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Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter 3
Reporting Operating Results on the Income Statement
3-2
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
3-3
Learning Objective 1
Describe common operating transactions and select appropriate
income statement account titles.
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Revenues and Expenses
RevenuesHaircut Revenue 15,600$ Total Revenue 15,600
ExpensesSalaries and Wages Expense 8,000 Rent Expense 2,400 Utilities Expense 600 Advertising Expense 400 Insurance Expense 300 Total Expenses 11,700 Net Income 3,900$
SUPERCUTSIncome Statement
For the Month Ended September 30, 2008
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.
3-5
Time Period Assumption
RevenuesHaircut Revenue 15,600$ Total Revenue 15,600
ExpensesSalaries and Wages Expense 8,000 Rent Expense 2,400 Utilities Expense 600 Advertising Expense 400 Insurance Expense 300 Total Expenses 11,700 Net Income 3,900$
SUPERCUTSIncome Statement
For the Month Ended September 30, 2008The time period assumption assumes that the long life of a company
can be divided into shorter time periods, such as months, quarters, and
years.
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Cash Basis Accounting
Cash basis accounting records revenues when cash
is received and expenses when cash is paid.
3-7
Cash Basis Accounting
The cash basis of accounting doesn’t measure financial
performance very well when transactions are conducted using
credit rather than cash.
3-8
Learning Objective 2
Explain and apply the revenue and
matching principles.
3-9
Accrual Basis Accounting
GAAPRecords revenues when they are
earned and expenses when they are incurred, regardless of the timing of
cash receipts or payments.
Accrual Basis Accounting
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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.
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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.
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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
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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
3-14
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
3-15
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
3-16
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?
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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 $300 on its account.
How much revenue would you report for September?(1) 15,000$ (3) 100 (4) 500
15,600$
(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.
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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
3-19
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
3-20
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.
3-21
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.
3-22
Learning Objective 3
Analyze, record, and summarize the effects of operating transactions, using the accounting
equation, journal entries, and T-accounts.
3-23
The Expanded Debit/Credit Framework
= ++ Increases Decreases - - Decreases Increases + - Decreases Increases +
Assets Liabilities Stockholders' Equity
Debit Credit Debit Credit Debit Credit
Debit = Left Credit = Right
Asset accounts increaseincrease on the left or debitdebit side and decreasedecrease
on the right or creditcredit side.
Liability accounts increaseincrease on the right or creditcredit side and decreasedecrease
on the left or debitdebit side.
Stockholders’ equity accounts increaseincrease on the right or creditcredit side
and decreasedecrease on the left or debitdebit side.
Remember this from Chapter 2?
Let’s take a closer look at the accounts that affect Stockholders’ Equity.
3-24
Debit CreditDebit Credit
The Expanded Debit/Credit Framework
Debit CreditDebit Credit
3-25
Provided haircut services in September for $15,000 cash.
Debit CreditCash (+A) 15,000
Haircut Revenue (+R, +SE) 15,000
Accounts
Beg. Bal. 10,000 (a) 15,000
Cash- Beg. Bal.
15,000 (a)
Haircut Revenue
Assets = Liabilities + Stockholders' EquityCash +15,000 Haircut Revenue (R) +15,000
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Debit CreditCash (+A) 300
Unearned Revenue (+L) 300
Accounts
Assets = Liabilities + Stockholders' EquityCash +300 Unearned Revenue +300
Sold $300 of gift certificates at the beginning of September.
- Beg. Bal.300 (b)
Uearned RevenueBeg. Bal. 10,000
(a) 15,000 (b) 300
Cash
3-27
Debit CreditAccounts Reveivable (+A) 500
Haircut Revenue (+R, +SE) 500
Accounts
Assets = Liabilities + Stockholders' EquityAccounts Receivable +500 Haircut Revenue (+R) +500
Provided $500 of haircut services to employees of a local TV station, which is billed every month.
Beg. Bal. - (c) 500
Accounts Reveivable- Beg. Bal.
15,000 (a)500 (c)
Haircut Revenue
3-28
Debit CreditCash (+A) 300
Accounts Reveivable (-A) 300
Accounts
Assets = Liabilities + Stockholders' EquityCash +300Accounts Reveivable -300
Supercuts received a $300 payment from the TV station.
Beg. Bal. - (c) 500 300 (d)
Accounts ReveivableBeg. Bal. 10,000
(a) 15,000 (b) 300 (d) 300
Cash
3-29
Debit CreditWages Expense (+E, -SE) 8,100
Cash (-A) 8,100
Accounts
Assets = Liabilities + Stockholders' EquityCash -8,100 Wages Expense (+E) -8,100
Supercuts paid stylists $8,100 for wages related to services they provided in September.
Beg. Bal. - (e) 8,100
Wages ExpenseBeg. Bal. 10,000
(a) 15,000 8,100 (e)(b) 300 (d) 300
Cash
3-30
Debit CreditPrepaid Rent (+A) 7,200
Cash (-A) 7,200
Accounts
Assets = Liabilities + Stockholders' EquityCash -7,200Prepaid Rent +7,200
On September 1, Supercuts paid $7,200 in advance for September, October, and November rent.
Beg. Bal. - (f) 7,200
Prepaid RentBeg. Bal. 10,000
(a) 15,000 8,100 (e)(b) 300 7,200 (f)(d) 300
Cash
3-31
Debit CreditPrepaid Insurance (+A) 3,600
Cash (-A) 3,600
Accounts
Assets = Liabilities + Stockholders' EquityCash -3,600Prepaid Insurance +3,600
On September 1, Supercuts paid $3,600 for an insurance policy that covers the period from September 1 until
August 31 of next year.
