Chapter 3 The Income Statement Power Point Author

Chapter 3 The Income Statement Power. Point Author: Brandy Mackintosh, CA Copyright © 2016 by Mc. Graw-Hill Education

Learning Objective 3 -1 Describe common operating transactions and select appropriate income statement account titles. 3 -2

Operating Activities Operating activities include buying goods and services from suppliers and employees and selling goods and services to customers and then collecting cash from them. 3 -3

Income Statement Accounts Time Period Assumption: dividing the company’s long life into shorter chunks of time such as months, quarters, and years. 3 -4

Cash Basis Accounting Cash basis accounting records revenues when cash is received and expenses when cash is paid. 3 -5

Learning Objective 3 -2 Explain and apply the revenue and expense recognition principles. 3 -6

Accrual Basis Accounting GAAP/IFRS Records revenues when they are earned and expenses in the same period as the revenues to which they relate, regardless of the timing of cash receipts or payments. 3 -7

Revenue Recognition Principle Timing of Reporting Revenue versus Cash Receipts Revenue Recognition Principle Revenues are recognized when they are earned. 3 -8

Expense Recognition Principle (“Matching”) Timing of Reporting Expenses versus Cash Payments Record expenses in the same period as the revenues with which they can be reasonably associated. 3 -9

Learning Objective 3 -3 Analyze, record, and summarize the effects of operating transactions using the accounting equation, journal entries, and T-accounts. 3 -10

The Expanded Accounting Equation 3 -11

Sonic. Gateway’s Accounting Records (a) Sell games for Cash. In September, Sonic. Gateway sold $3, 000 of games at its online store. 1 Analyze = Assets Liabilities + (a) Cash +$3, 000 2 Sales Revenue (+R) +$3, 000 Record (a) Cash (+A) Sales Revenue (+R, +SE) 3 3, 000 Summarize dr + Beg. Bal. (a) 3 -12 Stockholders’ Equity Cash (A) 20, 700 3, 000 cr - dr - Sales Revenue (R, SE) cr + 0 Beg. Bal. 3, 000 (a)

Sonic. Gateway’s Accounting Records (b) Receive cash for future services. Sonic. Gateway issued three $100 gift cards at the beginning of September. 1 Analyze = Assets (b) Cash +$300 2 Liabilities Unearned Revenue Record 300 Summarize dr + Beg. Bal. (a) (b) 3 -13 Stockholders’ Equity +$300 (b) Cash (+A) Unearned Revenue (+L) 3 + Cash (A) 20, 700 3, 000 300 cr - dr - Unearned Revenue (L) cr + 0 Beg. Bal. 300 (b)

Sonic. Gateway’s Accounting Records (c) Sell apps on credit. Sonic. Gateway sold $9, 000 of apps in the App Store and on Google Play. 1 Analyze = Assets + Liabilities (c) Accounts Receivable +$9, 000 2 Sales Revenue (+R) 9, 000 Summarize dr + Accounts Receivable (A) Beg. Bal. (c) 3 -14 +$9, 000 Record (c) Accounts Receivable (+A) Sales Revenue (+R, +SE) 3 Stockholders’ Equity 0 9, 000 cr - dr - Sales Revenue (R, SE) cr + 0 Beg. Bal. 3, 000 (a) 9, 000 (c)

Sonic. Gateway’s Accounting Records (d) Receive payment on account. Sonic. Gateway received checks totaling $8, 500 from Apple and Google, on account. 1 Analyze = Assets Liabilities + Stockholders’ Equity (d) Cash +$8, 500 Accounts Receivable -$8, 500 2 Record (d) Cash (+A) Accounts Receivable (-A) 3 8, 500 Summarize dr + Beg. Bal. (a) (b) (d) 3 -15 8, 500 Cash (A) 20, 700 3, 000 300 8, 500 cr - dr + Accounts Receivable (A) Beg. Bal. (c) 0 9, 000 8, 500 cr (d)

