Operating Decisions And The Income Statement

Operating Decisions and the Income Statement Chapter 3

McGraw-Hill/Irwin

© 2009 The McGraw-Hill Companies, Inc.

The Operating Cycle Begin Purchase or manufacture products or supplies on credit. Receive payment from customers.

Pay suppliers. Deliver product or provide service to customers on credit.

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Slide 2

Elements on the Income Statement Revenues Revenues Increases Increases in in assets assets or or settlement settlement of of liabilities liabilities from from ongoing ongoing operations. operations. Expenses Expenses Decreases Decreases in in assets assets or or increases increases in in liabilities liabilities from from ongoing ongoing operations. operations. Gains Gains Increases Increases in in assets assets or or settlement settlement of of liabilities liabilities from from peripheral peripheral transactions transactions.. Losses Losses Decreases Decreases in in assets assets or or increases increases in in liabilities liabilities from from peripheral peripheral transactions. transactions. McGraw-Hill/Irwin

Slide 3

Cash Basis Accounting

Revenue is recorded when cash is received.

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Expenses are recorded when cash is paid.

Slide 4

Accrual Accounting Assets, liabilities, revenues, and expenses should be recognized when the transaction that causes them occurs, not necessarily when cash is paid or received.

Required by Generally Acceptable Accounting Principles McGraw-Hill/Irwin

Slide 5

Revenue Principle When the company delivers the goods or services UNEARNED REVENUE is reduced and REVENUE is recorded. Cash received before revenue is earned Cash Received Cash (+A) Unearned revenue (+L)

Company Delivers xxx

xxx Revenue will be recorded when earned.

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Slide 6

Revenue Principle

Typical liabilities that become revenue when earned include . . . CASH COLLECTED (Goods or services due to customers)

REVENUE over time will (Earned when goods become or services provided)

Rent collected in advance

Rent revenue

Unearned air traffic revenue

Air traffic revenue

Deferred subscription revenue

Subscription revenue

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Slide 7

Revenue Principle When the cash is received the ACCOUNTS RECEIVABLE is reduced. Cash received after revenue is earned Cash Received

Company Delivers

Accounts receivable (+A) Revenue (+R)

xxx

xxx Cash will be collected.

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Slide 8

Revenue Principle

Assets reflecting revenues earned but not yet received in cash include . . . CASH TO BE COLLECTED (Owed by customers)

and already earned as

REVENUE (Earned when goods or services provided)

Interest receivable

Interest revenue

Rent receivable

Rent revenue

Royalties receivable

Royalty revenue

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Slide 9

The Matching Principle Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid.

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Slide 10

The Matching Principle When the expense is incurred PREPAID EXPENSE is reduced and an EXPENSE is recorded. Cash is paid before expense is incurred $ Paid Prepaid expense (+A) Cash (-A)

Expense Incurred xxx

xxx Expense will be recorded when incurred.

McGraw-Hill/Irwin

Slide 11

The Matching Principle

Typical assets and their related expense accounts include. . . CASH PAID FOR

as used over time becomes

EXPENSE

Supplies inventory

Supplies expense

Prepaid insurance

Insurance expense

Buildings and equipment

Depreciation expense

McGraw-Hill/Irwin

Slide 12

A = L + SE ASSETS

LIABILITIES

Debit Credit for for Increase Decrease

Debit Credit for for Decrease Increase

Next, let’s see how Revenues and Expenses affect Retained Earnings.

McGraw-Hill/Irwin

CONTRIBUTED CAPITAL

RETAINED EARNINGS

Debit Credit for for Decrease Increase

Debit Credit for for Decrease Increase Slide 13

How are Financial Statements Prepared? Income Statement

Revenues – Expenses = Net Income

Statement of Retained Earnings

Beginning Retained Earnings + Net Income - Dividends Declared Ending Retained Earnings

Balance Sheet

Statement of Cash Flows McGraw-Hill/Irwin

Assets = Liabilities + Stockholders’ Equity Contributed Capital Retained Earnings Change = Cash from Operating Activities in + Cash from Investing Activities Cash + Cash from Financing Activities Slide 14

End of Chapter 3

© 2009 The McGraw-Hill Companies, Inc.