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Principles of Accounting

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Revenues: the price of products, merchandise, and services supplied by a firm to its customers during a certain period

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  1. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Fulbright Economics Teaching Program Ho Chi Minh City, Vietnam Academic Year: 2005-2006 Principles of Accounting Lecture Notes 3a INCOME STATEMENT Nguyen Bao Linh 1
  2. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Measuring the Business Performance Net Income (NI) = Revenues (R) – Expenses (E) Revenues: the price of products, merchandise, and services supplied by a firm to its customers during a certain period Expenses: the cost of products, merchandise, and services used by a firm during a certain period by Nguyen Bao Linh Methods of Recognition The accrual basic recognizes the impacts of transactions on the financial statements when revenues and expenses occur regardless whether cash changes hands The cash basis only records transactions when cash is disbursed or received by Nguyen Bao Linh Nguyen Bao Linh 2
  3. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Accounting Period To periodically provide information to users, the firm’s operating process is allotted into relatively equal period, called accounting period The length of an accounting period may be a month, a quarter, or a year. One- year length is called a fiscal year by Nguyen Bao Linh Accounting Period A fiscal year is not necessarily a calendar year. The end of a fiscal year may not coincide with the harvest in order to – Lessen the accountant’s work at the end of the period – Simplify the inventory work – Reduce the workload of allocating revenues and expenses over various periods to account profits accurately by Nguyen Bao Linh Nguyen Bao Linh 3
  4. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Permanent and Temporary Accounts A temporary account is the one that will be closed (its balance equals zero) at the end of the accounting period to be prepared for recording in the next period A permanent account is not closed at the end of period; its ending balance becomes the beginning one for the next period by Nguyen Bao Linh Permanent and Temporary Accounts Assets (A) Permanent Liabilities (L) Accounts Owners’ Equity (OE): Capital Withdrawals Temporary Revenues (R) Accounts Expenses (E) by Nguyen Bao Linh Nguyen Bao Linh 4
  5. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Matching Rule Revenues are recognized in an accounting period during which the firm provides products, merchandise, and services to customers Expenses that are recognized in an accounting period must been used up during that period to generate the period revenues by Nguyen Bao Linh Going-concern Rule Firms are assumed to be continuously and indefinitely operating unless there is evidence on bankruptcy or stopping business This assumption allows accountants to simplify their calculation and allocation of revenues and expenses over more than one period such as – Deferred Revenue – Depreciation of Fixed Assets by Nguyen Bao Linh Nguyen Bao Linh 5
  6. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Revenue Recognition Revenues are recognized when goods and/or services are delivered to customers regardless whether collections have been made Revenue Cash Receivables To secure the matching rule, revenues are also recorded by adjusting accounts at the end of the accounting period by Nguyen Bao Linh Expense Recognition Expenses recognized under the matching rule must involve in products, merchandise, or services that have been used to generate the period revenues, regardless whether cash changes hands Cash Expense Payables Expenses are also recorded by adjusting accounts at the end of the accounting period by Nguyen Bao Linh Nguyen Bao Linh 6
  7. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Adjustments to the Accounts Adjustments are made through the adjusting entries at the end of each period The purpose of adjustments is to fully account revenues and expenses for an accurate profit measurement Only revenues and expenses involved in more than one period are adjusted An adjusting entry is always related to a permanent and a temporary account. Hence, an adjusting entry affects both balance sheet and income statement by Nguyen Bao Linh Types of Adjustments 1. Deferred revenue (Unearned revenue): Collections from customers have been received but should be allocated over many periods 2. Accrued revenue: Collections have not been received but should be accounted in advance 3. Deferred expense: Disbursements have been made but should be allocated over many periods 4. Accrued expense: Disbursements have not been made but should be accounted in advance by Nguyen Bao Linh Nguyen Bao Linh 7
