Chapter 2 income statement

OPEN UNIVERSITY HCMC MBA PREPARATORY COURSE Principles of Financial Accounting 06/04/16 NGUYEN TAN BINH - PHAN DUC DUNG Chapter Income statement 06/04/16 NGUYEN TAN BINH Learning Objectives After studying this chapter, you should be able to:     Explain how accountants measure income Use the concepts of recognition, matching, and cost recovery to record revenues and expenses Prepare an income statement and show how it is related to a balance sheet Calculate operating cash flows and show how cash flow differs from income 06/04/16 NGUYEN TAN BINH Introduction to Income Measurement  Income is a measurement of evaluating performance   All income should be measured in the same way following a common set of rules Using a common set of rules allows decision makers to compare the performance of one company with that of other companies because measurement is the same in all companies 06/04/16 NGUYEN TAN BINH Operating Cycle  Operating cycle - the time span during which cash is used to acquire goods and services, which in turn are sold to customers, who in turn pay for their purchases, with cash Buy Cash 7,000 Merchandise Inventory 7,000 Sell Accounts Receivable 10,000 Collect 06/04/16 NGUYEN TAN BINH Revenues and Expenses  Revenues (sales) - gross increases in owners’ equity arising from increases in assets received in exchange for the delivery of goods or services to customers  Expenses - decreases in owners’ equity that arise because goods or services are delivered to customers 06/04/16 NGUYEN TAN BINH Revenues and Expenses  Income (profit) - the excess of revenues over expenses   Revenues - Expenses = Profit Retained income - additional owners’ equity generated by income or profits   Revenues increase owners’ equity Expenses decrease owners’ equity 06/04/16 NGUYEN TAN BINH Accrual and Cash Basis  The most common ways of measuring income are the accrual basis and the cash basis  Accrual basis - recognizes the impact of transactions for the time periods when revenues and expenses occur even if no cash changes hands  Cash basis - recognizes the impact of transactions only when cash is received or disbursed 06/04/16 NGUYEN TAN BINH Accrual and Cash Basis  Under the accrual basis:  Revenues are recorded when earned   For example, a sale on account is recorded as revenue when the transaction takes place even though the seller receives no cash at that moment Expenses are recorded when incurred  For example, a purchase on account is recorded as an expense when the transaction takes place even though the buyer disburses no cash at that moment 06/04/16 NGUYEN TAN BINH Accrual and Cash Basis  Under the cash basis:   Revenues are recorded when a sale is made for cash at the time when the cash changes hands Expenses are recorded when a purchase is made for cash at the time when the cash changes hands 06/04/16 NGUYEN TAN BINH 10 Accrual and Cash Basis  The accrual basis is the current standard for the measurement of income    06/04/16 Presents a more complete summary of what happened during the year Recognizes revenues when they are earned and expenses when they are incurred Matches expenses to revenues NGUYEN TAN BINH 11 Recognition of Revenues  Recognition - a test to determine whether revenues should be recorded in the financial statements for a given period  To be recognized, revenue must be:   Earned - goods are delivered or a service is performed Realized - cash or a claim to cash (credit) is received in exchange for goods or services 06/04/16 NGUYEN TAN BINH 12 Matching and Cost Recovery Two types of expenses:  Product costs - those linked with revenue earned in the same period  Cost of goods sold or sales commissions   Without sales there is no cost of goods sold or sales commissions Period costs - those linked with the time period itself  Rent or other administrative expenses  06/04/16 Rent is paid even if no sales are made NGUYEN TAN BINH 13 Matching and Cost Recovery  Matching - recording of expenses in the same time period as the related revenues are recognized  Cost recovery - concept by which some purchases of goods or services are recorded as assets and “expired” later because the costs are expected to be recovered in future periods  An example is rent for one year paid in advance 06/04/16 NGUYEN TAN BINH 14 Matching and Cost Recovery  Another example of matching and cost recovery is depreciation  Depreciation - the systematic allocation of the acquisition cost of long-lived assets or fixed assets to the expense accounts of particular periods that benefit from the use of the assets 06/04/16 NGUYEN TAN BINH 15 Expansion of the balance sheet equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + Paid-in Capital + Retained Income Assets = Liabilities + Paid-in Capital + Revenues - Expenses 06/04/16 NGUYEN TAN BINH 16 The Income