Chapter 1-6 Introduction to Revenue and Expenses

Revenue recognition and timing

• Revenue is earned when the transfer of goods or services occurs, not necessarily when cash is collected.
• In July, a sale of Bully merchandise for $8,000 was made:
  • Journal entry on sale: Debit Cash 3{,}000; Debit Accounts Receivable 5{,}000; Credit Revenue 8{,}000.
  • Cash received from customers: 3{,}000; Accounts Receivable established for the rest: 5{,}000.
• If revenue is earned in a prior period but cash is collected later, recognize revenue in the period earned, not when collected.
  • Example (c): June sale on account for 4{,}000 collected in July. Revenue is recognized in June, not July.
  • July entry to reflect collection: Debit Cash 4{,}000; Credit Accounts Receivable 4{,}000. No July revenue recorded.
• Unearned revenue arises when cash is received before the service is performed.
  • Example: Bowling leagues gave Craig's a cash deposit of 2{,}500 for fall services.
  • July entry: Debit Cash 2{,}500; Credit Unearned Revenue 2{,}500 (liability).
  • In the fall, when the service is provided, Debit Unearned Revenue; Credit Revenue to recognize the income.
• Revenue is an income statement account; it increases stockholders’ equity via credits.
• Assets vs revenue distinction:
  • Assets (e.g., Cash) are balance sheet accounts and are Debited to increase.
  • Revenue is not an asset; it is an income statement account and is Credited to increase.
  • Revenue ultimately increases Retained Earnings (Stockholders’ Equity).

Core concepts: income statement and timing

• The income statement lists Revenue first, then Expenses.
• Expenses are the costs incurred to operate the business and are recognized in the period in which the related resources are used to generate revenue (matching principle).
• Cash timing does not decide when an expense or revenue is recorded.
• The two sides of the equation: Revenues increase equity; Expenses decrease equity (via Retained Earnings).
• Common expense examples include: Cost of Goods Sold (COGS), Wages, Rent, Utilities, Depreciation (not covered here), etc.
• Some cash outflows are not expenses (e.g., repaying debt, buying inventory or assets).

Journal entries and scenarios (summary of examples from the transcript)

• a) Craig's sold Bully merchandise for 8{,}000; received cash 3{,}000 and $5{,}000$ on account.
  • Entry: Debit Cash 3{,}000; Debit Accounts Receivable 5{,}000; Credit Revenue 8{,}000.
• c) June sale on account for 4{,}000; cash collected in July.
  • July collection entry (no July revenue): Debit Cash 4{,}000; Credit Accounts Receivable 4{,}000.
  • Revenue recognized in June (not July).
• Deposits for future services (Unearned Revenue)
  • July: Debit Cash 2{,}500; Credit Unearned Revenue 2{,}500.
  • In fall, when services performed: Debit Unearned Revenue; Credit Revenue.
• Revenue vs expense distinction recap
  • Revenue is the first line on the income statement.
  • Expenses are costs incurred to operate and are recognized in the period services or goods were used to generate revenue.
  • Example statement concept: Net Income = Revenue - Expenses.
• Asset vs revenue vs expense clarification
  • Assets (e.g., Cash) are on the balance sheet and increase with a Debit.
  • Revenue is on the income statement and increases equity via Credit.
  • Expenses reduce equity via Debit (and appear on the income statement).
• Cost of Goods Sold (COGS)
  • COGS is the expense associated with the inventory sold during the period.
• Wages and other operating costs (typical examples)
  • Wages: employees’ time is a resource used to generate revenue.
  • Wage example: August wages earned 100{,}000; paid in September.
  • August entry (incurred in August): Debit Wage Expense 100{,}000; Credit Wages Payable 100{,}000 (liability).
  • September payment: Debit Wages Payable 100{,}000; Credit Cash 100{,}000 (no effect on income statement in September for this portion).
• Cash paid before/after expense recognition (prepaid expenses)
  • Insurance prepaid example (advance payment):
  • 02/2024: Pay 10{,}000 for coverage starting 02/2025.
  • Entry: Debit Prepaid Insurance 10{,}000; Credit Cash 10{,}000.
  • In 02/2025, when the coverage begins: Debit Insurance Expense 10{,}000; Credit Prepaid Insurance 10{,}000.
  • This asset is expensed as the benefit is consumed.
  • Another example: Craig's purchased 2,100 of insurance for coverage Aug 1 to Nov 1.
  • July entry: Debit Prepaid Insurance 2{,}100; Credit Cash 2{,}100 (no July expense).
  • August–November: recognize Insurance Expense incrementally (e.g., per month 2{,}100/4 = 525 per month); Debit Insurance Expense 525; Credit Prepaid Insurance 525 each month until exhausted.
• Paying an expense after recognizing it (liability settlement)
  • Example: June electricity expense recorded; July cash payment.
  • July entry to settle liability: Debit Accounts Payable 800; Credit Cash 800.
• July operating cash payments to employees
  • July: Pay employees for work performed in July: Debit Wage Expense 3{,}500; Credit Cash 3{,}500.

Practical implications and conceptual takeaways

• Timing rules:
  • Revenue: recognize when earned (delivery/transfer of control or performance).
  • Expenses: recognize when the related resource is consumed or the obligation is incurred to generate revenue (matching concept).
• Cash does not determine revenue or expense recognition.
• Assets vs liabilities vs equity:
  • Cash is an asset; increases with debits.
  • Unearned Revenue is a liability; decreases when earned.
  • Wages Payable is a liability; decreases when paid.
  • Revenue increases equity via credits; Expenses decrease equity via debits.
• The income statement focuses on revenues and expenses to determine net income.
• The balance sheet tracks assets, liabilities, and stockholders’ equity; movements in revenue/expense eventually flow into equity through retained earnings.
• Practical note: In many real-world cases, timing differences (accruals, prepaid assets, and accrued expenses) require careful journal entries to accurately reflect period performance.

Key formulas and references

• Net Income: Net\ Income = Revenue - Expenses$$
• Revenue recognition principle: revenue is recorded when earned, not when cash is received.
• Matching principle: expenses are recorded in the same period as the related revenues.
• Prepaid asset handling: cash paid before use increases the asset; expense is recognized when the asset is consumed.