Income Statement Metrics and Accounting Principles

Flashcards covering key financial statement metrics, accounting principles (accrual vs. cash), revenue and expense recognition, capitalizing vs. expensing, and the accounting cycle including adjusting and closing entries.

Gross Profit (GP)

Calculated as Revenue minus Cost of Goods Sold (COGS).

Gross Margin (%)

Calculated as Gross Profit divided by Revenue.

Operating Income (EBIT)

Also known as Earnings Before Interest and Taxes, calculated as Gross Profit minus Operating Expenses.

EBIT Margin (%)

Calculated as EBIT divided by Revenue.

EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortization, calculated as EBIT plus Depreciation and Amortization.

Net Income (NI)

Calculated as Revenue minus Expenses plus Gains minus Losses.

Profit Margin (%)

Calculated as Net Income divided by Revenue.

Interest Income

Interest earned on cash.

Interest Expense

Interest owed on debt.

Other Expense, Net

A combination of peripheral gains and expenses, such as a gain or loss from the sale of land.

Covenants

Special terms included in contracts when corporations raise debt, often related to maintaining certain financial performance metrics.

Accrual Accounting (or Accrual Basis Accounting)

An accounting method that requires recording revenue when earned and expenses when incurred, regardless of the timing of cash receipts or payments. It is mandated by GAAP.

Cash Accounting (or Cash Basis Accounting)

An accounting method that records revenue when cash is received and records expenses when cash is paid.

Revenue Recognition

The process of recording revenue when both conditions are met: the goods are delivered or service performed (earned), and cash or a claim to cash is received (realized).

Expense

The consumption of assets in the process of generating revenues, leading to a reduction in the value of the remaining asset.

Matching Principle

An accounting principle that dictates expenses should be recognized in the same period as the revenues they helped generate (product costs) or when they produce benefits (period costs).

Product Costs

Costs that are easily traceable to the revenue and are recognized in the same period when related revenues are recognized (e.g., COGS).

Period Costs

Costs that are not easily traceable to revenue and are recognized in the same period when these costs produce benefits (e.g., rent expense).

Capitalizing a Cost

Recording an item as an asset and expensing it over time as the asset is consumed or 'used up'.

Expensing a Cost

Recording an item as an expense immediately, recognizing the entire cost in one period.

Asset

A resource that gives rise to a probable future economic benefit that can be measured with reasonable precision and is owned by the firm.

Accounting Cycle

The full set of accounting procedures repeated during each accounting period, from transactions to financial statements and closing the books.

Adjusting Entries

Entries made at the end of an accounting period to recognize implicit transactions that occur over time, such as depreciation, accrued interest, or the usage of prepaid expenses.

Depreciation Expense

The cost of using Property, Plant, and Equipment (PP&E) recognized over time as the asset is used, which lowers its carrying value.

Straight-line Depreciation

A method of calculating depreciation expense: (Acquisition Cost - Salvage Value) / #Years of Useful Life.

Accrued Interest Expense

Interest that has been incurred on a loan but has not yet been paid, recognized as a liability (Interest Payable) as time passes.

Income Tax Expense (Provision for Income Taxes)

The expense recognized for income taxes if a company makes positive earnings, calculated as Income Before Taxes multiplied by the tax rate.

Prepaid Expenses (Adjusting Entry)

An adjusting entry that reduces an asset (e.g., Prepaid Rent) and records an expense as the prepaid item is 'used up' over time.

Accrued Expenses (Adjusting Entry)

An adjusting entry that records an expense and increases a liability (e.g., Wages Payable) for costs incurred but not yet paid.

Closing the Books

The process at the end of an accounting period where temporary income statement accounts are reset to zero and their balances are transferred to Retained Earnings.

Temporary Accounts

Income statement accounts (revenues, expenses, gains, losses) that start each accounting period with a $0 balance and are closed to Retained Earnings.

Permanent Accounts

Balance sheet accounts (assets, liabilities, equity) that are never closed and whose ending balance for one period carries over as the beginning balance for the next period.