1. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Accounting Concepts: The Income Statement © The McGraw-Hill Companies, Inc., 1999 3 Part One: Financial Accounting

2. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Business Financial Flows Cash Accounts receivable Inventories Collection activities Purchasing or production activities Earnings activities Slide 3-1

3. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Accounting period Conservatism Realization Matching Consistency Materiality Money measurement Entity Going concern Cost Dual aspect Basic Concepts Slide 3-2

4. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Revenues$122,400 Less expenses: Food$42,756 Wages46,935 Rental12,000 Other costs 5,472 Total exp.107,163 Net income$ 15,237 Basic Concepts Let’s take a look at our summer camps income statement for a few summer months. Let’s take a look at our summer camps income statement for a few summer months. Accounting Period Concept Slide 3-3

5. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Revenues$122,400 Less expenses: Food$42,756 Wages46,935 Rental12,000 Other costs 5,472 Total exp.107,163 Net income$ 15,237 Basic Concepts The accounting period concept allows us to find out how we did for a specific period of time. The accounting period concept allows us to find out how we did for a specific period of time. Accounting Period Concept Slide 3-4

6. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Accounting period Conservatism Realization Matching Consistency Materiality Money measurement Entity Going concern Cost Dual aspect Basic Concepts Slide 3-5

7. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999  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. Basic Concepts Aspects of the conservatism concept: Slide 3-6

8. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 When should the revenue be recognized? Basic Concepts In December, customers pay for a year’s subscription to a magazine that they will begin receiving in January. Conservatism Concept Slide 3-7

9. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Revenue is recognized when the service is performed--thus in the year the magazine service is provided. Basic Concepts In December, customers pay for a year’s subscription to a magazine that they will begin receiving in January. Conservatism Concept Slide 3-8

10. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Accounting period Conservatism Realization Matching Consistency Materiality Money measurement Entity Going concern Cost Dual aspect Basic Concepts Slide 3-9

11. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts Realization Concept Joe makes credit sales of merchandise amounting to $100,000. Slide 3-10

12. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts If experience indicates that 3 percent of credit sales will eventually become bad debts, then revenue for the period is $97,000. Realization Concept Sorry Joe, I can’t pay. Slide 3-11

13. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts Accounting period Conservatism Realization Matching Consistency Materiality Money measurement Entity Going concern Cost Dual aspect Slide 3-12

14. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts Matching Concept Today is March 19 On March 19, an item of inventory costing $1,000 is received. Slide 3-13

15. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts Matching Concept Today is April 16 On April 16, the vendor is paid in full. Slide 3-14

16. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 When should the merchandise be an expense to the firm? Basic Concepts Matching Concept Today is May 9 On May 9, the item of merchandise is sold for $1,500. Slide 3-15

17. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 In May, when the merchandise is sold. Basic Concepts Matching Concept Today is May 9 On May 9, the item of merchandise is sold for $1,500. Slide 3-16

18. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999  Expenditures that are also expenses  Beginning assets that become expenses  Expenditures that are not yet expenses  Expenses not yet paid  Expenditures that are also expenses  Beginning assets that become expenses  Expenditures that are not yet expenses  Expenses not yet paid Basic Concepts 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. Slide 3-17

19. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts Accounting period Conservatism Realization Matching Consistency Materiality Money measurement Entity Going concern Cost Dual aspect Slide 3-18

20. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts The consistency concept: 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). LIFO Slide 3-19

21. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts Accounting period Conservatism Realization Matching Consistency Materiality Money measurement Entity Going concern Cost Dual aspect Slide 3-20

22. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Concepts Slide 3-21 Materiality 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.

23. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Income Statement Slide 3-22 GARDEN CORPORATION Income Statement For the Year Ended December 31, 1998 Net sales$75,478,221 Cost of sales52,227,004 Gross margin23,251,217 Research and development expense 2,158,677 Selling, genera, and administrative expenses 8,726,696 Operating income12,356,844 Other revenues (expenses): Interest expense(363,000 Interest and dividend revenues43,533 Royalty revenues 420,010 Income before income taxes12,466,387 Provision for income taxes 4,986,555 Net income$ 7,479,832 )

24. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Statement of Retained Earnings Slide 3-23 Statement of Retained Earnings Retained earnings at the beginning of year$16,027,144 Add: Net income7,479,832 Deduct: Dividends ($4 per common share)(4,390,000 Retained earnings at end of year$19,116,976

25. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Chapter 3 The End