Sonic. Gateway’s Accounting Records (e) Pay cash to employees. Sonic. Gateway wrote checks to employees totaling $7, 800 for wages related to hours worked in September. 1 Analyze = Assets Liabilities (e) Cash -$7, 800 2 + Stockholders’ Equity Salaries & Wages Expense (+E) -$7, 800 Record (d) Salaries and Wages Expense (+E, -SE) Cash (-A) 3 7, 800 Summarize dr + Beg. Bal. (a) (b) (d) 3 -16 7, 800 Cash (A) 20, 700 3, 000 300 8, 500 7, 800 cr (e) dr + Salaries & Wages Expense (E, SE) cr Beg. Bal. (e) 0 7, 800

Sonic. Gateway’s Accounting Records (f) Pay cash in advance. On September 1, Sonic. Gateway paid $7, 200 in advance for September, October, and November rent. 1 Analyze = Assets Liabilities + Stockholders’ Equity (f) Cash -$7, 200 Prepaid Rent +$7, 200 2 Record (f) 3 Prepaid Rent (+A) Cash (-A) 7, 200 Summarize dr + Beg. Bal. (a) (b) (d) 3 -17 7, 200 Cash (A) 20, 700 3, 000 300 8, 500 7, 800 7, 200 cr (e) (f) dr + Beg. Bal. (f) Prepaid Rent (A) 0 7, 200 cr -

Sonic. Gateway’s Accounting Records (g) Incur cost to be paid later. Sonic. Gateway displayed Facebook sidebar ads in September and received a bill for $500 to be paid in October. 1 Analyze = Assets Liabilities (g) Accounts Payable + $500 2 + Stockholders’ Equity Advertising Expense (+E) Record (g) Advertising Expense (+E, -SE) Accounts Payable (+L) 3 500 Summarize dr - Accounts Payable (L) cr + 10, 200 Beg. Bal (g) 500 3 -18 -$500 dr + Advertising Expense (E, SE) cr Beg. Bal. (g) 0 500

Sonic. Gateway’s Accounting Records (h) Pay cash for expenses. Sonic. Gateway was notified by its bank that an automatic monthly payment of $600 was transmitted to its utility company for electricity use in September. 1 Analyze = Assets (h) 2 Liabilities + Cash -$600 Stockholders’ Equity Utilities Expense (+E) Record (h) Utilities Expense (+E, -SE) Cash (-A) 3 600 Summarize dr + cr - Cash (A) Beg. Bal. 20, 700 (a) 3, 000 (b) 300 (d) 8, 500 3 -19 -$600 7, 800 7, 200 600 (e) (f) (h) dr + Utilities Expense (E, SE) Beg. Bal. (h) 0 600 cr -

Learning Objective 3 -4 Prepare an unadjusted trial balance. 3 -20

Unadjusted Trial Balance Cash Ledger Account 3 -21

Review of Revenues 3 -22

Review of Expenses 3 -23

Learning Objective 3 -5 Evaluate net profit margin, but beware of income statement limitations. 3 -24

Net Profit Margin = = = Net Income Revenue $3, 100 $12, 000 0. 258 or 25. 8% Net income = Revenues – Expenses = $12, 000 - $8, 900 = $3, 100 3 -25

Income Statement Limitations NI Cash NI Value NI Exact 3 -26

Chapter 3 Solved Exercises M 3 -2, M 3 -3, M 3 -4, M 3 -5, M 3 -13, M 3 -14 Copyright © 2016 by Mc. Graw-Hill Education

M 3 -2 Identifying Accrual Basis Revenues The following transactions are July activities of Bill’s Extreme Bowling Inc. , which operates several bowling centers. If revenue is to be recognized in July, indicate the amount. If revenue is not to be recognized in July, explain why. Activity 3 -28 Amount or Explanation a. Bill’s collected $12, 000 from $12, 000 customers for services related to games played in July. b. Bill’s billed a customer for $250 for a party held at the center on the last day of July. The bill is to be paid in August. $250 c. The men’s and women’s bowling leagues gave Bill’s advance payments totaling $1, 500 for the fall season that starts in September. No revenue is earned in July. The revenues will be earned when fall bowling service is provided (i. e. , when the games are played). d. Bill’s received $1, 000 from credit No revenue is earned in July. sales made to customers last The cash collections in July month (in June). related to revenues earned in June.