Beg. Bal. - (g) 3,600
Prepaid InsuranceBeg. Bal. 10,000
(a) 15,000 8,100 (e)(b) 300 7,200 (f)(d) 300 3,600 (g)
Cash
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Debit CreditAdvertising Expense (+E, -SE) 400
Accounts Payable (+L) 400
Accounts
Assets = Liabilities + Stockholders' EquityAccounts Payable +400 Advertising Exp. (+E) -400
Supercuts received a bill for $400 for running a newspaper ad about special back-to-school prices. The
bill will be paid in October.
Beg. Bal. - (h) 400
Advertising Expense630 Beg. Bal.400 (h)
Accounts Payable
3-33
Debit CreditUtilities Expense (+E, -SE) 600
Cash (-A) 600
Accounts
Assets = Liabilities + Stockholders' EquityCash -600 Utilities Expense (+E) -600
Supercuts paid utility bills totaling $600 for services received and billed in September.
Beg. Bal. - (i) 600
Utilities ExpenseBeg. Bal. 10,000
(a) 15,000 8,100 (e)(b) 300 7,200 (f)(d) 300 3,600 (g)
600 (i)
Cash
3-34
T-Account Balances
Beg. Bal. 630 Supplies
Here are the asset account balances for your Supercuts store. (Beginning balances
came from Chapter 2.)Beg. Bal. 10,000
(a) 15,000 8,100 (e)(b) 300 7,200 (f)(d) 300 3,600 (g)
600 (i)End. Bal. 6,100
Cash
Beg. Bal. - (c) 500 300 (d)
End. Bal. 200
Accounts Reveivable
Beg. Bal. - (f) 7,200
End. Bal. 7,200
Prepaid Rent
Beg. Bal. - (g) 3,600
End. Bal. 2,400
Prepaid Insurance
Beg. Bal. 60,000 Equipment
3-35
T-Account Balances
630 Beg. Bal.400 (h)
1,030 End. Bal.
Accounts Payable
- Beg. Bal.300 (b)300 End. Bal.
Uearned Revenue
20,000 Beg. Bal.Notes Payable
Here are the liability account balances for your Supercuts store. (Beginning balances
came from Chapter 2.)
3-36
T-Account Balances
Here are the stockholders’ equity account balances for your
Supercuts store. (Beginning balances came from Chapter 2.)
50,000 Beg. Bal.Contributed Capital
- Beg. Bal.15,000 (a)
500 (c)15,500 End. Bal.
Haircut Revenue
Beg. Bal. - (e) 8,100
End. Bal. 8,100
Wages Expense
Beg. Bal. - (h) 400
End. Bal. 400
Advertising Expense
Beg. Bal. - (i) 600
End. Bal. 600
Utilities Expense
3-37
Learning Objective 4
Prepare an unadjusted trial
balance.
3-38
Unadjusted Trial Balance
Debit CreditCash 6,100$ Supplies 630 Accounts Receivable 200 Prepaid Rent 7,200 Prepaid Insurance 3,600 Equipment 60,000 Accounts Payable 1,030$ Unearned Revenues 300 Notes Payable 20,000 Contributed Capital 50,000 Haircut Revenue 15,500 Wages Expense 8,100 Utilities Expense 600 Advertising Expense 400 Total 86,830$ 86,830$
SUPERCUTSUnadjusted Trial BalanceAs of September 30, 2008
Amounts come from
ledger balances
Not a financial
statement
Debits = Credits
Listed in financial
statement order
3-39
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.
Debit CreditCash 6,100$ Supplies 630 Accounts Receivable 200 Prepaid Rent 7,200 Prepaid Insurance 3,600 Equipment 60,000 Accounts Payable 1,030$ Unearned Revenues 300 Notes Payable 20,000 Contributed Capital 50,000 Haircut Revenue 15,500 Wages Expense 8,100 Utilities Expense 600 Advertising Expense 400 Total 86,830$ 86,830$
SUPERCUTSUnadjusted Trial BalanceAs of September 30, 2008
3-40
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$
3-41
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
$(3) Cash is paid after
the expense is incurred.
dr. Accounts Payable
cr. Cash
dr. Business Expense
cr. Accounts Payable$
3-42
Learning Objective 5
Describe limitations of the income statement.
3-43
Income Statement Limitations
NI Cash
NI Value
NI Precise
3-44
Ethical Insights
Bernie Ebbers, CEO, WorldComRecorded expenses as assets
Sentenced to 25 years
Barry Minkow, CEO, ZZZZ BestRecorded 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 3Supplement
Account Names
3-46
Chart of AccountsAccount Name Description
Sales Revenues Sales of products in the ordinary course of businessService Revenues Sales of services in the ordinary course of businessRental Revenues Amounts earned by renting out company propertyInterest Revenues Amounts earned on savings accounts and certificates of depositDividend Revenues Dividends earned from investing in other companiesOther Revenues Miscellaneous sources of revenues
Cost of Goods Sold Cost of products sold in the ordinary course of businessRepairs & Maintenance Cost of routine maintenance and upkeep of buildings/equipmentAdvertising Expense Cost of advertising services obtained during the periodDepreciation Expense Cost of plant and equipment used up during the periodInsurance Expense Cost of insurance coverage for the current periodSalaries & Wages Expense Cost of employees' salaries and wages for the periodRent Expense Cost of rent for the periodSupplies Expense Cost of supplies used up during the periodTransportation Expense Cost of freight to transport goods out to customersUtilities Expense Cost of power, light, heat, internet, and telephone for the periodAmortization Expense Cost of intangible assets used up or expired during the periodInterest Expense Interest charged on outstanding debts owedIncome Tax Expense Taxes charged on reported earnings
Revenues
Expenses
3-47
End of Chapter 3