subgroups such as “Food Sales” and “Beverage Sales.” By doing so, it also sep- arates the cost of sales into the “Cost of Food Sales” and the “Cost of Beverage Sales.” This approach allows operators to separately track the individual lines of operations to obtain as accurate information as possi- ble. Operators can modify this approach and develop more effective for- mats of their own. One example is dividing sales into “sales on premise”
and “pick-up or delivery.” Many fast food operators who deliver their products have adopted this format. Another example is to divide sales into different types of meal such as “breakfast sales,” “lunch sales,” and
“dinner sales.”
Dividing the sales by the line of operations is easy. However, allo- cating costs and expenses accordingly is hard. For this reason, the cost of sales is usually calculated comprehensively. The next important expense account in restaurant businesses is the “Labor Cost.” These two expenses – Cost of Sales and the Labor Cost – are often called the “Prime Cost”
in the industry. Labor Cost is also hard to be allocated accurately to spe- cifi c lines of operations due to the overlapping effect of employees’ task, but it can be divided, for example, into salaries and wages to identify the spending volume on each category. It also includes all other specifi c spending for employee-related activities, such as benefi ts, overtime pay- ment, travel, and other similar accounts. All expenses can be divided into as many subcategories as possible for effi cient control of the business.
However, when they are presented in the fi nal report, only the master
account titles are presented like the example in Table 3.3. Specifi c indi- vidual titles of accounts are only used inside each business. They are not presented to the public.
Among the list of expenses displayed in the Income Statement in our examples, the group of expenses that are listed under the title of the
“Operating expenses,” from Labor Expenses to Depreciation Expense, led to the Operating Profi ts of $4,300. This is the amount of profi t gen- erated by the operating activities of R&B Grill during the fi rst month.
Many businesses also use the title of “Earnings before Interest and Taxes (EBIT)” for this as presented in the Table.
Beneath the Operating Profi t (EBIT), non-operating expenses are listed. One of them is Interest and the other is Income Tax. Both are non-operating expenses. As pointed out, the interest expense is incurred due to the loan. Sometimes, a business may bring in interest income from the loans they have given to others. In such occasions, the receiving is an “income” rather than an “expense.” Any expenses listed in the section of the expense in positive value are subtracted in calculation process. To add the value of “income,” it must be presented in negative value. This is why the “Income” is presented in a parenthesis in Table 3.1.
Once the Interest Expense (Income) is subtracted from (or added to) the Operating Profi ts, the amount left over is used to calculate the Income Tax. For this nature, this title (Income before Income Taxes) is often called the “Taxable income.” Many businesses present this amount under the title of the “Earnings before Taxes (EBT).” The Income tax amount is calculated by applying the tax rate to the Income before income taxes. In our example, the Income tax is calculated at 35% of the EBT.
3.4.2 Advanced Format of the Balance Sheet
The Balance Sheet can also be presented in a standardized format commonly used by the industry in a more effi cient structure as shown in Table 3.4. Most companies in the restaurant industry present their Bal- ance Sheets in the format presented in the Table 3.4.
First, the assets are divided into two groups as “Current Assets”
and “Long-term Assets.” The items included in the “Current Assets”
are the resources that can be consumed within a year in operational activities. The business, by consuming them, will bring in cash. This nature is usually described in most accounting books as “the current assets are the items that can be converted into cash within one year.”
The “Account Receivable” can be collected; and the collected amount becomes “cash” of the business. The “Inventory” should be processed into the products for sales and “cash” will be brought in when sold.
“Prepaid Expenses” do not usually bring in cash. Because they are deposits made for future expenses, however, they will save cash when they are used for expenses. This is how current asset items are “con- verted” into cash within 1 year. The following is the revised format of the Balance Sheet of R&B, followed by a brief analysis of its fi nancial position.
Table 3-04 The Balance Sheet in a Revised Format The Balance Sheet
R&B Caterer, Inc.
Pre-opening After 1 month Assets:
Current Assets
Cash 415,000 438,000
Accounts receivable 60,000
Inventory 80,000 34,800
Prepaid Rent 100,000 85,000
Prepaid insurance 18,000 16,500
Total Current Assets 613,000 634,300
Long-term Assets
FF&E 500,000 150,000
Less Acc. Depreciation (2,000)
Leasehold Improvement 250,000
Less Acc. Depreciation (2,000)
Smallware 100,000
Less Acc. Depreciation (2,000)
Net FF&E 500,000 494,000
Total Long-term Assets 500,000 494,000
Total Assets 1,113,000 1,128,300
Table 3-04 (Continued)
Pre-opening After 1 month Liabilities & Equity
Liabilities
Current Liabilities
Accounts payable 55,000 55,000
Accrued expenses 21,480
Unearned revenues 8,000 –-
Total Current Liabilities 63,000 76,480
Long-term Liabilities
Notes payable-A 450,000 150,000
Notes payable-B 250,000
Total Long-term Liabilities 450,000 400,000
Total Liabilities 513,000 476,480
Owners’ Equity Common stock
– Rachel & Brad 450,000 450,000 Common stock
– Jane 200,000 200,000
Retained Earnings 1,820
Total Owners’ Equity 650,000 651,820
Total Liabilities & Equity 1,163,000 1,128,300
3.4.3 Explanation of the Revised Balance Sheet Information After the First Month
After 1 month, R&B Grill still has $634,000 in the Current Assets.