M 3 -3 Identifying Accrual Basis Expenses The following transactions are July activities of Bill’s Extreme Bowling, Inc. , which operates several bowling centers. If an expense is to be recognized in July, indicate the amount. If an expense is not to be recognized in July, explain why. Activity 3 -29 Amount or Explanation a. Bill’s paid $1, 500 to plumbers for repairing a broken pipe in the restrooms. $1, 500 b. Bill’s paid $2, 000 for the June electricity bill and received the July bill for $2, 500, which will be paid in August. $2, 500 was incurred as an expense in July. The $2, 000 was an expense in June and is not an expense in July. c. Bill’s paid $5, 475 to employees for work in July. $5, 475

M 3 -4 Recording Accrual Basis Revenues For each of the transactions in M 3 -2, write the journal entry using the format shown in the chapter. a. Cash (+A) Service Revenue (+R, +SE) b. Accounts Receivable (+A) Service Revenue (+R, +SE) c. Cash (+A) Unearned Revenue (+L) d. Cash (+A) Accounts Receivable ( A) 3 -30 12, 000 250 1, 500 1, 000

M 3 -5 Recording Accrual Basis Expenses For each of the transactions in M 3 -3, write the journal entry using the format shown in the chapter. a. Repairs and Maintenance Expense (+E, SE) Cash ( A) b. Accounts Payable (–L) Cash ( A) Utilities Expense (+E, SE) Accounts Payable (+L) c. Salaries and Wages Expense (+E, SE) Cash ( A) 3 -31 1, 500 2, 000 2, 500 5, 475

M 3 -13 Preparing Accrual Basis Journal Entries for Business Activities Quick Cleaners, Inc. (QCI) has been in business for several years. It specializes in cleaning houses but has some small business clients as well. Prepare journal entries for the following transactions, which occurred during a recent month, and determine QCI’s preliminary net income. a. Issued $25, 000 of QCI stock for cash. b. Incurred $600 of utilities costs this month and will pay them next month. a. Cash (+A) Common Stock (+SE) b. Utilities Expense (+E -SE) Accounts Payable (+L) 3 -32 25, 000 600

M 3 -13 Preparing Accrual Basis Journal Entries for Business Activities c. Paid wages for the current month totaling $2, 000. d. Performed cleaning services on account worth $2, 800. e. Some of Quick Cleaners’ equipment was repaired at a total cost of $150. The company paid the full amount at the time the repair work was done. c. Salaries and Wages Expense (+E -SE) Cash (-A) 2, 000 d. Accounts Receivable (+A) Service Revenue (+R +SE) 2, 800 2, 000 e. Repairs and Maintenance Expense (+E -SE) Cash (-A) Preliminary Net Income = Revenues – Expenses = $2, 800 - $2, 000 - $600 - $150 = $50 3 -33 2, 800 150

M 3 -14 Preparing Accrual Basis Journal Entries for Business Activities Junktrader is an online company that specializes in matching buyers and sellers of used items. Buyers and sellers can purchase a membership with Junktrader, which provides them advance notice of potentially attractive offers. Prepare journal entries for the following transactions, which occurred during a recent month, and determine Junktrader’s preliminary net income. a. Junktrader provided online advertising services for another company for $200 on account. b. On the last day of the month, Junktrader paid $50 cash to run an ad promoting the company’s services. The ad ran that day in the local newspaper. a. Accounts Receivable (+A) Service Revenue (+R +SE) b. Advertising Expense (+E -SE) Cash (-A) 3 -34 200 50 50

M 3 -14 Preparing Accrual Basis Journal Entries for Business Activities c. Received $200 cash in membership fees for the month from new members. d. Received an electricity bill for $85 for usage this month. The bill will be paid next month. e. Billed a customer $180 for helping them sell their junk. The customer is expected to pay by the end of next month. c. Cash (+A) Service Revenue (+R +SE) d. Utilities Expense (+E -SE) Accounts Payable (+L) e. Accounts Receivable (+A) Service Revenue (+R +SE) 200 85 85 180 Preliminary Net Income = Revenues – Expenses = $200 + $180 - $50 - $85 = $445 3 -35 180

End of Chapter 3 3 -36