1102AFE Lecture Notes - Lecture 5: Net Profit, Current Asset, Accrual

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Week 5 Accounting for Decision Making Lecture Notes

Income Statement

1. The income statement

• Purpose

o To measure and report how much profit the business has generated

over a period

o To evaluate past decisions and revise future predictions

• Income statement Formula:

o Profit= revenues (income)- expenses

o Profit= R-E

• Income and expenses

o Income typically includes

▪ Revenue from operating activities

▪ Plus othe ioe suh as iteest ad diideds eeied

o Expenses

▪ Outflows of resources (cash and other assets) to generate

income

o Expenses often broken down into four categories:

▪ 1. Cost of Sales

▪ 2. Selling and distribution

▪ 3. Administration and general

▪ 4. Finance/ Financial

2. Revenue

• Definition:

o Increases in economics benefits during the accounting period

o In the form of inflows or enhancements of assets or decreases of

liabilities

o That result in increases in equity (other than increases resulting from

owner contributions)

• Recognized in the accounts when it can reliably be measured

• Revenues will arise from:

o An inflow of assets- most commonly cash or accounts receivable

o E.g. Received cash for services performed

Performed services on credit

o A decrease in liabilities- not as common

o E.g. Revenue received in advance and then gradually earned as the

services are performed

3. Expenses

• Definition:

o Decreases in economic benefits during the accounting period

o In the form of outflows or depletions of assets or increases in

liabilities

o That result in decreases in equity (other than decreases resulting from

owner withdrawals/ dividends)

• Recognized in the accounts when expenses can be reliably measured (which

includes ESTIMATES)

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• An expense is a cost incurred in earning revenue

• An expense will be matched with either:

o An outflow of assets (most commonly cash)

▪ E.g. paid insurance expense in cash

o An increase in liabilities

▪ E.g. rent expense incurred but not paid, creates the liability

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4. Accounting concepts- Influence on income statement

4.1 Cash Vs Accrual Accounting

• Cash-based accounting

o Records transactions related to income and expense only when cash

is received and when cash is paid

• Accrual-based accounting

o Records income when earned whether cash is received or not

o Records expenses when incurred whether cash is paid or not

• Whe aoutats use the od eogize they siply ea he do e

eod the tasatio i the aouts

• Accrual accounting

o Where accrual accounting is used, it will usually be necessary to make

adjustments at the end of the financial year

o This is because the receipt/payment of cash does not always align

with the earning of revenue and incurring of expenses

o Examples on slides 14-17

4.2 Accounting policies and estimates

• Preparing financial reports requires considerable judgment (subjectivity).

Firms will make both:

o Accounting policy choices

• Accounting policy choices: Examples include:

o Method of Depreciation to use (straight line, diminishing balance)

o Inventory costing method (FIFO, Weighted average)

o Method of valuing property, plant and equipment (cost, Valuation)

o How to account for leases (finance, operating)

• Accounting estimate choices:

o Useful life of the asset for depreciation purposes

o Residual value of the asset for depreciation

o Estimate for warranty provisions

5. Depreciation of tangible assets

• Definition: Depreciation is the allocation of cost of a tangible asset over its

useful life

• There are NO cash flows involved. Depreciation does not lead to any reserve

of cash

• It affects both income statement and balance sheet

• All tangible non-current assets (EXCEPT LAND) are depreciated

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Document Summary

Week 5 accounting for decision making lecture notes. Income statement: the income statement, purpose, to measure and report how much profit the business has generated over a period, to evaluate past decisions and revise future predictions. Income statement formula: profit= revenues (income)- expenses, profit= r-e. Income typically includes: revenue from operating activities, plus (cid:862)othe(cid:396) i(cid:374)(cid:272)o(cid:373)e(cid:863) su(cid:272)h as i(cid:374)te(cid:396)est a(cid:374)d di(cid:448)ide(cid:374)ds (cid:396)e(cid:272)ei(cid:448)ed, expenses, outflows of resources (cash and other assets) to generate income, expenses often broken down into four categories, 1. Increases in economics benefits during the accounting period. Performed services on credit: a decrease in liabilities- not as common, e. g. Revenue received in advance and then gradually earned as the services are performed: expenses, definition, decreases in economic benefits during the accounting period. Or: an increase in liabilities, e. g. rent expense incurred but not paid, creates the liability (cid:862) e(cid:374)t paya(cid:271)le(cid:863, accounting concepts- influence on income statement. 4. 2 accounting policies and estimates: preparing financial reports requires considerable judgment (subjectivity).

