Transcript Slide 1

CHAPTER 3
Operating Decisions
& the Income Statement
Acct 2301, Fall 2009
Cox School of Business, SMU
Zining Li
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Elements of the Income Statement
Revenues
–
Cost of goods sold
=
Gross Profit
–
Operating costs and expenses
=
Operating Income
–
Other gains and losses
=
–
Pretax Net Income
=
Net Income
Income tax expense
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Assumptions & Principles of Accounting
•
Time period assumption
•
Revenue principle: Criteria for revenue recognition
•
•
•
•
•
Delivery of goods has occurred or services have been
rendered
Evidence of arrangement for customer payment
Price is fixed or determinable
Collection is reasonably assured
Matching principle: Outlines expense recognition
•
Costs incurred to generate revenues recognized in the same
period as revenues
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Accrual Accounting
•
Required by GAAP
• Revenues are recognized when earned under the
revenue principle, regardless of when cash is received
• Expenses are recognized when incurred under the
matching principle, regardless of when cash is paid
•
Prepaid expenses, unearned revenue
•
Accrual vs. cash-basis accounting
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Examples: Recording revenues and expenses
1. Company employees earned $420 in wages during the month of
December and will receive their paychecks in January. How much
salary expense should the company record in December?
2. The company purchased a one-year insurance policy on January 1 for
$1,200. At the end of January, what should the company record as
insurance expense?
3. On December 1 the company makes a one year loan to one of its
employees for $12,000. The loan carries an interest rate of 10%.
Should the company record any revenues or expenses in December
related to the loan?
4. At the beginning of the year a company has $200 of supplies in
storage. During the year, $600 of additional supplies are purchased.
At December 31, $250 of supplies are left. How much supplies
expense should the company record for the year?
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Exercise: Revenue & expense recognition under accrual
accounting
The Mozart Music Co. operates a retail store that sells musical
instruments. The company had the following transactions in July. For
each of following transactions, identify the amount of revenue or
expense that should be recognized for July under accrual accounting.
1. Sold instruments to customers for $10,000. The company received
$6,000 cash and the rest was charged on account. The cost of the
instruments was $7,000.
2. Purchased $4,000 of new instruments inventory with cash.
3. Paid $600 in wages to employees who worked during July.
4. Received a $200 telephone bill for July that will be paid in August.
5. Received $1,000 from customers as deposits on orders of new
instruments that will be delivered to customers in August.
Under accrual accounting what is the company’s net income for July?
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Transaction Analysis
The type of account determines how increases and
decreases are recorded in it:
Accounting
Equation
Rules of
Debit and
Credit
Assets
DR
+
=
CR
-
Liabilities
DR
-
CR
+
+
Stockholder’s
Equity
DR
-
CR
+
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Expanded Transaction Analysis
Stockholder’s
Equity
DR
-
-
=
CR
+
Retained
EarningsBEGIN
DR
Contributed
Capital
CR
+
CR
+
DR
-
+
Revenues
DR
-
+
CR
+
Retained
EarningsEND
CR
+
DR
-
–
Expenses
DR
+
CR
–
–
Dividends
DR
+
CR
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Accounting for Business Transactions
1.
Determine whether event is recordable
2.
Identify specific accounts affected (at least two
accounts per transaction)
3.
Determine direction and $ amount of each effect
4.
Record journal entry
5.
Verify that the total debits = total credits
6.
Verify that the accounting equation is in balance
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Examples: Recording revenue and expense
transactions with journal entries
1. Company performs services for customers in exchange for
$500 cash (e.g., Landscaping business).
2. Employees worked and earned wages of $200, the company
paid cash.
3. Company declares and pays dividends to its shareholders
totaling $1,000.
4. Company performs services worth $300 for customers on
account.
5. Company receives payment in full from customer in item 4
above.
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Exercise: Recording transactions with journal entries
College Caps, Inc. operates a small retail store in the mall that sells
baseball caps. The following transactions occurred during the first
month of operations:
May 1
Sold 1,000 shares of stock to investors for $30 per share
May 1
Purchased a supply of UT, SMU, and A&M baseball caps for
$7,800 in cash.
May 1
Paid $1,200 for the current month’s rent and another $1,200 for
next month’s rent.
May 21 Paid employee salaries of $300 for first three weeks of May.
May 24 Received $300 utilities bill for first two weeks of May. The bill
was paid that day with check no. 7005.
May 31 Monthly sales totaled $12,200, half of which was charged on
account. The cost of the caps sold was $5,400.
May 31 Salaries due to employees for the last week of May is $100. These
salaries will be paid June 7.
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Effect of transactions on cash flow
Statement of Cash Flows
Beginning cash balance
+ inflows of cash – outflows of cash
= Ending cash balance
Cash Inflows & Outflows:
• Operating activities
• Investing activities
• Financing activities
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Exercise: Identifying cash flow effects
Identify the cash flow effect of each transaction as either an operating,
investing, or financing activity. Indicate if there is no cash effect.
May 1
Sold 1,000 shares of stock to investors for $30 per share
May 1
Purchased a supply of UT, SMU, and A&M baseball caps for
$7,800 in cash.
May 1
Paid $1,200 for the current month’s rent and another $1,200 for
next month’s rent.
May 21 Paid employee salaries of $300 for first three weeks of May.
May 24 Received $300 utilities bill for first two weeks of May. The bill
was paid that day with check no. 7005.
May 31 Monthly sales totaled $12,200, half of which was charged on
account. The cost of the caps sold was $5,400.
May 31 Salaries due to employees for the last week of May is $100. These
salaries will be paid June 7.
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Ratio Analysis
Asset
Turnover Ratio
Earnings per
Share
=
=
Sales (or Operating) Revenues
Average Total Assets
Net Income
# of Shares Outstanding
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Flow of Accounting Data
1.
2.
3.
4.
5.
6.
7.
8.
Identify recordable financial transactions
Record the journal entries
Post journal entry amounts to T-accounts
Prepare the unadjusted trial balance
Record adjusting journal entries
Prepare the adjusted trial balance
Prepare the financial statements
Record the closing entries
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