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Chapter 3 - The income statement. In this chapter you will learn why the income statement is so important to all those who will typically review and analyze it. You will also see why it is so critical for the manager who is actually operating the business to be able to read and correctly analyze and interpret the income statement.
Chapter The Income Statement © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Chapter Outline The Purpose of the Income Statement Income Statement Preparation Income Statement Analysis © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Learning Outcomes State the purpose of regularly preparing an income statement for a hospitality business Explain the way managers and accountants actually prepare an income statement Analyze an income statement to improve the operation of your own business © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes The Purpose of the Income Statement When you manage a hospitality facility, you will receive Revenue, the term used to indicate the money you take in, and you will incur Expenses, the cost of the items required to operate the business The dollars that remain after all expenses have been paid represent your profit Revenue – Expenses = Profit © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes The Purpose of the Income Statement Many hospitality managers call each individual revenue generating segment within their business a profit center The revenue-expense = profit formula holds even in what is not typically considered a for-profit segment of the hospitality industry In many business dining situations, food is provided as a service to the company’s employees either as a nocost (to the employee) benefit or at a greatly reduced price Thus, it is common in many situations to operate a cost center that generates costs but no revenue © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes The Purpose of the Income Statement All stakeholders who are affected by a business’s profitability will care greatly about the effective operation of a hospitality business Owners Investors Lenders Creditors Managers When an accurate income statement is used to provide information, the business’s owners, lenders, investors and managers can all make better decisions about how best to develop and operate it © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Return on Investment Investors are particularly interested in return on investment (ROI), which measures the quality or strength of an investment The income statement is the source of the information required to determine the numerator of the ROI calculation ROI is computed as follows: Money earned on funds invested Funds invested © 2009 John Wiley & Sons Hoboken, NJ 07030 = ROI Managerial Accounting for the Hospitality Industry Dopson & Hayes Income Statement Preparation In very small hospitality operations, the owner or managers of the business may be responsible for the preparation of the income statement In larger restaurant chain operations, the manager may submit financial data to a centralized accounting office, which would then prepare the unit’s income statement In very large restaurants and in many hotels, the income statement may be prepared by professionals who work on-site © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Format of the Income Statement An income statement is designed to identify revenues, expenses, and profits and is a summary of financial information for a defined accounting period In its very simplest structure, the income statement appears as follows: Figure 3.1 Summary of Financial Information Blue Lagoon Water Park Resort Income Statement For the Period: January through January 31, 2010 © 2009 John Wiley & Sons Hoboken, NJ 07030 Revenues $ 2,100,150 Expenses $ 1,937,976 Income (Loss) Before Income Taxes $ 162,174 Managerial Accounting for the Hospitality Industry Dopson & Hayes Format of the USAR A restaurant income statement, using the Uniform System of Accounts for Restaurants (USAR), shows sales and cost of sales related to food and beverage and any other expenses related to the functioning of the restaurant Figure 3.2 shows the restaurant income statement using the USAR © 2009 John Wiley & Sons Hoboken, NJ 07030 10 Managerial Accounting for the Hospitality Industry Dopson & Hayes Vertical Analysis Expenses should increase when increased revenues require management to provide more products or labor to make the sale If expenses are reduced too much, the effect on revenue can be both negative and significant Managers analyzing the expense portion of an income statement should be most concerned about the relationship between revenue and expense (vertical analysis) and less concerned about the total dollar amount of expense © 2009 John Wiley & Sons Hoboken, NJ 07030 42 Managerial Accounting for the Hospitality Industry Dopson & Hayes Vertical Analysis As a professional hospitality manager, you can even more to analyze expenses in each line item Figure 3.13 expresses each direct operating