Topic 5 - Measurement Of Business Income

Chapter MEASUREMENT OF

5

BUSINESS INCOME

Learning Objectives  Explain

expenses and revenue concept  Describe permanent and temporary accounts  Explain the accounting cycle

REVENUE  Are

the gross increase in owner’s equity resulting from business activities entered into for the purpose of earning income  Revenues usually result in an increase in an asset.  Revenue result from the sales of goods and services, fees, interest, dividends, royalties, grants and rent.

EXPENSES  Expenses

are decreases in owner’s equity that result from operating the business.  They are the costs of assets consumed or services used in the process of earning revenue  Decrease in assets or an increase in liabilities  E.g: rent expense, delivery expense, supplies expense, interest expense, salary expense, utility expense

Recognizing Revenues and Expenses Accrual Basis

Cash Basis

Revenues are recognized when earned and expenses are recognized when incurred.

Revenues are recognized when cash is received and expenses recorded when cash is paid.

Accounting

Recognizing Revenues and Expenses Accrual Basis

Cash Basis

Revenues are recognized when earned and expenses are recognized when incurred.

Revenues are recognized when cash is received and expenses recorded when cash is paid.

Not GAAP Accounting

Recognizing Revenues and Expenses (Accrual Basis) 1.

Revenue Recognition - Revenue be recorded when earned, either    

Ownership has been transferred Services has been completely provided Percentage of completion method Installment method

We have delivered the product to our customer, so I think we should record the revenue earned.

Recognizing Revenues and Expenses (Accrual Basis) 2. Matching Principle 

Expenses are matched against revenues, and recorded in the same period in which the related revenues are earned

Summary of Expenses Rent Gasoline Advertising Salaries Utilities and . . . .

$1,000 500 2,000 3,000 450 ....

Now that we have recognized the revenue, let’s see what expenses we incurred to generate that revenue.

Example

Example – Cash Basis Insurance Expense 2006 Jan Feb Mar Apr $

May

$

Jun

$

Jul

$

Aug

$

Sep

$

Oct

$

Nov

$

Dec

$

-

$

-

$

-

$ 2.400

On the cash basis the entire $2,400 would be recognized as insurance expense in 2006. No insurance expense from this policy would be recognized in 2007 or 2008, periods covered by the policy.

Example - Accrual Basis Insurance Expense 2006 Jan Feb Mar Apr $

May

$

Jun

$

Jul

$

Aug

$

Sep

$

Oct

$

Nov

$

Dec

$

-

$

-

$

-

$

100

Insurance Expense 2007 Jan Feb Mar Apr $

100 $ 100 $ 100 $ 100 May Jun Jul Aug

$

100 $ 100 $ 100 $ 100 Sep Oct Nov Dec

$

100 $

100 $

100 $

100

Insurance Expense 2008 Jan Feb Mar Apr $

100 $ 100 $ 100 $ 100 May Jun Jul Aug

On the accrual basis $100 of insurance expense is recognized in 2006, $1,200 in 2007, and $1,100 in 2008. The expense is matched with the periods benefited by the insurance coverage.

Examples: Revenue Recognition 20 Dec 2007 : Completed work for a client and sent a bill for RM5,000 to be paid within 30 days. The accounting period for year 2007 is 1 January 2007 31 December 2007. 

Cash basis?



Accrual basis?

Temporary and Permanent Accounts

Income Summary

Liabilities

Permanent Accounts

Owner’s Capital

Temporary Accounts

Assets

Withdrawals

Expenses

Revenues

The Theclosing closing process process applies appliesonly onlyto to temporary temporaryaccounts. accounts.

The Accounting Cycle Closing Entries Financial Statements

Journal

Adjusted Trial Balance

Adjustments

Source Documents

Trial Balance

Ledger