Chapter 3 Operating a Business and the Income Statement © 2009 The McGraw-Hill Companies, Inc.

Chapter 3

Operating a Business and Operating a Business and the Income Statementthe Income Statement

© 2009 The McGraw-Hill Companies, Inc.

RevenuesSales revenue 11,000$ Total revenue 11,000

ExpensesSupplies expense 4,000 Wages expense 2,000 Rent expense 2,000 Utilities expense 600 Insurance expense 300 Advertising expense 100 Total expenses 9,000 Net income 2,000$

For the Month Ended May 31, 2009Income Statement

PIZZA AROMARevenues are earned when there is an exchange of a business’s products or

services for cash or a promise to pay cash.

Net income is the excess of revenues over expenses.

Income Statement Accounts

Expenses are costs incurred to generate revenues.

Income Statement Accounts

Cash Expenditu

res

Debt Payments

Expenses

Asset Purchase

s

Income Statement AccountsAccount Number Account Name

401 Pizza Revenue410 Investment Revenue450 Gain on Sale of Assets501 Wages Expense503 Supplies Expense506 Utilities Expense507 Telephone Service Expense510 Rent Expense511 Insurance Expense512 Advertising Expense530 Interest Expense550 Loss on Sale of Assets

Operating Cycle

Typical Operating Cycle

Purchase good and services

Pay cash to suppliers

Sell goods and services to customers

Receive cash from customers

Cash basis accounting records revenues when cash

is received and expenses when cash is paid.

Cash-Based Measurements

GAAP

Revenues are recognized when they are earned and expenses are recognized when they are incurred,

regardless of the timing of cash receipts or

payments.

Accrual Basis Accounting

Business delivers goods or services.

here

(2)

here

(3)

here

(1)

Cash can be received . . .

(1) Cash is received in the same period as the goods or services are delivered.

Revenue is recorded here.

Time

Recording Revenues versus Cash Receipts

(2) Cash is received before the goods or services are delivered.

(3) Cash is received after the goods or services are delivered.


here

(2)

here

(1)

here

(3)



Time


(1) Cash is received in the same period as the goods or services are delivered.

(2) Cash is received before the goods or services are delivered.

(3) Cash is received after the goods or services are delivered.


here

(2)

here

(1)

here

(3)


(1) Cash is received in the same period as the promised acts are performed.

(2) Cash is received in a period before the promised acts are performed.

(3) Cash is received in a period after the promised acts are performed.


Time

When cash is received before goods or services are delivered, the company receiving the cash will report an

increase in cash and an increase in a liability, called unearned revenue, which represents the obligation to

perform the acts in the future.



here

(2)

here

(1)

here

(3)


(1) Cash is received in the same period as the promised acts are performed.

(2) Cash is received in a period before the promised acts are performed.

(3) Cash is received in a period after the promised acts are performed.


Time

When cash is received after goods or services are delivered, the company performing the services will report an increase

in revenue and an increase in accounts receivable. Later, when the cash is received, the accounts receivable is

reduced.


Business incurs costs to generate revenues.

here

(2)

here

(1)

here

(3)

Cash can be paid . . .

(1) Cash is paid at the same time as the expense is incurred to generate revenue.

Expense is recognized here.

Time

Recording Expenses versus Cash Payments

(2) Cash is paid before the expense is incurred to generate revenue.

(3) Cash is paid after the expense is incurred to generate revenue.


here

(2)

here

(1)

here

(3)



Time


(1) Cash is paid at the same time as the expense is incurred to generate revenue.

(2) Cash is paid before the expense is incurred to generate revenue.

(3) Cash is paid after the expense is incurred to generate revenue.


here

(2)

here

(1)

here

(3)


(1) Cash is paid at the same time as the cost is incurred to generate revenue.

(2) Cash is paid before the the cost is incurred to generate revenue.

(3) Cash is paid after the the cost is incurred to generate revenue.


Time


Given the matching principle, the expense should be reported when the cost is incurred to earn revenue and not in the period

when the cash is paid.

The Expanded Transaction Analysis Model

= ++ Increases Decreases - - Decreases Increases + - Decreases Increases +

Assets Liabilities Owner's Equity

Debit Credit Debit Credit Debit Credit

Debit = Left Credit = Right

Asset accounts increaseincrease on the left or debitdebit side and decreasedecrease

on the right or creditcredit side.

