Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 3 Reporting Operating Results on the Income Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Toni Braxton’s Situation Toni Braxton had no way of knowing that she was headed for financial trouble since she had not reviewed her personal income statement. Revenues > Expenses = Net Income Revenues < Expenses = Net Loss

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 1 Describe common operating transactions and select appropriate income statement account titles.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Revenues and Expenses Revenues are increases in a company’s resources created by sales of goods or services to customers during the period. Expenses are costs of business necessary to earn revenues. Net income is the excess of revenues over expenses.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Time Period Assumption The time period assumption assumes that the long life of a company can be divided into shorter time periods, such as months, quarters, and years.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Cash Basis Accounting Cash basis accounting records revenues when cash is received and expenses when cash is paid.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Cash Basis Accounting The cash basis of accounting doesn’t measure financial performance very well when transactions are conducted using credit rather than cash.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 2 Explain and apply the revenue and matching principles.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Accrual Basis Accounting GAAP Records revenues when they are earned and expenses when they are incurred, regardless of the timing of cash receipts or payments. Accrual Basis Accounting

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Accrual Basis Accounting Revenues are earned when goods or services are provided to customers at a determined price and with reasonable assurance of collection. Expenses are incurred when the economic benefits of an item are used up in the current period, resulting in a decrease in the company’s resources.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Accrual Basis Accounting The revenue principle is a concept that requires that revenues be recorded when they are earned, rather than when cash is received for them. The matching principle is a concept that requires that expenses be recorded in the period in which they are incurred to generate revenue, rather than the period in which they are paid.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Company performs promised acts. here (2) here (1) here (3) Cash can be received... (1)Cash is received in the same period as the promised acts are performed. (2)Cash is received in a period before the promised acts are performed. (3)Cash is received in a period after the promised acts are performed. Revenue is recorded here. Time Timing of Reporting Revenue versus Cash Receipts

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Company performs promised acts. here (2) here (1) here (3) Cash can be received... (1)Cash is received in the same period as the promised acts are performed. (2)Cash is received in a period before the promised acts are performed. (3)Cash is received in a period after the promised acts are performed. Revenue is recorded here. Time Timing of Reporting Revenue versus Cash Receipts

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Company performs promised acts. here (2) here (1) here (3) Cash can be received... (1)Cash is received in the same period as the promised acts are performed. (2)Cash is received in a period before the promised acts are performed. (3)Cash is received in a period after the promised acts are performed. Revenue is recorded here. Time When cash is received before promised acts are performed, the company receiving the cash will report an increase in cash and an increase in a liability, called unearned revenue, which represents the obligation to perform the acts in the future. Timing of Reporting Revenue versus Cash Receipts

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Company performs promised acts. here (2) here (1) here (3) Cash can be received... (1)Cash is received in the same period as the promised acts are performed. (2)Cash is received in a period before the promised acts are performed. (3)Cash is received in a period after the promised acts are performed. Revenue is recorded here. Time When cash is received after promised acts are performed, the company performing the services will report an increase in revenue and an increase in accounts receivable. Later, when the cash is received, the accounts receivable is reduced. Timing of Reporting Revenue versus Cash Receipts

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Quick Check The following transactions occurred during the month of September for your Supercuts store. 1.Provided haircut services in September to customers for $15,000 cash. 2.Sold $300 of gift certificates in September. 3.Customers used $100 of gift certificates to pay for haircuts in September. 4.Provided $500 of hair styling services to employees of a local TV station, which is billed monthly. 5.The TV station paid $300 on its account. How much revenue would you report for September?

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Quick Check The following transactions occurred during the month of September for your Supercuts store. 1.Provided haircut services in September to customers for $15,000 cash. 2.Sold $300 of gift certificates in September. 3.Customers used $100 of gift certificates to pay for haircuts in September. 4.Provided $500 of hair styling services to employees of a local TV station, which is billed monthly. 5.The TV station paid $300 on its account. How much revenue would you report for September? (2) Is unearned revenue because services have not been provided at the time the gift certificate were sold. (5) Is a payment on an accounts receivable.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Company incurs costs to generate revenue. here (2) here (1) here (3) Cash can be paid... (1)Cash is paid at the same time as the cost is incurred to generate revenue. (2)Cash is paid before the the cost is incurred to generate revenue. (3)Cash is paid after the the cost is incurred to generate revenue. Expense is recognized here. Time Timing of Reporting Expenses versus Cash Payments

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Company incurs costs to generate revenue. here (2) here (1) here (3) Cash can be paid... (1)Cash is paid at the same time as the cost is incurred to generate revenue. (2)Cash is paid before the the cost is incurred to generate revenue. (3)Cash is paid after the the cost is incurred to generate revenue. Expense is recognized here. Time Timing of Reporting Expenses versus Cash Payments