Related Questions

Identify two categories of revenue for Panera Bread from the table in the article Revenue Recognition: Key differences between U.S. GAAP and IFRSs. Compare and contrast the companyâs current U.S. GAAP revenue recognition with the potential adoption of IFRS. Provide the IASB Framework or the IAS statement, the changes in revenue recognition as well as potential challenges the company may face in adoption.

Table:

Subject	U.S. GAAP	IFRSs
Concept/objective	realized or realizable and earned.	According to paragraph 83 of the IASB's Framework for the Preparation and Presentation of Financial Statements, revenue is recognized when (1) "it is probable that any future economic benefit" will flow to the entity and (2) such a benefit can be measured reliably. Further, paragraph 93 of the IASB Framework indicates that revenue normally must be earned before it can be recognized.
Definition of revenue	Paragraph 78 of FASB Concepts Statement No. 6, Elements of Financial Statements, defines revenue as "inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations."	Paragraph 74 of the IASB Framework states, "The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent." Paragraph 7 of IAS 18 defines revenue as "the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants."
Sale of goods or products	SAB Topic 13 indicates that revenue from the sale of goods or products should not be recognized until it is earned and realized, or realizable. Revenue is generally earned and realized, or realizable, when all of the following conditions have been satisfied: There is persuasive evidence of an arrangement. Delivery has occurred (e.g., an exchange has taken place). The sales price is fixed or determinable. Collectibility is reasonably assured. In addition, ASC 605-15 provides guidance on product transactions that include a right of return. Further, various industry- and transaction-specific guidance is provided in other U.S. GAAP.	Under paragraph 14 of IAS 18, revenue from the sale of goods is recognized if all of the following conditions are met: The "entity has transferred to the buyer the significant risks and rewards of ownership of the goods." The "entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold." The "amount of revenue can be measured reliably." "[I]t is probable that the economic benefits associated with the transaction will flow to the entity." The "costs incurred or to be incurred in respect of the transaction can be measured reliably."
Rendering services	>Like revenue from product sales, revenue from service transactions should not be recognized until it is earned and realized, or realizable. Revenue is generally earned and realized, or realizable, when all of the following conditions have been satisfied: There is persuasive evidence of an arrangement. Service has been rendered. The sales price is fixed or determinable. Collectibility is reasonably assured. Other than the limited guidance in >ASC 605-20, no specific guidance on the rendering of services exists under U.S. GAAP. The appropriate method for recognizing revenue in such transactions depends on the individual transaction but is usually based on the proportional performance as of the balance sheet date.	Paragraph 20 of IAS 18 states, "When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage [i.e., percentage] of completion of the transaction at the balance sheet date." Paragraph 20 goes on to list specific conditions for determining whether an outcome of a transaction can be estimated reliably. And subsequent paragraphs provide guidance on determining the stage of completion. Paragraph 26 of IAS 18 states, "When the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognised only to the extent of the expenses recognised that are recoverable."
Software arrangements	ASC 985-605 provides guidance on recognizing revenue in a software arrangement.	There is no specific guidance on software revenue recognition in IFRSs. An entity should apply the provisions of IAS 18 as appropriate.
Construction-type contracts	ASC 605-35 provides guidance on construction-type contracts. ASC 605-35-25-90 indicates that when the percentage-of-completion method is deemed inappropriate (e.g., when dependable estimates cause the outcome to be doubtful), the completed-contract method is preferable. ASC 605-35-25-25 through 25-27, the customer must approve the scope and price of change orders before the related revenue can be recognized.	IAS 11, Construction Contracts, provides guidance on construction-type contracts. Paragraph 32 of IAS 11 indicates that when the percentage-of-completion method is deemed inappropriate (e.g., when the outcome of the contract cannot be estimated reliably), revenue is recognized to the extent that costs have been incurred, provided that the costs are recoverable. Use of the completed-contract method is prohibited under IFRSs. Paragraph 13 of IAS 11 specifies that when it is probable that the customer will approve the scope and price of a change order, the related revenue can be recognized.