Liability accounts increaseincrease on the right or creditcredit side and decreasedecrease

on the left or debitdebit side.

Owner’s equity accounts increaseincrease on the right or creditcredit side

and decreasedecrease on the left or debitdebit side.

Let’s take a closer look at the accounts that affect Owner’s Equity.

The Expanded Transaction Analysis Model

+ Increases Decreases -

M. Rosa, Drawing

- Decreases Increases +

Revenues

+ Increases Decreases -

Expenses

Debit Credit

Debit Credit

Debit Credit

Debit Credit

= ++ Increases Decreases - - Decreases Increases + - Decreases Increases +

Assets Liabilities Owner's Equity

Analysis of Pizza Aroma’s Transactions

(h) During May, Pizza Aroma sells pizza to restaurant customers for $12,000.

Debit CreditCash (+A) 12,000

Pizza Revenue (+R, +OE) 12,000

Accounts

Beg. Bal. 5,200 (h) 12,000

Cash- Beg. Bal.

12,000 (h)

Pizza Revenue


(i) Pizza Aroma delivers $2,000 in pizza on account to various college departments.

Debit CreditAccounts Receivable (+A) 2,000

Pizza Revenue (+R, +OE) 2,000

Accounts

Beg. Bal. - (i) 2,000

Accounts Receivable- Beg. Bal.

12,000 (h)2,000 (i)

Pizza Revenue


(j) Fraternities place large orders for end-of-May graduation events and for mid-June reunion weekend, giving Pizza Aroma $600 cash on deposit in mid-May.

Debit CreditCash (+A) 600

Unearned Revenue (+L) 600

Accounts

Beg. Bal. 5,200 (h) 12,000 (j) 600

Cash

- Beg. Bal.600 (j)

Unearned Revenue


(k) Pizza Aroma purchases $3,000 of additional supplies, paying $2,200 in cash and owing the rest on account.

Debit CreditSupplies (+A) 3,000

Cash (-A) 2,200 Accounts Payable (+L) 800

Accounts

Beg. Bal. 5,200 (h) 12,000 2,200 (k)(j) 600

Cash

4,000 Beg. Bal.800 (k)

Accounts Payable

Beg. Bal. 2,000 (k) 3,000

Supplies


(l) Pizza Aroma pays $800 cash for newspaper advertising during May.

Debit CreditAdvertising Expense (+E, -OE) 800

Cash (-A) 800

Accounts

Beg. Bal. 5,200 (h) 12,000 2,200 (k)(j) 600 800 (l)

Cash

Beg. Bal. - (l) 800

Advertising Expense


(m) Pizza Aroma pays $1,000 cash to employees for work during May.

Debit CreditWages Expense (+E, -OE) 1,000

Cash (-A) 1,000

Accounts

Beg. Bal. 5,200 (h) 12,000 2,200 (k)(j) 600 800 (l)

1,000 (m)

Cash

Beg. Bal. - (m) 1,000

Wages Expense


(n) College departments pay Pizza Aroma $1,300 cash owed on their accounts (see event i above.)

Debit CreditCash (+A) 1,300

Accounts Receivable (-A) 1,300

Accounts

Beg. Bal. 5,200 (h) 12,000 2,200 (k)(j) 600 800 (l)

(n) 1,300 1,000 (m)

Cash

Beg. Bal. - (i) 2,000 1,300 (n)

Accounts Receivable


(o) Pizza Aroma receives and pays a $600 bill for telephone service in May.

Debit CreditTelephone Service Expense (+E, -OE) 600

Cash (-A) 600

Accounts

Beg. Bal. 5,200 (h) 12,000 2,200 (k)(j) 600 800 (l)

(n) 1,300 1,000 (m)600 (o)

Cash

- Beg. Bal.600 (o)

Telephone Service Expense


(p) At the end of May, Pizza Aroma purchases insurance for its restaurant equipment, paying $2,400 cash to cover the months of June, July, and August.

Debit CreditPrepaid Insurance (+A) 2,400

Cash (-A) 2,400

Accounts

Beg. Bal. 5,200 (h) 12,000 2,200 (k)(j) 600 800 (l)

(n) 1,300 1,000 (m)600 (o)

2,400 (p)

Cash

Beg. Bal. - (p) 2,400

Prepaid Insurance


(q) Owner Mauricio Rosa withdraws $3,000 in cash at the end of May.