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Company incurs costs to generate revenue. here (2) here (1) here (3) Cash can be paid... (1)Cash is paid at the same time as the cost is incurred to generate revenue. (2)Cash is paid before the the cost is incurred to generate revenue. (3)Cash is paid after the the cost is incurred to generate revenue. Expense is recognized here. Time Timing of Reporting Expenses versus Cash Payments Given the matching principle, the expense should be reported when the cost is incurred to earn revenue and not in the period when the cash is paid.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Company incurs costs to generate revenue. here (2) here (1) here (3) Cash can be paid... (1)Cash is paid at the same time as the cost is incurred to generate revenue. (2)Cash is paid before the the cost is incurred to generate revenue. (3)Cash is paid after the the cost is incurred to generate revenue. Expense is recognized here. Time Timing of Reporting Expenses versus Cash Payments Given the matching principle, the expense should be reported when the cost is incurred to earn revenue and not in the period when the cash is paid.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 3 Analyze, record, and summarize the effects of operating transactions, using the accounting equation, journal entries, and T-accounts.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Expanded Debit/Credit Framework DebitCreditDebitCreditDebitCredit Debit = LeftCredit = Right increase debit decrease credit Asset accounts increase on the left or debit side and decrease on the right or credit side. increase creditdecrease debit Liability accounts increase on the right or credit side and decrease on the left or debit side. increase credit decrease debit Stockholders’ equity accounts increase on the right or credit side and decrease on the left or debit side. Remember this from Chapter 2? Let’s take a closer look at the accounts that affect Stockholders’ Equity.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin DebitCreditDebitCredit The Expanded Debit/Credit Framework DebitCredit DebitCredit

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Provided haircut services in September for $15,000 cash.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Sold $300 of gift certificates at the beginning of September.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Provided $500 of haircut services to employees of a local TV station, which is billed every month.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Supercuts received a $300 payment from the TV station.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Supercuts paid stylists $8,100 for wages related to services they provided in September.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin On September 1, Supercuts paid $7,200 in advance for September, October, and November rent.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin On September 1, Supercuts paid $3,600 for an insurance policy that covers the period from September 1 until August 31 of next year.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Supercuts received a bill for $400 for running a newspaper ad about special back-to-school prices. The bill will be paid in October.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Supercuts paid utility bills totaling $600 for services received and billed in September.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin T-Account Balances Here are the asset account balances for your Supercuts store. (Beginning balances came from Chapter 2.)

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin T-Account Balances Here are the liability account balances for your Supercuts store. (Beginning balances came from Chapter 2.)

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin T-Account Balances Here are the stockholders’ equity account balances for your Supercuts store. (Beginning balances came from Chapter 2.)

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 4 Prepare an unadjusted trial balance.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Unadjusted Trial Balance Amounts come from ledger balances Not a financial statement Debits = Credits Listed in financial statement order

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Unadjusted Trial Balance Some adjustments will have to be made at the end of the accounting period to update the accounts. For example, at the end of September, do we still have 3 months of Prepaid Rent left to use? No, we used up 1/3 of the rent in September. We will look more closely at adjustments in Chapter 4.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Accounting for Revenues and Expenses (2) Cash is received before the company delivers goods/services. dr. Cash cr. Unearned Rev. dr. Unearned Rev. cr. Service Revenue $  (1) Cash is received in the same period the company delivers goods/services. dr. Cash cr. Service Revenue $  (3) Cash is received after the company delivers goods/services. dr. Cash cr. Accounts Rec. dr. Accounts Rec. cr. Service Revenue $ 

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Accounting for Revenues and Expenses (2) Cash is paid before the expense is incurred. dr. Prepaid Expense cr. Cash dr. Business Expense cr. Prepaid Expense $  (1) Cash is paid in the same period the expense is incurred. dr. Business Expense cr. Cash $  (3) Cash is paid after the expense is incurred. dr. Accounts Payable cr. Cash dr. Business Expense cr. Accounts Payable $ 

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 5 Describe limitations of the income statement.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Income Statement Limitations NI  Cash NI   Value NI  Precise

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Ethical Insights Bernie Ebbers, CEO, WorldCom Recorded expenses as assets Sentenced to 25 years Barry Minkow, CEO, ZZZZ Best Recorded fraudulent sales Sentenced to 25 years Martin Grass, CEO, Rite Aid Corp. Recorded rebates before earned Sentenced to 8 years

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 3 Supplement Account Names

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chart of Accounts

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin End of Chapter 3