This should be compared with the Current Liabilities. The Current Lia- bilities are the amount of debt (or obligation) that must be paid within 1 year. As mentioned earlier, however, these obligations must be han- dled within the next couple of weeks in most cases. This company has
$76,480 in its current liabilities, while it carries $634,000 in its current assets. The cash amount available in the business is $438,800. The capa- bility of a fi rm to pay its current liabilities is called the “Liquidity.” R&B Grill, according to the given information, has enough cash on hand for
its immediate debt, which indicates it has strong liquidity. It must be explained for the excessive amount of cash on hand. As R&B Grill just started its business as a new company, it is highly recommended to pre- serve enough cash for future contingency. Restaurant business has been known for its high risk of failure, and many experts have pointed out the lack of cash on hand as the primary reason. For potential fi nancial diffi - culties that the company may face in the future, Rachel and Brad decided to keep enough cash in a separate account. This is why the current bal- ance of cash is excessively high. Many restaurant fi rms usually keep this type of emergency funds in a separate account called “Short-term Investments” or “Marketable Securities.” R&B Grill is recommended to invest its extra cash into short-term governmental bonds or other similar fi nancial securities that will earn interest income in the future.
Under the Current Assets are the Long-term Assets that refer to the resources that can be used by the business for longer than a year. These include, but are not limited to, buildings, land, furniture and/or equipment (FF&E), and other similar items. Many practitioners call these as “Fixed assets.” Except land, all Long-term Assets depreciate over time. It has been introduced how to estimate the amount of depreciation expenses using the straight-line method. As mentioned earlier, there are other methods. One of them is called the “usage method” that calculates the depreciation by counting the actual output of the item. Vehicles are a good example of this method. Every mile driven will deduct from the value of the vehicle at the predetermined rate such as 45 cents per mile, for example. Using this method, the more a vehicle is driven, the more depreciation expense will be incurred. The other method is called the “accelerated method.”
This method applies a larger amount of depreciation expense during the early years, and the amount of depreciation gradually decreases as the time passes by until the item reaches its predetermined residual value.
Technical details of these methods are not introduced in this book because they are not conceptually signifi cant. Readers may refer to other sources (books or online) to fi nd out necessary technical details.
What is important about depreciation expense is that it is a “Non- cash expense,” which means that, different from other expenses, it does not involve actual cash payments. Because there is no cash payment involved with depreciation expenses, the cash amount presented for it remains in the business. However, as an expense, it reduces the amount of the taxable income (EBT).
In summary, depreciation expenses are incurred on the long-term assets obtained as the result of investing activities of the business itself.
Once long-term assets are obtained, the business presents the esti- mated amount of depreciation expenses. However, as they are non-cash expenses, the business does not make the payment of it. Instead it keeps the cash. Due to this nature, depreciation expenses over time will be accumulated in the business. By doing so, the business can recover its investments in time. Regardless the different methods of calculating this expense, when the amount of depreciation is added to the net profi t to determine the cash earned through operations, the total amount (net profi t plus depreciation) becomes the same. More details of this effect will be explained when the Cash Flows are introduced in Chapter 7.
The Balance Sheet presented in Table 3.4 shows a restructured item- ized list of the FF&E of R&B Grill. It is revised to accommodate more details to present more accurate information of the R&B Grill’s fi nancial position. The original FF&E T-account of $500,000 is now divided into three separate long-term asset accounts – FF&E, Leasehold Improve- ment, and Smallware. FF&E stands for Furniture, Fixture, and Equip- ment. Leasehold Improvement is the amount spent to convert the leased space into a restaurant by installing power cables, pluming, carpet and fl ooring, signage, and many other supporting devices. Smallware rep- resents such items as plates, cups and glasses, silverware, linen, and other similar items. It must be noticed that each account is followed by individual Accumulated Depreciation T-accounts. This is explained fur- ther in the sixth problem in the Example 3.1.
The “Long-term Liabilities” are listed under the Current Liabilities.
Long-term Liabilities include the liability items that can be paid over 1-year time. Notes Payable account is a good example. Usually these items incur interest expenses that are presented in the Income State- ment. These debts, however, usually require a long series of monthly payments of a fi xed amount that includes the principal and the interest.
This is called the “debt service.” The technique of determining the fi xed amount of debt service will be introduced in the third part of this book.
In the revised Balance Sheet (Table 3.4), one comprehensive Notes Pay- able account is divided into two separate accounts of N/P-A and N/P-B.
This will be introduced with more details in the eighth problem in the Example 3.1.
Table 3-05 Beginning Balances of T-accounts in the Year 1 Asset accountsLiability accountsEquity accountsRevenues & Expenses CashAccounts payableCommon stock – Rachel & BradRevenues Beg. Bal.438,00055,000Beg. Bal450,000Beg. Bal Accrued expenses 20,500Beg. BalCommon stock – JaneCost of sales 200,000Beg. Bal
Accounts receivableUnearned revenuesLabor expenses Beg. Bal.60,000–Beg. Bal InventoryNotes payable – ARestaurant operating expenses Beg. Bal34,800150,000Beg. Bal
Prepaid rentNotes payable – BUtility expenses Beg. Bal85,000250,000Beg. Bal Prepaid InsuranceInsurance expense Beg. bal16,500
Table 3-05 (Continued)
FF&E Administrative expenses
Beg. Bal500,000 Accumulated Depreciation – FF&ERepair and maintenance expenses 6000Beg.Bal
Rent expenses Interest expenses
Table 3-05 (Continued)
The revised formats of R&B Grill’s fi nancial statements can pro- vide readers with specifi c information that can analyze the performance and the status of the business using the subtotals on each segment. It is time to move to more advanced applications. Let us practice with the following examples of the next year’s business activities. Example 3.1 is provided to help readers review and practice necessary accounting concepts and techniques introduced so far. It is strongly recommended that readers follow through the given problems thoroughly and prepare their own fi nancial statements. For practice purpose, miscellaneous cal- culations are eliminated. Readers are encouraged to post these records to each T-account. The solution table (of the T-accounts) will be provided later for verifi cation. Make sure that the beginning balances are recorded correctly.