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Financial Accounting Lesson 3: The Income Statement
Ben Trnka/Boz Bostrom
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Let’s start with an example!
To the right is Amazon’s income statement Is Amazon a profitable company? How much has Amazon grown over the past two years? Is Amazon paying more taxes as it grows?
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Overview: Understand cash vs. accrual accounting
Understand revenues, expenses, and net income Learn how to prepare journal entries for income statement accounts Learn how to prepare an income statement
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The Operating Cycle Companies receive cash payment
Companies purchase goods, often on account Companies sell goods, often on account Companies pay for these goods with cash
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Accounts receivable/payable can be significant
What is Wal-Mart’s revenue? $500B What is Wal-Mart’s accounts receivable? $6B What is Wal-Mart’s accounts payable? $46B What is Exxon Mobil’s revenue? $244B What is Exxon Mobil’s accounts receivable? $21B What is Exxon Mobil’s accounts payable? $22B
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Revenues Inflows of assets due to regular/ongoing transactions
Usually either cash, or accounts receivable, which when collected becomes cash Recorded when earned Considered earned when goods are delivered or services are provided An inflow of assets due to a peripheral transaction is called a gain
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Expenses Ouflows of assets due to regular/ongoing transactions
Usually either cash, or a payable/liability, which is ultimately paid in cash Recorded when incurred / matched to revenue Specific requirements Probable Reasonable estimable An outflow of assets due to a peripheral transaction is called a loss
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Knowledge Check Order the accounts as they would appear on an income statement Accounts: Cost of sales Gain from sale of assets General and administrative expenses Income tax expense Interest expense Loss on sale of assets Sales revenue Service revenues Sales revenue Service revenues Cost of sales General and administrative expenses Interest expense Gain from sale of assets Loss on sale of assets Income tax expense
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Income Statement Subtotals
Gross margin Sales – cost of sales Earnings before interest, taxes, depreciation, and amortization (EBITDA) Subtracts selling, general, and administrative expenses Operating income (EBIT) Subtracts depreciation and amortization Income before income taxes Subtracts interest expense, net of interest income Subtracts peripheral losses, net of gains Net income Subtracts income taxes
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Why should you care? Investors/creditors generally want cash from their returns In the long-run, net income and cash flows will be fairly similar Increasing revenues often leads to increasing income and cash flows Expenses – are they increasing more or less quickly than revenues? Net income – is it increasing?
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Accounting Equation - Expanded
Assets = Liabilities + Equity Debit Credit + - Debit Credit - + Debit Credit - Dividends and Losses + Income Revenues Expenses Debit Credit - + Debit Credit + -
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Revenue Examples A company provides $100 of services for cash
Dr. Cash Cr. Service Revenues A company provides $150 of services on account Dr. Accounts Receivable Cr. Service Revenues A company collects $150 for the services provided on account Dr. Cash Cr. Accounts receivable
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Revenue Examples A company collects $200 cash for services to be provided in the future Dr. Cash Cr. Unearned Revenues 200 A company provides services for the $200 collected in advance Dr. Unearned Revenues 200 Cr. Service Revenues
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Expense Examples A company pays interest of $100 in cash
Dr. Interest expense Cr. Cash A company pays income taxes of $90 in cash Dr. Income Tax Expense 90 Cr. Cash A company incurs wages of $250 but doesn’t yet pay them Dr. Wages expense Cr. Wages payable A company pays the wages Dr. Wages payable Cr. Cash
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Combined Example A company purchases inventory for $300 on account
Dr. Inventory Cr. Accounts payable A company sells the $300 of inventory for $500 cash Dr. Cash Cr. Sales revenues Dr. Cost of goods sold Cr. Inventory A company pays off its $300 on account Dr. Accounts payable Cr. Cash
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T-Accounts
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Prepare the company’s income statement
Service revenue Sales revenue Cost of Goods Sold Gross margin Wages expense Operating income Interest expense Income before income taxes 300 Income tax expense -90 Net income If the company has 100 shares outstanding, what is its earnings per share? $210 net income / 100 shares outstanding = $2.10 earnings per share
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Thanks for tuning in! Key Takeaways Revenues, Expenses, and Net income
Record revenues when earned Record expenses when incurred / match to revenues Know how to record transactions using journal entries Revenues are credits Expenses are debits Cash receipt does not equal revenues Cash payment does not equal expenses Know how to create an income statement Thanks for tuning in!
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