Statement  Income Statement - a report of all revenues and expenses pertaining to a specific time period  Net income - the remainder after all expenses (including income taxes) have been deducted from revenue   Often seen as the “bottom line” Net loss - the excess of expenses over revenues 06/04/16 NGUYEN TAN BINH 17 The Income Statement (IS) SAIGON MILK COMPANY Income Statement for the Year Ended December 31, 2005 (in millions VND) Sales Expenses: Wages expense Rent expense Utilities expense Depreciation expense Total expenses Net Income 06/04/16 10,000 1,800 3,500 1,500 400 7,200 2,800 NGUYEN TAN BINH 18 Relationship between IS and BS  The balance sheet provides a snapshot of an entity’s financial position at an instant in time  The income statement provides a moving picture of events over a span of time and explains the changes that have taken place between balance sheet dates 06/04/16 NGUYEN TAN BINH 19 Cash Flows Statement (CFS)  Income does not measure an entity’s performance in generating cash, especially if the income is measured using the accrual basis  In a way, accountants use both the accrual and cash bases   The accrual basis is used in the income statement The cash basis is used in the cash flows statement 06/04/16 NGUYEN TAN BINH 20 Cash Flows Statement  Statement of cash flows - reports the cash receipts and cash payments of an entity during a particular period  It summarizes activity over a period of time, so it must be labeled with the exact period covered • It details the changes in the cash account, much like the income statement which shows changes in retained earnings 06/04/16 NGUYEN TAN BINH 21 The Language of Accounting in the Real Life  Organizations use different terms to describe the same concept or account Net Income Retained Income Net Earnings Profit Retained Earnings Reinvested Earnings Earnings retained for use in the business Profit employed in the business References: Horngren, Introduction to financial accounting 06/04/16 NGUYEN TAN BINH 22 [...]... the excess of expenses over revenues 06/04/16 NGUYEN TAN BINH 17 The Income Statement (IS) SAIGON MILK COMPANY Income Statement for the Year Ended December 31, 20 05 (in millions VND) Sales Expenses: Wages expense Rent expense Utilities expense Depreciation expense Total expenses Net Income 06/04/16 10,000 1,800 3,500 1,500 400 7 ,20 0 2, 800 NGUYEN TAN BINH 18 Relationship between IS and BS  The balance... the income statement The cash basis is used in the cash flows statement 06/04/16 NGUYEN TAN BINH 20 Cash Flows Statement  Statement of cash flows - reports the cash receipts and cash payments of an entity during a particular period  It summarizes activity over a period of time, so it must be labeled with the exact period covered • It details the changes in the cash account, much like the income statement. .. Owners’ Equity Assets = Liabilities + Paid-in Capital + Retained Income Assets = Liabilities + Paid-in Capital + Revenues - Expenses 06/04/16 NGUYEN TAN BINH 16 The Income Statement  Income Statement - a report of all revenues and expenses pertaining to a specific time period  Net income - the remainder after all expenses (including income taxes) have been deducted from revenue   Often seen as the... entity’s financial position at an instant in time  The income statement provides a moving picture of events over a span of time and explains the changes that have taken place between balance sheet dates 06/04/16 NGUYEN TAN BINH 19 Cash Flows Statement (CFS)  Income does not measure an entity’s performance in generating cash, especially if the income is measured using the accrual basis  In a way,... 06/04/16 NGUYEN TAN BINH 21 The Language of Accounting in the Real Life  Organizations use different terms to describe the same concept or account Net Income Retained Income Net Earnings Profit Retained Earnings Reinvested Earnings Earnings retained for use in the business Profit employed in the business References: Horngren, Introduction to financial accounting 06/04/16 NGUYEN TAN BINH 22 ... current standard for the measurement of income    06/04/16 Presents a more complete summary of what happened during the year Recognizes revenues when they are earned and expenses when they are incurred Matches expenses to revenues NGUYEN TAN BINH 11 Recognition of Revenues  Recognition - a test to determine whether revenues should be recorded in the financial statements for a given period  To be... recognized, revenue must be:   Earned - goods are delivered or a service is performed Realized - cash or a claim to cash (credit) is received in exchange for goods or services 06/04/16 NGUYEN TAN BINH 12 Matching and Cost Recovery Two types of expenses:  Product costs - those linked with revenue earned in the same period  Cost of goods sold or sales commissions   Without sales there is no cost of