1. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Operating Decisions and the Income Statement Chapter 3

2. 3-2 Understanding the Business How do business activities affect the income statement? How do business activities affect the income statement? How are these activities recognized and measured? recognized and measured? How are these activities recognized and measured? recognized and measured? How are these activities reported on the income statement? How are these activities reported on the income statement?

3. 3-3 The Operating Cycle Begin Purchase or manufacture products or supplies on credit. Deliver product or provide service to customers on credit. Paysuppliers.Paysuppliers. Receive payment from customers.

4. 3-4 The Operating Cycle Time Period: The long life of a company can be reported over a series of shorter time periods. Recognition Issues : When should the effects of operating activities be recognized (recorded)? Measurement Issues: What amounts should be recognized?

5. 3-5 Elements on the Income Statement Losses Decreases in assets or increases in liabilities from peripheral transactions. Losses Revenues Increases in assets or settlement of liabilities from ongoing operations. Revenues Expenses Decreases in assets or increases in liabilities from ongoing operations. Expenses Gains Increases in assets or settlement of liabilities from peripheral transactions. Gains

6. 3-6

7. 3-7 Papa John’s Primary Operating Expenses Cost of sales (used inventory) Salaries and benefits to employees Other costs (like advertising, insurance, and depreciation)

8. 3-8 How Are Operating Activities Recognized and Measured? Revenue is recorded when cash is received. Revenue is recorded when cash is received. Expenses are recorded when cash is paid. Expenses are recorded when cash is paid. Cash Basis

9. 3-9 Assets, liabilities, revenues, and expenses should be recognized when the transaction that causes them occurs, not necessarily when cash is paid or received. Required by - G enerally A cceptable A ccounting P rinciples How Are Operating Activities Recognized and Measured? Accrual Accounting

10. 3-10 Revenue Principle Recognize revenues when... Delivery has occurred or services have been rendered. Delivery has occurred or services have been rendered. There is persuasive evidence of an arrangement for customer payment. There is persuasive evidence of an arrangement for customer payment. The price is fixed or determinable. The price is fixed or determinable. Collection is reasonably assured. Collection is reasonably assured. Recognize revenues when... Delivery has occurred or services have been rendered. Delivery has occurred or services have been rendered. There is persuasive evidence of an arrangement for customer payment. There is persuasive evidence of an arrangement for customer payment. The price is fixed or determinable. The price is fixed or determinable. Collection is reasonably assured. Collection is reasonably assured.

11. 3-11 Revenue Principle Typical liabilities that become revenue when earned include...

12. 3-12 Revenue Principle Assets reflecting revenues earned but not yet received in cash include...

13. 3-13 The Matching Principle Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid.

14. 3-14 The Matching Principle Typical assets and their related expense accounts include...

15. 3-15 A = L + SE ASSETS Debit for Increase Credit for Decrease LIABILITIES Debit for Decrease Credit for Increase RETAINED EARNINGS Debit for Decrease Credit for Increase CONTRIBUTED CAPITAL Debit for Decrease Credit for Increase Next, let’s see how Revenues and Expenses affect Retained Earnings.

16. 3-16 EXPENSES Debit for Increase Credit for Decrease REVENUES Debit for Decrease Credit for Increase RETAINED EARNINGS Debit for Decrease Credit for Increase Expanded Transaction Analysis Model Dividends decrease Retained Earnings. Net Income increases Retained Earnings.

17. 3-17 End of Chapter 3