Financial Management: Module 3 Revenue, Expenses, and the Income Statement

1. Financial Management: Module 3 Revenue, Expenses, and the Income Statement Produced in conjunction with The African Entrepreneur Collectiveand Opportunity International www.oppteachers.org

2. Learning Objectives By the end of this section you will be able to: • Describe the purpose of the chart of accounts • Understand how revenue and expenses affect Owners’ Equity • Explain how and when to record revenue and expenses • Articulate the key elements of the income statement • Understand how inventory affects revenue and expenses

3. Recap: Module 2 • The entity assumption • Analysing transactions according to the accounting equation • Posting journals into the general ledger Remember that every transaction must keep the accounting equation in balance Assets = Liabilities + Owners' Equity

4. Review question: Transaction analysis • If I take out a loan for $50,000, it will have the following effect on the accounting equation: A) Assets increase, Liabilities decrease B) Liabilities increase, Liabilities decrease C) Assets increase, Liabilities increase D) Liabilities increase, Owners’ equity increase

5. Recap: the Accounting Cycle • Analyzing transactions • Journals (The book of original entry) • Posting (General Ledger) • Trial Balance • Adjusting journal entries • Closing • Financial Statements (Balance sheet and Income statement)

6. What is the chart of accounts? • Itis the list of accounts used by a business. • Each business entity has its unique chart of accounts. • Every chart of accounts has the same numbered account categories: • Assets, Liabilities, Owner’s Equity • Revenues, Expenses

7. Revenues and Expenses • Revenues increase owners' equity (Cash ) • Expenses decrease owners' equity (Cash )

8. Revenues • Revenues are inflows of assets (or reductions in liabilities) in exchange for providing goods and services to customers. • Examples: • A retail store such as Nakumatt earns revenues by selling goods to customers. • An accounting firm earns revenues by providing services such as tax return preparation or auditing. • A school earns revenues through tuition fees and selling uniforms and school textbooks

9. When are revenues earned? • Critically important point: • Cash need not be received in order for revenue to be recorded. • Revenues are earned when a company does what it is supposed to do according to a contract.

10. Accounts Receivable and Unearned Revenue • Accounts receivable are promises by a customer or client to pay cash in the future. • A related concept, Unearned Revenue, concerns cash received before a service is performed or goods are delivered.

11. Revenue: consider the following example: • A school receives $50,000 from each student in school fees at the beginning of the year. • The student pays in advance, before he or she has received the education. • How do you account for this?

12. Revenue: consider the following example: • The school may not record revenue because it has not earned revenue yet. • To earn revenue, it must provide education for the next 2 semesters. • It owes education to the student and thus has a liability (called unearned revenue), not revenue. • Revenues may be recorded each quarter or each semester as the service is provided, ie as the child receives education for their fees.

13. Revenue: consider the following example: • Unearned revenues are usually settled by the performance of a service, unlike other liabilities which are usually settled by the payment of cash.

14. Revenue examples

15. Revenues

16. Practice question 1 Is unearned revenue: A) An asset B) A liability C) Owner’s equity?

17. Practice question 2 I am going on holiday in 2 weeks and I have paid for the hotel I am staying in today. Can the hotel record the revenue it has received for my booking? A) Yes • No

18. Expenses • Expenses occur when resources are consumed in order to generate revenue. • They are the cost of doing business. • Examples include rent, salaries and wages, insurance, electricity, utilities, and the like.

19. Expenses

20. Expenses • A critically important point similar to that for revenues holds true for expenses. • A business need not pay out cash in order to have to record that an expense has occurred.

21. Expenses • An example: • Arepairman repairs the plumbing system but the business does not pay for that service until it is invoiced. The business has a repair expense even though the business has not paid for the service yet. • The company will have a liability which it will settle later with the payment of cash. • The liability is called Accounts Payable

22. Expenses

23. The Income Statement • The income statement summarizes a company's revenues and expenses for a period of time. • The date on the income statement will be a phrase such as, "For the month ended July 31," or "For the year ended December 31."

24. The Income Statement • If revenues exceed expenses, then the result is net income (profit). Revenues > Expenses = Net income • If expenses exceed revenues, then the result is a net loss. Revenues < Expenses = Net loss

26. Practice question 3 Should cash appear on the income statement? A) Yes • No

27. Sales of Inventory • Sales of inventory contain both revenue and expense components. • A revenue transaction exists because an asset has been obtained and goods have been provided to customers. • An expense transaction exists because an asset has been consumed to generate the revenue. • The resulting expense is called cost of goods sold.

29. Sales of Inventory example • A car business has finished building a car which cost $2,200 to build. • The finished car is accounted for as inventory – this will be an asset of $2,200. • The car is sold to a customer for $4,000. • The customer pays cash after 30 days.

30. Sales of Inventory

31. In the next module… We will continue to look at financial statements, moving onto the balance sheet. We will also look at the trial balance and adjustments to the trial balance.

32. End of Financial Management: Module 3 Revenue, Expenses, and the Income Statement To continue your learning experience, visitwww.oppteachers.org