Basic Accounting Concepts The Income Statement ppt

Basic Accounting Concepts The Income Statement ppt - Transcript

3
Basic Accounting Concepts The Income Statement

Balance Sheet Review
Status report Financial position at point in time Assets liabilities shareholders equity

1 2

Basic Concepts Chapter 2 Last Chapter
Money measurement Entity Going concern Cost Dual aspect

1 3

Basic Concepts Chapter 3 This Chapter
Accounting period Conservatism Realization Matching Consistency Materiality

1 4

Nature of Income
Summarizes results of operations for a period of time Flow report Flows are continuous Focuses on earnings activities or operating activities
Reports nature and magnitude

1 5

Elements of Income Statement
Revenues
Inflows or creation of assets that result from sales of goods or services

Expenses
Outflows or consumption of resources to generate revenues

Revenues expenses income net income loss earnings profit net earnings loss
1 6

Concept 6 Accounting Period
Net income for life of company
Money in money out

Accounting period
Specified arbitrary interval of time

Accounting year fiscal year calendar year if fiscal YE is 12 31 Natural business year 1 31 for retailers
1 7

Interim Reports
Reports on periods less than fiscal year SEC requires quarterly Management may require monthly or weekly or daily

1 8

Income and Owners Equity
Owners equity Stockholders equity for a corporation Paid in capital Retained earnings RE net income dividends Net income Revenues expenses Increases RE
Revenues and net income

Decreases RE
Expenses and net losses
1 9

Terminology Cautions
Read as not necessarily the same as
Income revenue Net income increase in cash Retained earnings cash

1 10

Concept 7 Conservatism
prudent reporting based on healthy skepticism builds confidence in the results Preference for understatement rather than overstatement of assets and earnings and Owners equity
If 2 estimates are equally likely use the one that results in smaller assets and earnings
1 11

Conservatism More Formally Stated
Recognize revenues when reasonably certain Recognize expenses when reasonably possible Requires judgment

1 12

Application of Conservatism Inventory
How much should the following inventory items be valued at 12 31
Cost of item A is 500 We could sell item A for 800 Cost of item B is also 500 Because of a new competitor s product on the market item B can be sold for only 400

Example of lower of cost or market LCM
1 13

Application of Conservatism Revenue Recognition
Earning process is complete
Sale of goods recognized when
Goods are shipped

Revenue from services recognized when
Services are performed

1 14

Cash Receipts and Revenue Recognition
Cash can be collected in the period before same as or after revenue is earned
Precollected
Unearned revenue a liability

Collected after recognition
Sale on credit Accounts receivable on BS

Accrued revenue
E g interest receivable Accrued interest 1 15 Earned but not yet received

Revenue Recognition Exercise
For each of the following indicate how much revenue is earned and the amount of receivable or liability on the BS
We sold subscriptions for 1 200 The magazines will be sent next year We shipped goods for which the customer will pay 1 500 next month On 9 30 we loaned 1 000 8 interest and principal are to be paid in one year It is now 12 31
1 16

Concept 8 Realization
Indicates amount of revenue that should be recognized
Conservatism concept indicates when revenue should be recognized

Recognize as revenue
Amount that is reasonably certain to be realized

Realized cash received
1 17

Realization Concept Exercise
For each of the following how much revenue should be recorded
The list price of the product sold to a customer is 100 000 Because of the large quantity we agreed to a 15 discount off of list We are a retail store that sells for cash and on credit We sold 400 000 on credit last month Based on prior experience we expect that we will eventually collect about 97 of our sales We sold 10 000 of old product on credit The customer is very weak financially
1 18

Summary of Determination of Revenue
Recognize revenue when
Earned Conservatism and Realized or realizable Realization

1 19

Concept 9 Matching
When an event affects both revenues and expenses the effect should be recognized in the same accounting period
First determine revenues for period Then expense matching items of cost

1 20

Terminology Related to Expenses
Cost a monetary measurement of the amount of resources used for some purpose Expenditure a decrease in an asset or increase in a liability Expense an item of cost applicable to the current accounting period Disbursement a payment of cash
1 21

Criteria for Expense Recognition
Direct matching e g COGS Period costs items of expense of an accounting period that cannot be traced to specific revenue transactions e g president s salary Costs not associated with future revenue e g inventory determined to be obsolete unsalable