Debit CreditM. Rosa, Drawing (-OE) 3,000

Cash (-A) 3,000

Accounts

Beg. Bal. 5,200 (h) 12,000 2,200 (k)(j) 600 800 (l)

(n) 1,300 1,000 (m)600 (o)

2,400 (p)3,000 (q)

Cash

Beg. Bal. - (q) 3,000

M. Rosa, Drawing

Here are the asset account balances. (Transactions (a) to (g)

came from Chapter 2.)Beg. Bal. -

(a) 30,000 4,800 (e)(b) 20,000 33,000 (d)(h) 12,000 1,000 (f)(j) 600 6,000 (g)

(n) 1,300 2,200 (k)800 (l)

1,000 (m)600 (o)

2,400 (p)3,000 (q)

End. Bal. 9,100

Cash

Beg. Bal. - (i) 2,000 1,300 (n)

End. Bal. 700

Accounts Receivable

Beg. Bal. - (c) 4,800

End. Bal. 4,800

Prepaid Rent

Beg. Bal. - (p) 2,400

End. Bal. 2,400

Prepaid InsuranceBeg. Bal. -

(g) 6,000 End. Bal. 6,000

Investments

Beg. Bal. - (e) 2,000 (k) 3,000

End. Bal. 5,000

Supplies

Beg. Bal. - (d) 36,000

End. Bal. 36,000

Equipment

Beg. Bal.(f) 1,000 3,000 (d)

2,000 (e)800 (m)

4,800 End. Bal.

Accounts Payable

- Beg. Bal.600 (j)600 End. Bal.

Unearned Revenue

Here are the liability account balances.

(Transactions (a) to (g) came from Chapter 2.)

- Beg. Bal.20,000 (b)20,000 End. Bal.

Notes Payable

Here are the owner’s equity account balances. (Transactions (a) to (g) came from Chapter 2.)

- Beg. Bal.12,000 (h)2,000 (i)

14,000 End. Bal.

Pizza Revenue

Beg. Bal. - 0 1,000

End. Bal. 1,000

Wages Expense

Beg. Bal. - (o) 600

End. Bal. 600

Telephone Service Expense

- Beg. Bal.30,000 (a)30,000 End. Bal.

M. Rosa, Capital

Beg. Bal. - (q) 3,000

End. Bal. 3,000

M. Rosa, Drawing

Beg. Bal. - (l) 800

End. Bal. 800

Advertising Expense

Debit CreditCash 9,100$ Investments 6,000 Accounts Receivable 700 Supplies 5,000 Prepaid Rent 4,800 Prepaid Insurance 2,400 Equipment 36,000 Accounts Payable 4,800$ Unearned Revenue 600 Notes Payable 20,000 M. Rosa, Capital 30,000 M. Rosa, Drawing 3,000 Pizza Revenue 14,000 Wages Expense 1,000 Telephone Service Expense 600 Advertising Expense 800 Total 69,400$ 69,400$

Pizza AromaUnadjusted Trial Balance

On May 31, 2009

Unadjusted Trial BalanceAmounts

come from ledger

balances

Amounts come from

ledger balances

Not a financial

statement

Not a financial

statement

Debits = CreditsDebits = Credits

Listed in financial

statement order

Listed in financial

statement order

Operating Revenues: Pizza Revenue 14,000$ Total Operating Revenues 14,000 Operating Expenses: Wages Expense 1,000 Telephone Service Expense 600 Advertising Expense 800 Total Operating Expenses 2,400 Operating Income 11,600 Other Items: Investment Revenue - Interest Expense - Net Income 11,600$

Pizza AromaIncome Statement (unadjusted)

For the Month Ended May 31, 2009

Classified Income StatementOperating revenues

result from the sale of goods and services.

Operating expenses are the costs that are directly related to the

generation of operating revenues.

Other items include peripheral

transactions such as interest and dividends.

McGraw-Hill/Irwin Slide 33

NI Cash

NI Value

NI Counting

Limitations of the Income Statement

End of Chapter 3

Chapter 3 Operating a Business and the Income Statement © 2009 The McGraw-Hill Companies, Inc.

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Transcript of Chapter 3 Operating a Business and the Income Statement © 2009 The McGraw-Hill Companies, Inc.