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Operating Decisions and the Income Statement

Operating Decisions and the Income Statement. Chapter 3. McGraw-Hill/Irwin. © 2009 The McGraw-Hill Companies, Inc. The Operating Cycle. Begin. Purchase or manufacture products or supplies on credit. Receive payment from customers. Pay suppliers.

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Operating Decisions and the Income Statement

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  1. Operating Decisions andthe Income Statement Chapter 3 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

  2. The Operating Cycle Begin Purchase or manufacture products or supplies on credit. Receive payment from customers. Pay suppliers. Deliver product or provide service to customers on credit.

  3. Elements on the Income Statement Revenues Increases in assets or settlement of liabilities from ongoing operations. Expenses Decreases in assets or increases in liabilities from ongoing operations. Gains Increases in assets or settlement of liabilities from peripheral transactions. Losses Decreases in assets or increases in liabilities from peripheral transactions.

  4. Cash Basis Accounting Revenue is recorded when cash is received. Expenses are recorded when cash is paid.

  5. Accrual Accounting Assets, liabilities, revenues, and expenses should be recognized when the transaction that causes them occurs, not necessarily when cash is paid or received. Required by - GenerallyAcceptableAccountingPrinciples GAAP

  6. Cash (+A) xxx Unearned revenue (+L) xxx Revenue Principle When the company delivers the goods or services UNEARNED REVENUE is reduced and REVENUEis recorded. Cash received before revenue is earned - CashReceived Company Delivers Revenue will be recorded when earned.

  7. Revenue Principle Typical liabilities that become revenue when earned include . . .

  8. Accounts receivable (+A) xxx Revenue (+R) xxx Revenue Principle When the cash is received the ACCOUNTS RECEIVABLE is reduced. Cash received after revenue is earned - CashReceived Company Delivers Cash will be collected.

  9. Revenue Principle Assets reflecting revenues earned but not yet received in cash include . . .

  10. The Matching Principle Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid.

  11. Prepaid expense (+A) xxx Cash (-A) xxx The Matching Principle When the expense is incurred PREPAID EXPENSE is reduced and an EXPENSE is recorded. Cash is paid before expense is incurred - $Paid ExpenseIncurred Expense will be recorded when incurred.

  12. The Matching Principle Typical assets and their related expense accounts include. . .

  13. A = L + SE ASSETS LIABILITIES Debit for Increase Credit for Decrease Debit for Decrease Credit for Increase CONTRIBUTED CAPITAL RETAINED EARNINGS Debit for Decrease Credit for Increase Debit for Decrease Credit for Increase Next, let’s see how Revenues and Expenses affect Retained Earnings.

  14. Beginning Retained Earnings+ Net Income- Dividends Declared Ending Retained Earnings Statement ofRetainedEarnings BalanceSheet Assets = Liabilities + Stockholders’ Equity Contributed CapitalRetained Earnings ChangeinCash = Cash from Operating Activities+ Cash from Investing Activities+ Cash from Financing Activities Statementof Cash Flows How are Financial Statements Prepared? IncomeStatement Revenues – Expenses = Net Income

  15. End of Chapter 3

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