  8. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Deferred revenue: Collections from customers have been received but should be allocated over many periods Adjustment to Revenues See the example in the previous lecture notes January 18, the firm receives advances from customers for advertising services on real estate costing $800; a journal entry has been made Cash 800 Advances from Customers 800 Suppose, by January 31, the firm has provided services costing $400 Adjusting entry (a) Advances from Customers 400 Revenues 400 by Nguyen Bao Linh Nguyen Bao Linh 8
  9. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Deferred expense: Disbursements have been made but should be allocated over many periods Prepaid Expense See the example, on January 1, the firm advances a rental of $3,000 for 6 month use. On Jan 31, $500 out of this amount is regarded as “expired” and should be recognized by an adjusting entry (b) Rental Expense 500 Prepaid Rental 500 Similarly, with prepaid insurance on Jan 5, the adjusting entry will be (c) Insurance Expense 100 Prepaid Insurance 100 by Nguyen Bao Linh Nguyen Bao Linh 9
  10. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Cost of Supplies Suppose that an ending-period inventory reveals a stationery balance of $200 Hence, the portion of stationery used during period is $800 - $200 = $600 Adjusting entry (d) Stationery Expense 600 Stationery 600 by Nguyen Bao Linh Depreciation Expense Depreciation expense is the cost of long-term or fixed assets Depreciation expense is calculated based on the value of the asset and its estimated usable life There are many methods to account depreciation; the most commonly used is the straight line depreciation method The going concern rule is applied in accounting depreciation by Nguyen Bao Linh Nguyen Bao Linh 10
  11. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Depreciation Expense Suppose that the office equipment is depreciated under the straight-line method and has a usable life of 5 years (60 months) The depreciation expense is $6,000 ÷ 60 = $100 for each month Adjusting entry (e) Depreciation Expense of Equipment 100 Accumulate Depreciation of Equipment 100 by Nguyen Bao Linh Accrued expense: Disbursements have not been made but should be accounted in advance Nguyen Bao Linh 11
  12. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Wages & Salaries Expenses Salaries are paid on January Friday after two-week Mon Tue Wed Thu Fri Sat Sun working, costing $1,000 Average salaries expense 1 2 3 4 5 6 7 is $100 per day 8 9 10 11 12 13 14 Salaries payments were 15 16 17 18 19 20 21 made on the 12th and 26th of January 22 23 24 25 26 27 28 How about the next 29 30 31 1/2 2 3 4 payment? 5 6 7 8 9 10 11 by Nguyen Bao Linh Wages & Salaries Expenses Recording salaries payment on Feb 9 as usual is not reasonable, because it includes 3-day salaries (the 29th, 30th, & 31st) of Jan costing $300 in the Feb wages expense An adjusting entry (f) is necessary Salaries Expense 300 Salaries Payable 300 by Nguyen Bao Linh Nguyen Bao Linh 12
  13. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Work sheet Transaction Adjusted Financial Journal Ledger Trial Balance Analysis Trial Balance Statements Preparing a Work Sheet 1. Take balances from ledger accounts and enter them into “Trial Balance” column 2. Make necessary adjustments in “Adjustment” column 3. Calculate adjusted balances on accounts and enter them into “Adjusted Trial Balance” 4. Transfer revenue and expense balances into “Income Statement” column, other balances into “Balance Sheet,” and then balance them to calculate profits by Nguyen Bao Linh Nguyen Bao Linh 13
  14. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Uses of Work Sheet Preparing financial statements Closing temporary Recording accounts adjusting entries by Nguyen Bao Linh Closing Temporary Accounts Temporary accounts must be closed at the end of the period to be prepared for recording in the next period Temporary accounts include – Revenues – Expenses – Withdrawals Closing can be directly done or through the Income Summary Account by Nguyen Bao Linh Nguyen Bao Linh 14
  15. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement Closing Expense Income Summary Revenue XXX XXX XXX XXXXX XXXXX XXXXX XX / / / / / / Withdrawals Capital X X X XXXXXX XX / / XXXXXXX by Nguyen Bao Linh Post-closing Trial Balance After closing, only permanent accounts have balances, including – Assets – Liabilities – Owners’ Equity Balances on these accounts will be the beginning balances for the next periods; an accounting cycle has been closed, and a new one starts by Nguyen Bao Linh Nguyen Bao Linh 15
  16. Fulbright Economics Teaching Program Principles of Accounting Lecture Notes 3 2005-2006 Income Statement References Financial accounting – Clyde P. Stickney; Roman L. Weil Accounting – Charles T. Horngren; Walter T. Harrison; Linda Smith Bamber Principles of accounting – Belverd E Needles, Jr.; Henry R. Anderson; James C. Caldwell by Nguyen Bao Linh Nguyen Bao Linh 16
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