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Chapter 3 Operating Decisions and the Income Statement

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Wilfrid Laurier University
James Moore

BU227 Lecture Ch 3 Operating Decisions and the Income Statement 2013 How Business Activities Affect the Income Statementincome statement provides the basis for comparing analysts projections to results of operationsNOT A SNAPSHOTthis is a report over a period of timeThe Operating CycleLT goalturn cash into more cash by operations not by borrowingor selling noncurrent assets Operating cashtocash cycle time it takes for a firm to pay cash to suppliers sell goodsservices to customers and collect cash from customers the cycle depends on the nature of the businessShortterm debt financing many businesses pay suppliersworkers before they receive cash from customers so they seek ST financing When they receive cash from customers they pay off liabilitiesIn order to improve the companys cash flows firms try to shorten the operating cycle by creating incentives for customers to buy sooner and pay fasterhigher profits faster growth Periodicity assumption long life of a company can be reported in shorter periods 2 types of issues when reporting periodic income to users 1 Recognition issues when should the effects of operating activities be recognized recorded 2 Measurement issues what amounts should be recognized Elements of the Income StatementClassification of various income statement items helps financial statement users assess the company 1 Continuing operations presents the results of continuing operationsSingle step format list all revenues then all expenses and sow difference between the twoMultiple step format gross margin is shown then operating profit income as a second subtotalGross profit gross margin net salesCOGSOperating profitgross profitother operating expenses Operating revenues increases in assets or settlement of liabilities from ongoing operationso Sometimes a company receives cash for a promise to provide goods in the future Here revenue is not earned but a liability account deferred revenue is created When the firm provides the promised goodsservices revenue is recognized and the liability is settledOperating expenseso Expenditure any outflow of cash for any purpose whether to buy equipment or pay loans o Expense decreases in assets or increase in liabilities to generate revenues during the period Cost of goods sold cost of products sold to customers importing supplies handling etcOperating expenses usual expenses other than COGS incurred in operating a business during a specific accounting period International Accounting Standard 1 requires firms to classify their expenses by function marketing promotion distribution research administrative or by nature of the expense materials labour propertyequipment 2 Nonoperating items gainslosses from other actives are categorized as other income expenseso Investment income interestdividends earned by purchasing shares in other firmso Interest expense borrowing money is a financing activity that is costlyo Except for financial institutions interest expenses or investment income are not central operations so they are peripheral transactionso Gains increases in assets or decreases in liabilities from peripheral transactions o Losses decreases in assets or increases in liabilities from peripheral transactions ex impairment of assets restructuring costs and litigation settlementso Pretax profit revenuesall expenses except income tax expense3 Income Tax Expense last expense on income statemento forprofit corporations must compute income taxes owed to federal provincial foreign governments calculated as aof profit before income taxes
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