Milestone method	ASC 605-28 provides guidance on the application of the milestone method for recognizing revenue in research or development arrangements.	There is no specific guidance in IFRSs on the application of the milestone method for recognizing revenue in research or development arrangements.
Multiple-element arrangements	ASC 605-25 provides guidance on multiple-element revenue arrangements and establishes detailed criteria for determining whether each element may be separately considered for recognition. This guidance does not apply to arrangements or deliverables that are within the scope of other authoritative literature (e.g., ASC 985-605).	Paragraph 13 of IAS 18 indicates that the recognition criteria under IAS 18 are usually applied separately to each transaction unless either of the following conditions applies: "[I]t is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction." Two or more transactions "are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole."
Bill-and-hold arrangements	The SEC staff lists specific criteria that must be met for revenue to be recognized in bill-and-hold arrangements before delivery of the product. (Non-SEC entities also use these revenue recognition criteria because no other authoritative guidance in U.S. GAAP addresses the accounting for these transactions.) The criteria restrict revenue recognition to limited circumstances.	Illustrative Examples to IAS 18 list criteria for recognizing revenue under bill-and-hold arrangements before delivery of the product. While the objective for recognizing revenue in bill-and-hold arrangements may be similar to that in U.S. GAAP, the criteria are not the same.
Gross versus net	ASC 605-45 provides guidance on whether to report revenue on the basis of the gross amount billed to the customer (as a principal) or the net amount retained by the company (as an agent).	Paragraph 8 of IAS 18 requires that revenue be reported on a net basis in agency relationships but does not provide specific guidance to consider. Improvements to IFRSs issued in April 2009) provides examples that indicate whether an entity is acting as a principal or as an agent.
Customer loyalty programs	Revenue recognition for customer loyalty programs is not specifically addressed in U.S. GAAP. (The EITF attempted to address this issue but did not reach a consensus.) Although entities account for customer loyalty programs in different ways, such programs are typically accounted for under ASC 605-25 as multiple-element arrangements or under an incremental-cost model.	IFRIC 13 indicates that customer loyalty programs are deemed multiple-element revenue transactions and that the fair value of the consideration received should be allocated between the components of the arrangement.
Rebates, discounts, incentives, and other consideration	ASC 605-50 indicates that consideration given by an entity to its customers is presumed to be a reduction of revenue unless an identifiable benefit whose fair value can be reasonably estimated is received.	Paragraph 10 of IAS 18 states that revenue "is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity." There is no specific guidance on other types of consideration given by an entity to its customers.
Specific industry and other guidance	Certain standards in U.S. GAAP provide specialized guidance on revenue recognition, including guidance that applies to specific industries and transactions.	IFRSs provide no (or limited) revenue recognition guidance that applies to specific industries or transactions.

greyhornet170

Investment and financing decisions, which may beshort-term or long-term decisions are best describedas:

financial decision making.

economic decision making.

accounting decision making.

Mutual funds, pension funds, investment dealers andinsurance companies are best described as examples of:

corporate finance.

market intermediaries.

financial intermediaries.

Farmers and Merchants Bank lends money to Ruth topurchase a car from Steven Toyota. Ruth is going to insure the carwith Allstate Insurance. Which party is best described as thecreditor?

Ruth

Steven Toyota

Allstate Insurance

Farmers and Merchants Bank

Which of the following would not be described as adebenture?

An unsecured loan

A loan secured by collateral

A loan secured by the âfull faith and creditâ of theissuer

Morgan Stanley was the investment banking firm that tookFacebook from being a closely held company to issuing stock to thepublic for the first time. Which of the following terms mostclosely describes this?

money market security.

issuing commercial paper.

initial public offering (IPO).

debt security backed by the general credit of theissuer.

