Basic Accounting

Concepts: The
Income Statement
Part One: Financial Accounting

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 Basic Business Financial Flows Slide 3-1

Collection Cash Purchasing or

activities production
activities

Accounts
Inventories
receivable

Earnings
activities
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 Basic Concepts Slide 3-2

• Accounting
• Money period
measurement
• Conservatism
• Entity
• Realization
• Going concern
• Matching
• Cost
• Consistency
• Dual aspect
• Materiality

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 Basic Concepts Slide 3-3

Let’s take a look at Revenues $122,400

our summer camps Less expenses:
income statement for a Food $42,756
few summer months.
Wages 46,935
Rental 12,000
Other costs 5,472
Total exp. 107,163
Net income $ 15,237

Accounting Period Concept

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 Basic Concepts Slide 3-4

The accounting period Revenues $122,400

concept allows us to find Less expenses:
out how we did for a specific Food $42,756
period of time.
Wages 46,935
Rental 12,000
Other costs 5,472
Total exp. 107,163
Net income $ 15,237

Accounting Period Concept

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 Basic Concepts Slide 3-5

• Accounting
• Money period
measurement
• Conservatism
• Entity
• Realization
• Going concern
• Matching
• Cost
• Consistency
• Dual aspect
• Materiality

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 Basic Concepts Slide 3-6

Aspects of the conservatism concept:

 Recognize revenues (increases in retained

earnings) only when they are reasonably
certain.
 Recognize expenses (decreases in retained
earnings) as soon as they are reasonably
possible.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 Basic Concepts Slide 3-7

In December, customers
pay for a year’s
subscription to a
magazine that they will
begin receiving in When should the
January. revenue be
recognized?

Conservatism Concept

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 Basic Concepts Slide 3-8

In December, customers
Revenue is
pay for a year’s
subscription to a recognized when
magazine that they will the service is
begin receiving in
performed--thus
January.
in the year the
magazine service
is provided.
Conservatism Concept

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 Basic Concepts Slide 3-9

• Accounting
• Money period
measurement
• Conservatism
• Entity
• Realization
• Going concern
• Matching
• Cost
• Consistency
• Dual aspect
• Materiality

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 Basic Concepts Slide 3-10

Joe makes credit sales of merchandise

amounting to $100,000.

Realization Concept

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 Basic Concepts Slide 3-11

If experience indicates that 3 percent of credit

sales will eventually become bad debts, then
revenue for the period is $97,000.

Sorry Joe,
I can’t pay.

Realization Concept

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 Basic Concepts Slide 3-12

• Accounting
• Money period
measurement
• Conservatism
• Entity
• Realization
• Going concern
• Matching
• Cost
• Consistency
• Dual aspect
• Materiality

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 Basic Concepts Slide 3-13

Today is On March 19, an

March item of inventory

19 costing $1,000 is
received.

Matching Concept

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 Basic Concepts Slide 3-14

Today is On April 16, the

April vendor is paid in full.

16
Matching Concept

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 Basic Concepts Slide 3-15

Today is On May 9, the item of

May merchandise is sold

9 for $1,500.
When should the
merchandise be an
expense to the firm?
Matching Concept

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 Basic Concepts Slide 3-16

Today is On May 9, the item of

May merchandise is sold

9 for $1,500.
In May, when the
merchandise is sold.

Matching Concept

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 Basic Concepts Slide 3-17

Types of transactions that need to be considered in

distinguishing between amounts that are properly
considered as expenses of a given accounting period
and the expenditures made in connection with the
item.

 Expenditures that are also expenses

 Beginning assets that become expenses
 Expenditures that are not yet expenses
 Expenses not yet paid

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 Basic Concepts Slide 3-18

• Accounting
• Money period
measurement
• Conservatism
• Entity
• Realization
• Going concern
• Matching
• Cost
• Consistency
• Dual aspect
• Materiality

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 Basic Concepts Slide 3-19

The consistency concept:

LIFO Once an entity has decided
on one accounting
method, it should use the
same method for all
subsequent events of the
same character (unless it
has a sound reason to
change methods).

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 Basic Concepts Slide 3-20

• Accounting
• Money period
measurement
• Conservatism
• Entity
• Realization
• Going concern
• Matching
• Cost
• Consistency
• Dual aspect
• Materiality

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 Basic Concepts Slide 3-21

A dozen pencils were purchased

for the office secretary. These
pencils are assets to the firm
and technically should be
expensed each time one is used.
Materiality allows the firm to
expense the pencil either at the
time of purchase or when an
inventory is taken of office
supplies at period-end.

Materiality

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 Income Statement Slide 3-22

GARDEN CORPORATION
Income Statement
For the Year Ended December 31, 1998
Net sales $75,478,221
Cost of sales 52,227,004
Gross margin 23,251,217
Research and development expense 2,158,677
Selling, genera, and administrative expenses 8,726,696
Operating income 12,356,844
Other revenues (expenses):
Interest expense (363,000
)
Interest and dividend revenues 43,533
Royalty revenues 420,010
Income before income taxes 12,466,387
Provision for income taxes 4,986,555
Net income $ 7,479,832
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 Statement of Retained Earnings Slide 3-23

Statement of Retained Earnings

Retained earnings at the beginning of year $16,027,144
Add: Net income 7,479,832
Deduct: Dividends ($4 per common share) (4,390,000
Retained earnings at end of year $19,116,976

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 Chapter 3

The End

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999