Unit 4 Preparing the Income Statement

Key Concepts Classify items as revenue or expense Prepare an income statement Time period principle Matching principle Accrual basis of accounting Cash basis of accounting

Key Terms Profit - in owner’s equity that results from the successful operation of a business. A business sells goods and services. – Example Goods (cameras, cars, clothes, furniture..) – Example Services (tv repairs, transportation, internet access, hair styling…) Revenue – money or the promise of money received from the sale of goods and services Expenses – are the costs of items or services used up in the routine operation of the business – Examples: (Salaries, advertising, delivery…)

Key Terms cont. Net Income: is the difference between revenue and expenses when revenue > expenses Revenue – Expenses = Profit or Net Income - Ex: $500 - $400 = $100 ** There is a net loss when the expenses > revenue - the use of brackets indicates a loss Ex: $(50)

The Income Statement Every business prepares an income statement which presents revenue, expenses, and net income/loss for a specific period of time. (accounting period) Fiscal period (synonym for accounting period) – Businesses prepare statements on a yearly basis for tax purposes (may or may not coincide with a calendar yr)

The Income Statement Another Textbook Example: Page 69

Income Statement Preparation 1)Prepare Statement Heading - Who, What, When? - Income: Time period, Balance sheet: on a specific date. 2)Prepare Revenue Section - Largest revenue item listed first 3)Prepare Expenses Section - Listed in the order in which they appear in the ledger 4)Determine Net Income or Net Loss - (Revenue – Expenses), Double line to indicate the final total (Follow layout demonstrated in your textbook)

Facts to Remember For the income statement, dollar signs should be placed: – Beside the first figure in each column – Beside the net income or net loss figure at the bottom of the statement

Time-Period Principle Requires the definition and use of the same period of time for the accounting period. – Purpose: this allows the owners and other users of financial statements to analyze and compare data for similar periods of time. – Is the business maintaining a consistent profit, increasing it or doing worse than before? – Certain time periods that are struggling? Why?

Matching Principle Expenses should be recorded and matched with the revenue they help to generate during the same accounting period. It is important to include only revenue earned during that period and only expenses incurred during that period to produce the revenue. Simple Rule: Expenses are recorded when the cost is incurred, whether paid in cash or on credit. Errors when the Matching Principle is not applied. – Example Page 71-72

Accrual Basis of Accounting A business that records revenue when earned and expenses when incurred is using the accrual basis of accounting. (matches the revenue earned with the expenses necessary to produce the revenue during the accounting period)

Recording Revenue Revenue is recognized as it is earned even if cash has not been received. Revenue = Owner’s Equity See Example on Page 72.

Recording Expenses The transactions are recorded in the expense accounts whether they are cash transactions or credit transactions. (recorded as they are incurred)

Cash Basis of Accounting Recognizes revenue and expenses on a cash basis. – Expenses are recorded only when cash is paid for an expense. – Revenue is recorded only when cash is received for sales or other revenue. ** In other words, this form of accounting does not follow the matching principle…and as a result is not used by accountants for a business.