1 / 22

Measuring Business Income

Measuring Business Income Chapter 3 Net Income The net increase in stockholders’ equity that results from operations of a company Accumulated in the R/E account NI or NL = Revenues - expenses Revenues The price of goods sold or services rendered over a specific period of time.

oshin
Download Presentation

Measuring Business Income

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Measuring Business Income Chapter 3

  2. Net Income • The net increase in stockholders’ equity that results from operations of a company • Accumulated in the R/E account • NI or NL = Revenues - expenses

  3. Revenues • The price of goods sold or services rendered over a specific period of time. • Not all cash receipts are revenues • Cash receipts for reducing accounts receivable are not revenues

  4. Expenses • Costs of the goods and services used up in the course of earning revenues • Including • Costs of goods sold • Costs of carrying on a business

  5. Expenses • Not all cash payments are expenses • Be aware of a two-step process to incur expenses, e.g., • Prepaid rent as an asset and when the rent is used up over time, it become an expense. • A building bought is an asset. For each accounting period, a portion of the building is “used up” to become an expense

  6. Periodicity • An assumption • Assuming that the net income for a period of time is still a useful estimate of an entity’s profitability for the period • Net worth and Investment horizon are two concepts interacting with the usefulness of periodicity assumption

  7. Accounting period • Fiscal year versus calendar year • More like to choose a fiscal year that ends during a slack season • For example, the last month of fiscal year for The Walt Disney Company is September – a slack season

  8. Continuity issue • Going concern assumption • Unless there is evidence to the contrary, the accountant assumes that the business will continue to operate indefinitely

  9. Liquidation value • The value of assets to a going concern is much higher than the value of assets to a firm facing bankruptcy • Book value vs. stock price • Some company may have $10 book value but stock price went down to only $2.50

  10. Cash basis of accounting • Some for income tax purposes • Revenues are reported in the period in which cash is received • Expenses are reported in the period in which cash is paid • Challenges?

  11. Accrual accounting • Attempts to record the financial effects in the periods in which those transactions, events, and circumstances occur rather than only in the periods in which cash is received or paid. • How? Applying the matching rule

  12. Accrual accounting • By recording revenues when earned and expenses when incurred, and • By adjusting the accounts

  13. Revenue recognition • Recognized when earned • If cash payment is not received, use accounts receivable or notes receivable as holding accounts until payment is received

  14. Adjusting the accounts • Adjustments are necessary because the accounting period ends before the use-up of assets and the fulfillment of obligations of liabilities like the fact that some unearned revenues became earned during the period

  15. Adjusting entries • Never involve the cash account • Require judgement • A potential area for abuse and misrepresentation • Affect profitability, balance sheet accounts

  16. Adjusting entries • Adjusting the use-up of assets – reclassified as expenses • Adjusting the fulfillment of unearned revenues (liabilities) – reclassified as revenues • Revenues earned but not recorded yet – recorded as accounts receivable (asset) • Expenses incurred but not yet recorded – recorded as accounts payable (liability)

  17. Adjusting entries • Recorded some assets and liabilities will be reclassified as expenses and revenues, respectively • Unrecorded revenues and expenses will be recorded as assets and liabilities

  18. Recorded assets • E.g. prepaid rent, prepaid insurance, supplies, buildings, etc. • Allocation of the used-up portion

  19. Prepaid rent • P. 140 • Paid two months’ rent in advance • By period end, in this case, Jan. 31, a month rent should be classified as expense • Expense increase  debit • Use credit to reduce asset account  credit prepaid rent

  20. Unrecorded expenses • E.g. interest expenses, taxes, wages, utilities for those unpaid portions • Accrue means to accumulate over time; thus those expenses will be called accrued expenses

  21. Accrued expenses • P. 145 • The end of the accounting period ended on Wed. and thus it accumulates three days unpaid expenses • How much is one day wage expense?

More Related