Chapter 3 Unit 4 - AccountingThe Income Statement

Mrs. Joudrey

Purpose of Accounting

• Purpose of accounting – to provide financial information that is used to make decisions

What is Profit and Loss?

• Profit – the increase in owner’s equity that results from the successful operations of a business.

• Loss – decrease in owner’s equity – happens when the business is not successful

Revenue

• Businesses sell goods (ex. cars) or services (ex. haircuts)

• Revenue is the money the company will get from the sale of a good or service.– Money coming in

Expenses

• Expenses are the cost of items or services needed to run the business (all the things the business has to spend money on to be able to sell the goods or services – example: salaries, advertising etc.)– Money going out

Example:

• A company sells a television for $500. The business has to pay $400 to be able to sell the television. Does this business make a profit or loss? How much?

• Answer: ?

• The total revenue is greater than the total expenses so there is a profit

Net Income

• Net Income is the term we use in accounting for profit.

• Net Income occurs when total revenue is greater than total expenses.

Example:

• A company sells haircuts for $50. The business has to pay $55 to be able to sell these haircuts. Does this business make a profit or loss? How much?

• Answer: ?

• The total expenses are greater than the total revenue so there is a loss

Net Loss

• Net Loss is the term we use in accounting for loss.

• Net Loss occurs when total expenses are greater than total revenue.

• Revenue>Expenses=Net Income

• Revenue<Expenses= Net Loss

Income Statement

• Income statements summarize the items of revenue and expense to determine if there is a net income or net loss for a specific period of time (this period of time is referred to as the accounting period – the period of time covered by the financial statements).

Heading Information

• Who? – Goldman’s Gym

• What? – Income Statement

• When? – For the month ended September 30, 2011-10-04

• Note: Balance sheets are prepared for a specific date

• Income statements are prepared for a period of time

Note the Following:

• Dollar signs at the beginning of each column and at the final total

• Revenue section then space then expenses

• Amounts are listed in the column closest to the accounts – totals are in the far right column.

• Difference between total revenue and total expenses is the net income or net loss.

Time-Period Principle

• Time-Period Principle – same period of time must be used for the accounting period (ex. monthly, semi-annually etc.) you can’t change the period of time between when you will put your financial statement out.

Matching Principle

• Matching Principle – costs recorded as expenses must be matched with the revenue they helped generate during the same accounting period. This will give an accurate net income/loss. Expenses are recorded when the cost happened, whether paid in cash or on credit.

Effects of an Error in Applying the Matching Principle

• The chart below shows what could happen if the expense of $2000 that should have been recorded in July was recorded in August.

Results of the Error

• If someone was looking at these statements they would think that the company had a great month in June (net income of 3000), but they didn’t have a good month in July (net loss $1000). It looks like the company is inconsistent and might make some potential investors think twice if they were planning on investing in this company. However, if the company recorded everything correctly, it would show that the company has been consistent during June and July (Net Income of 1000 each month).

Accrual Basis of Accounting

• Accrual Basis of Accounting – matches revenue earned with expenses incurred during the accounting period.

• A business that records revenue when earned and expenses when incurred is using the accrual basis of accounting.

Recording Revenue:

• Revenue is recorded when the service is performed or when goods are shipped to a customer (even if cash has not been received).

Recording Expenses:

• Expenses are the costs incurred to generate revenue

• Expenses are recorded as they are incurred (doesn’t matter if they are cash or on credit)

Example:

• During the first week of June, lawyer Carmen Piccolo performed a variety of services for clients. Some for the clients paid cash for services totalling $2000. The remainder of the clients were billed $2500 for the services. The total revenue recorded for June was $4500 even though only $2000 cash was received.

Example

Services

performed and paid for in cash

+ Services performed on credit

= Total Revenue to record

2000 + 2500 = 4500

Cash Basis of Accounting

• Cash basis of accounting is another method to record expenses and revenue. The cash basis of accounting is when expenses are recorded only when the cash is paid for an expense and revenue is recorded only when cash is received. This principle does not follow the matching principle – for that reason the cash basis of accounting is not used by accountants for a business.