1 22

Expense Recognition Exercise
Classify the following as 1 direct matching 2 period costs or 3 costs not associated with future benefits and indicate when expensed
Costs of goods sold Controller s salary Sales person s commission based on sales Inventory that just became obsolete Sales person s monthly salary Building lost in a fire
1 23

Expenses and Expenditures
Expenditures
Made by paying cash or incurring a liability Occur when acquiring goods or services Can be assets and or expenses No necessary relationship between amounts of expenditures and expenses
Except over life of entity

1 24

Types of Expenditure Expense Transactions
1 Expenditures and expenses of same year 2 Expenditures of prior year assets at beginning of year that are expenses of this year 3 Expenditures of this year that are expenses of future years assets at end of year 4 Expenses of this year that will be paid for in future years liabilities at end of year
1 25

Exercise
Which type of expenditure are each of the following President s salary rent of sales office Inventory purchased last year sold this Building purchased several years ago Insurance premium paid last year Costs of goods purchased or produced this year but not yet sold Equipment purchases December salary of president not yet paid Interest expense on loan not yet paid

1 26

Dividends
Distribution of earnings to owners not an expense Cash dividends reduce cash and Retained earnings by same amount

1 27

Gains and Losses
Not associated with routine operations Cash received if any less costs Gains increase RE similar to revenues Losses decrease RE similar to expenses In practice no sharp distinction between gains and revenues and expenses and losses
1 28

Concept 10 Consistency
Once an accounting method is selected use for all subsequent events of same character Can change if there is sound reason to change
Must be disclosed to users

Consistency overtime not over different types of transactions
1 29

Concept 11 Materiality
Insignificant events may be disregarded
Amounts need not be exact as long as inaccuracy would not affect decisions of users

Full disclosure of all important info Overriding concern Would knowledge of event affect decisions of users Application of judgment and common sense
1 30

Income Statement
Also called Profit Loss statement P L statement statement of earnings statement of operations Technically subordinate to BS
Shows detail of changes to RE

Many investors consider IS more important than BS Variations in format
1 31

Parts of Income Statement
Heading
1 Name of entity 2 Name of statement 3 Time period covered



Revenues Cost of Sales Gross Margin Expenses Net Income
1 32

Revenues in Income Statement
Several separate revenue items or net Net sales gross sales sales returns and allowances sales or cash discounts
Trade discounts not shown Excludes sales or excise taxes collected for government Other revenues from activities not associated with sales of entity s goods services may be included in net sales or shown separately
1 33

Expenses on Income Statement
Cost of Sales or cost of goods sold
Associated with a decrease in the asset inventory

Gross margin gross profit Sales COGS
May or may not be shown

Separate disclosure of
Research development expenses Interest expense

1 34

Income Statement Format
Operating income may be shown before Other revenues and expenses Income before taxes Operating income adjusted for other revenues and expenses Net income Income before taxes Income tax expense

1 35

Statement of Retained Earnings
May be presented at bottom of Income Statement Reconciles change in RE from beginning i e end of last period to end of this period Beg RE NI Div End RE Articulates BS and IS
NI from IS less dividends explains changes in RE
1 36

Concepts of Income
Accrual accounting GAAP focus of text Cash basis accounting
Cash receipts revenues cash payments expenses

Modified cash basis accounting
E g cash basis except for inventory and longlived assets

1 37

Concepts of Income Continued
Income Tax Accounting
Similar but not identical to accrual GAAP Objectives differ from GAAP

Pro forma earnings
Alternative to GAAP excludes item s management deems to be nonrecurring

Economic Income
Value at end value at beginning return on invested capital Considers cost of using owners investment as an expense

1 38

Accounting for Changing Prices
Not required by U S GAAP
Required in some countries with high rates of inflation Used by some multinational companies for internal performance measurement Previously required by U S GAAP in supplemental disclosures

Ignoring changing prices during periods of inflation tends to
Overstate return on investment Makes comparisons between companies difficult
1 39

Approaches to Accounting for Price Changes
Constant dollar accounting
Adjust for general price changes Restates financial statements to purchasing power equivalent as of a common date

Current cost accounting
Costs adjusted to their replacement cost or specific prices

1 40