Which of the following transactions does not take placein the primary market? An investor:

buying a newly issued municipal bond.

buying shares of an initial publicoffering.

selling one hundred shares of stock through a stockbroker.

buying a U.S. Treasury bill through the governmentauction.

The majority of home purchases in the U.S. are securedwith a mortgage. A mortgage is:

an unsecured loan.

an equity investment in the property.

a debt obligation secured by a specificproperty.

Which form of business would most likely describe thefollowing, a college student other students, a retired woman whobabysits children, a teenager who mows lawns, and a partyclown?

Partnership

Corporation

Sole proprietorship

Limited liability company

Flow-through taxation is a characteristic for all butthe following forms of business?

Partnership

Corporation

Sole proprietorship

Limited liability company

Your sister wants to start a tee shirt business on e-Baywith you to help pay for college tuition. All of the following areadvantages to partnerships that you should both consider, except____________?

Easy to form

Access to capital

Business income is taxed once, at the individualpartnerâs level

Which of the following takes into account takes intoaccount the opportunity cost of funds?

Net profit

Economic profit

Accounting profit

When we talk about capital structure, this refersto:

the cash, inventory, and accountsreceivable.

mix of debt and equity to finance anenterprise.

the investment in plant, property andequipment.

The uncertainty associated with the use of debt tofinance a business enterprise is best described as:

financial risk.

business risk.

operating risk.

The mix of debt and equity that is used to finance abusiness enterprise is best described as theenterpriseâs:

assets.

working capital.

capital structure.

capital expenditures

Generally accepted accounting principles (GAAP) are bestdescribed as a(n):

organization that establishes the accounting principlesfor U.S. financial reporting.

accounting standards promulgated by the InternationalAccounting Standards Board (IASB.)

set of basic principles and conventions that are appliedin the preparation of financial statements.

organization that establishes the accounting principlesfor business entities in the European EconomicCommunity.

Which reporting convention requires recording revenueand expenses when the transaction occurs, regardless of when cashchanges hands?

Cost basis

Cash basis

Accrual basis

The summary of the companyâs performance over a periodof time, typically a fiscal quarter or fiscal year

Balance sheet

Statement of stockholderâs equity

Income statement

Statement of cash flows

_______ is the cash flow from the day-to-day operationsof the business; the result of subtracting the increase in newworking capital from traditional cash flow.

Cash flow from investing

Cash flow from financing

Simple cash flow

Cash flow from operations

The debt ratio is classified as which type ofratio?

Owner

Liquidity

Efficiency

Productivity

Financial Leverage

Inventory turnover, accountsreceivable turnover, fixed asset turnover, and total asset turnoverare all classified as which type of ratio?

Owner

Liquidity

Efficiency

Productivity

Financial Leverage

ABC Company attempts tomanage its earnings by extending the useful life of all of itsequipment. Which of the following will not be an outcome of thischoice by management?

Income will be higher than it would have been underprior accounting methods.

Equipment values will be higher than they would havebeen without the change.

Depreciation expense will be lower than it would havebeen under prior accounting methods.

Depreciation expense will be higher than it would havebeen under prior accounting methods.

It is important for a companyto know the level of sales at which it covers all its variable andfixed operating costs. This level of sales is best described asthe:

gross profit margin.

contribution margin.

operating break even.

operating profit margin.

The minimum return thatinvestors expect to earn on the investment in stock is bestdescribed as:

growth rate.

risk premium.

capital gains yield.

required rate of return

If a company returns more than the required rate ofreturn on a stock, what happens to the value of thatstock?

The stock price falls.

The stock price rises.

The stock price stays the same.