expense as a percentage of total direct operating expenses This is a form of vertical analysis because the common denominator for all expense % calculations is total direct operating expenses © 2009 John Wiley & Sons Hoboken, NJ 07030 43 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 3.13 Vertical Analysis - Direct Operating Expenses Schedule Joshua’s Restaurant Direct Operating Expenses Schedule For the Year Ended December 31, 2010 © 2009 John Wiley & Sons Hoboken, NJ 07030 Type of Expense Uniforms Laundry and Linen China and Glassware Expense $ 13,408 40,964 22,475 Silverware Kitchen Utensils Kitchen Fuel Cleaning Supplies Paper Supplies Bar Expenses Menus and Wine Lists 3,854 9,150 2,542 10,571 2,675 5,413 6,670 Exterminating Flowers and Decorations Licenses Total Direct Operating Expenses 1,803 9,014 3,604 132,143 44 % of Direct Operating Expenses Notes 10.2 31.0 17.0 Expense is higher than budgeted because china shelf collapsed on March 22 2.9 6.9 1.9 8.0 2.0 4.1 5.1 Expense is lower than budgeted because the new wine supplier agreed to print the wine lists free of charge 1.4 6.8 2.7 100.00 Managerial Accounting for the Hospitality Industry Dopson & Hayes Vertical Analysis For example, the $40,964 expended for laundry and linen comprises 31.0% of all direct operating expenses g o fig u re! The formula utilized to compute the percentage in this example is: Specific Expense Total Expenses = Specific Expense % or Laundry and Linen Expense Total Direct Operating Expenses = Laundry and Linen Expense % or $40,964 $132,143 © 2009 John Wiley & Sons Hoboken, NJ 07030 45 = 31.0% Managerial Accounting for the Hospitality Industry Dopson & Hayes Horizontal Analysis Managers can utilize horizontal analysis (also called comparative analysis) to evaluate the dollars or percentage change in revenues, expenses, or profits A horizontal analysis of income statements requires at least two different sets of data Managers may be concerned with comparisons such as: Current period results vs prior period results Current period results vs budgeted (planned) results Current period results vs the results of similar business units Current period results vs industry averages © 2009 John Wiley & Sons Hoboken, NJ 07030 46 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 3.14 Comparative Analysis of a Restaurant Income Statement Joshua’s Restaurant Income Statements For the Years Ended December 31, 2009 and 2010 SALES: Food Beverage Total Sales COST OF SALES: Food Beverage Total Cost of Sales GROSS PROFIT: Food Beverage Total Gross Profit OPERATING EXPENSES: Salaries and Wages Employee Benefits Direct Operating Expenses Music and Entertainment Marketing Utility Services Repairs and Maintenance Administrative and General Occupancy Depreciation Total Operating Expenses Operating Income Interest Income Before Income Taxes Income Taxes Net Income 2009 2010 $ Change % Change $1,891,011 415,099 2,306,110 $2,058,376 482,830 2,541,206 167,365 67,731 235,096 8.9 16.3 10.2 712,587 94,550 807,137 767,443 96,566 864,009 54,856 2,016 56,872 7.7 2.1 7.0 1,178,424 320,549 1,498,973 1,290,933 386,264 1,677,197 112,509 65,715 178,224 9.5 20.5 11.9 641,099 99,163 122,224 2,306 43,816 73,796 34,592 66,877 120,000 41,510 1,245,383 253,590 86,750 166,840 65,068 101,772 714,079 111,813 132,143 7,624 63,530 88,942 35,577 71,154 120,000 55,907 1,400,769 276,428 84,889 191,539 76,616 114,923 72,980 12,650 9,919 5,318 19,714 15,146 985 4,277 14,397 155,386 22,838 (1,861) 24,699 11,548 13,151 11.4 12.8 8.1 230.6 45.0 20.5 2.8 6.4 0.0 34.7 12.5 9.0 (2.1) 14.8 17.7 12.9 Prepared using USAR © 2009 John Wiley & Sons Hoboken, NJ 07030 47 Managerial Accounting for the Hospitality Industry Dopson & Hayes Determining Variance The variance shows changes from previously experienced levels, and will give you an indication of whether your numbers are improving, declining, or staying the same All dollar variances and percentage variances of expenses on the income statement can be calculated in the same way The comparative income statement helps managers analyze their expenses and take corrective action if it is needed © 2009 John Wiley & Sons Hoboken, NJ 07030 48 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! To calculate the variance, Joshua would use the following formula: Sales This Year – Sales Last Year =Variance or $2,541,206 - $ 2,306,110 = $235,096 Effective managers are also interested in computing the percentage variance, or percentage change, from one time period to the next Thus, Joshua’s sales percentage variance is determined as follows: (Sales This Year –Sales Last Year) Sales Last Year = Percentage Variance or ($2,541,206 - $2,306,110) $2,306,110 © 2009 John Wiley & Sons Hoboken, NJ 07030 49 = 10.2% Managerial Accounting for the Hospitality Industry Dopson & Hayes (g o fig u re! continued) Of course, an alternative and shorter formula for computing the percentage variance is as follows: Variance Sales Last Year = Percentage Variance or $235,096 $2,306,110 = 10.2% Another way to compute the percentage variance is to