The income statement

Operating activities

day-to-day functions involved in running a business

Typical operating activities include

• Buying goods and services from suppliers and employees

• Selling goods and services to customers

• Collecting and paying out cash

The income statement

Summarizes the financial impact of operating activities undertaken by the company during the accounting period

Time period assumption

Divides the long life of a company into shorter periods, such as month, quarters, or years

What are the primary source of revenues and expenses from?

operating activities

Income statement formula

Net Income = Revenues - Expenses

Revenues

Amounts earned by selling goods or services to customers.

Expenses

Costs of business necessary to earn revenues.

Net Income

The excess of revenues over expenses.

• it is a total not an account

Net loss

when expenses are greater than revenues on the income statements

A key time based distinction between the balance sheet and the income statement

The revenues and expenses on an income statement only report the financial impact of activities in the current period, whereas items on a balance sheet will continue to have a financial impact beyond the end of the current period.

• Balance sheet accounts are considered permanent, whereas income statement accounts are considered temporary.

Cash Basis Accounting

Reports revenues when cash is received and expenses when cash is paid; this is not allowed under GAAP.

Which accounting method is not for running a business, but could still be fine when used to manage personal finances

Cash basis accounting

accrual basic accounting

Reports revenues when they are earned and expenses when they are incurred, regardless of the timing of cash receipts or payments; required under GAAP.

Revenue recognition principle

The requirement under accrual basis accounting to record revenues when they are earned, not necessarily when cash is received for them.

• revenues are based on work completed not the cash received

What three conditions must be met for revenue to be recognized?

1. Risks and rewards have passed or the earnings process is substantially complete.

2. Measurability is reasonably certain.

3. Collectability is reasonably assured.

Deferred Revenue

A liability representing a company’s obligation to provide goods or services to customers in the future.

Expense recognition principal (matching)

The requirement under accrual basis accounting to record expenses in the same period as the revenues they generate, not necessarily the period in which cash is paid for them.

Why is Cash Basis Accounting not allowed by GAAP?

It distorts financial statements