When market rates are greaterthan the dividend rate, preferred shares will tradeat:

par.

a discount.

a premium.

byzantiummoose662

12. For the purpose of government-wide financial statements, thecost of cleaning up a government-owned landfill and closing thelandfill

A) Is not recognized until the costs are actually incurred
B) Is accrued and amortized over the expected useful life of thelandfill
C) Is accrued on a pro-rated basis each period based on how fullthe landfill is
D) Is accrued in full at the time the costs become estimable
E) Is treated as an encumbrance at the time it become estimable andas an expenditure when it is actually paid

13. Drye Township has received adonation of a rare painting worth $1,000,000. For Drye'sgovernment-wide financial statements, three criteria must be metbefore Drye can opt not to recognize the painting as an asset.Which of the following is not one of the three criteria?(1.) Thepainting is held for public exhibition, education, or research infurtherance of public service, rather than financial gain.(2.) Thepainting is scheduled to be sold immediately at auction.(3.) Thepainting is protected, kept unencumbered, cared for, andpreserved.

A) Item 1 is not one of the three criteria
B) Item 2 is not one of the three criteria
C) Item 3 is not one of the three criteria
D) All three items are required criteria
E) None of the three items are required criteria

14. Which of the following is nota criterion of a capital lease?

A) The lease transfers ownership of the property to the lesseeby the end of the lease term
B) The present value of the minimum lease payments equals orexceeds 90 percent of the fair value of the leased property, net oflessor's investment tax credit
C) The lease contains an option to purchase the leased property ata bargain price
D) The lease contains an option to renew
E) The lease term is equal to or greater than 75 percent of theestimated economic life of the leased property

15. Which statement is falseregarding the government-wide Statement of Net Assets?

A) The purpose of the Statement of Net Assets is to report theeconomic resources of the government as a whole
B) Assets are reported excluding capital assets
C) Capital assets are reported net of depreciation
D) Investments are reported at fair value rather than historicalcost
E) Business-type activities include Enterprise Funds

16. Which statement is falseregarding the Balance Sheet for Fund-Based Statements?

A) The Balance Sheet for Fund-Based Statements measures onlycurrent financial resources of the governmental entity
B) The Balance Sheet for Fund-Based Statements uses the modifiedaccrual method for timing purposes
C) Capital assets are not reported on the Balance Sheet forFund-Based Statements
D) The Balance Sheet for Fund-Based Statements measures onlylong-term financial resources of the governmental entity
E) Long-term debts are not reported on the Balance Sheet forFund-Based Statements

17. The city operates a publicpool where each person is assessed a $2 entrance fee. Which fund ismost appropriate to record these revenues?

A) General Fund
B) Enterprise Fund
C) Special Revenue Fund
D) Internal Service Fund
E) Capital Projects Fund

18. Which of the following typesof health care organizations follow FASB Accounting StandardsCodification for GAAP?

	Investor-Owned Health Care Enterprises	Not-for-Profit Organizations	Governmental Health Care Organizations
A)	Yes	Yes	No
B)	Yes	Yes	Yes
C)	No	No	Yes
D)	Yes	No	Yes
E)	Yes	No	No

A) Entry A
B) Entry B
C) Entry C
D) Entry D
E) Entry E

19. In accruing patient chargesfor the current month, which one of the following accounts should ahospital credit?

A) Accounts Payable
B) Deferred Revenue
C) Unearned Revenue
D) Patient Service Revenues
E) Accounts Receivable

20. Which account would becredited in recording a gift of medicine to a nursing home from anoutside party?

A) Nonoperating Gain - Contributions
B) Contractual Adjustments
C) Patient Service Revenues
D) Drugs and Medicines
E) Nonoperating Revenues - Contribution

21. Unconditional transfers ofcash or other resources to an entity in a voluntary nonreciprocaltransaction is the GAAP definition for

A) miscellaneous revenues
B) contributions
C) unconditional promises to give
D) exchange transactions
E) pledges

22. On a statement of functionalexpenses for a voluntary health and welfare organization, how areexpenses classified?

A) Health services expenses and operating expenses
B) Program services expenses and administrative servicesexpenses
C) Program services expenses and supporting services expenses
D) Operating expenses and supporting services expenses
E) Operating expenses and administrative expenses

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1102AFE Lecture Notes - Lecture 5: Net Profit, Current Asset, Accrual

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