use a math shortcut, as follows: Sales This Year Sales Last Year –1 = Percentage Variance –1 = 10.2% or $2,541,206 $2,306,110) © 2009 John Wiley & Sons Hoboken, NJ 07030 50 Managerial Accounting for the Hospitality Industry Dopson & Hayes Determining Variance from Budget There are two basic formulas used by managers to compare actual expenditures to budgeted expenditures These are: Variation (in dollars) from budget Percent of variation from budget For example, Figure 3.16 shows a comparative analysis for the Property Operations and Maintenance Schedule for the Blue Lagoon © 2009 John Wiley & Sons Hoboken, NJ 07030 51 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 3.16 Comparative Analysis - Property Operations and Maintenance Schedule Blue Lagoon Water Park Resort Property Operations and Maintenance Schedule For the Period: January through January 31, 2010 Difference $ % Budget Actual Payroll and Related Expenses Chief Engineer Engineer Assistants Benefit Allocation Total Payroll and Related Expenses $ 4,800 12,060 6,840 $23,700 $ 4,711 12,089 7,500 $24,300 (89) 29 660 600 (1.9) 0.2 9.6 2.5 Other Expenses Computer Equipment Equipment Rental Electrical & Mech Equipment Elevators Elevator Repairs Engineering Supplies Floor Covering Furniture Grounds HVAC (heating/ventilation and air conditioning.) Kitchen Equipment Laundry Equipment Light Bulbs Maintenance Contracts Operating Supplies Painting & Decorating Parking Lot Pest Control Plants & Interior Plumbing & Heating Refrigeration & A/C Signage Repair Snow Removal Travel & Entertainment Telecommunications Trash Removal Uniforms Total Other Expenses $1,200 3,900 9,000 2,520 420 1,350 600 9,000 3,000 9,000 300 450 900 4,200 480 1,500 1,800 1,200 885 4,500 5,460 300 6,000 1,200 600 1,800 1,650 $73,215 $1,695 4,200 8,490 2,520 840 1,050 11,460 3,360 8,550 534 336 900 3,948 477 852 2,568 1,290 888 5,340 5,880 5,910 570 528 1,680 1,584 $75,450 495 300 (510) 420 (300) (600) 2,460 360 (450) 234 (114) (252) (3) (648) 768 90 840 420 (300) (90) (630) (72) (120) (66) 2,235 41.3 7.7 (5.7) 0.0 100.0 (22.2) (100.0) 27.3 12.0 (5.0) 78.0 (25.3) 0.0 (6.0) (0.6) (43.2) 42.7 7.5 0.3 18.7 7.7 (100.0) (1.5) (52.5) (12.0) (6.7) (4.0) 3.1 Total Property Operations and Maintenance $96,915 $99,750 2,835 2.9 © 2009 John Wiley & Sons Hoboken, NJ 07030 52 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! Thus, for example, (from Figure 3.16) in the area of computer equipment, the variation (in dollars) from budget for the Blue Lagoon’s Property Operations and Maintenance department would be computed as: Actual Expense – Budgeted Expense =Variance or $1,695- $1,200 = $495 Some managers prefer to express variations from budget in percentage terms Thus, the percentage variance for computer equipment is determined as follows: (Actual Expense –Budgeted Expense) Budgeted Expense = Percentage Variance or ($1,695 - $1,200) $1,200 = 41.3% © 2009 John Wiley & Sons Hoboken, NJ 07030 53 Managerial Accounting for the Hospitality Industry Dopson & Hayes (g o fig u re! continued) Of course, an alternative and shorter formula for computing the percentage variance is as follows: Variance Budgeted Expense = Percentage Variance or $495 $1,200 = 41.3% Another way to compute the percentage variance is to use a math shortcut, as follows: Actual Expense Budgeted Expense – = Percentage Variance or $1,695 $1,200 © 2009 John Wiley & Sons Hoboken, NJ 07030 54 – = 41.3% Managerial Accounting for the Hospitality Industry Dopson & Hayes Determining Variance from Budget If our budget was accurate, and we are within reasonable limits of our budget, we are said to be in-line or in compliance with our budget If, as management, we decided that plus (more than) or minus (less than) a designated percentage (such as 10%) of budget in each category would be considered in-line or acceptable, we are in-line with regard to expenses A significant variation is any variation in expected costs that management feels is a case for concern © 2009 John Wiley & Sons Hoboken, NJ 07030 55 Managerial Accounting for the Hospitality Industry Dopson & Hayes Review of Learning Outcomes State the purpose of regularly preparing an income statement for a hospitality business Explain the way managers and accountants actually prepare an income statement Analyze an income statement to improve the operation of your own business © 2009 John Wiley & Sons Hoboken, NJ 07030 56 Managerial Accounting for the Hospitality Industry Dopson & Hayes ... Interest Income Before Income Taxes Income Taxes Net Income 2,058 ,37 6 482, 830 2,541,206 767,4 43 96,566 864,009 1,290, 933 38 6,264 1,677,197 714,079 111,8 13 132 ,1 43 7,624 63, 530 88,942 35 ,577 71,154... Hoboken, NJ 07 030 30 Managerial Accounting for the Hospitality Industry Dopson & Hayes Profit (Loss) Analysis For most hospitality managers, the “bottom line” is not the most important number on the income... horizontal format © 2009 John Wiley & Sons Hoboken, NJ 07 030 13 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 3. 3 Hotel Income Statement – Vertical Format Blue