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Exam Review

16 Pages

Course Code
ACC 100
Walter Krystia

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P a g e | 1 Financial Accounting Exam Review Chapter 5 Income Measurement and the Income Statement The Revenue Recognition Principle Revenues Increases in economic resources resulting from ordinary activities such as the sale of goods, rendering of services, or use of other entitys resources. Revenue recognition principle Revenues are recognized in the income statement when they are earned. o Time-of-sale method The method used by merchandising and manufacturing industries to recognize revenue when goods are sold. o Percentage-of-completion method The method used by contractors to recognize revenue before the completion of a long-term contract. o Production method The method in which revenue is recognized when a commodity is produced rather than when it is sold. o Instalment method The method in which revenue is recognized at the time cash is collected. The Matching Principle and Expense Recognition Matching Principle The revenues for the period are associated with the costs of generating those revenues. o Certain costs directly generate revenues, so they can be directly matched with them. o Other costs indirectly generate revenues, so they are matched with the periods they provide benefit. o Other costs do not give rise to assets because no future benefits from these costs are discernible, like the cost of heating and lighting. Thus they are treated as expiring immediately as they are acquired. o Unexpired Costs are called assets, expired ones, expenses. P a g e | 2 The Format and Content of the Income Statement Single-step income statement An income statement in which all expenses are added together and subtracted from all revenues. Advantage is that its simple, but doesnt classify revenues and expenses or associate them with anything. Multiple-step income statement An income statement that shows classifications of revenues and expenses as well as important subtotals. o Net Sales Sales revenue less sales returns and allowances and sales discounts. o Gross Profit Sales less cost of goods sold, also termed gross margin. Total sales $368,00 revenue 0 Less: Sales returns and allowances 6,000 Sales discounts 4,500 $357,50 Net sales 0 Cost of goods sold 218,300 $13 9,2 Gross Profit 00 o Sales Returns and Allowances Contra-revenue account (Shareholders Equity) used to record both refunds to customers and reductions of their accounts. Example of someone returning a $25 shirt: Apr. 25 Sales Returns and Allowances 25 Cash 25 To record return of stained T-shirt by customer for cash refund Contra-revenue account Has a balance opposite to its related account, and is deducted from that account on the statement. Thus the P a g e | 3 effect of this debit to this account is the same as if Sales Revenue had been reduced (debited) directly. A Shareholders Equity account. o Trade discount Selling price reduction offered to a special class of customers. o Quantity discount Reduction in selling price for buying a large number of units of a product. o Credit terms Commonly used to give customers sales discounts, 1/10, n/30 means deduct 1% from selling price if paid within 10 days of receiving the invoice (usually starts day after invoice date), otherwise pay full invoice amount within 30 days. o Sales Discounts Contra-revenue account used to record discounts given customers for early payment of their account. Cost of goods sold model: P a g e | 4 o Cost of goods available for sale Beginning inventory plus cost of goods purchased. o Cost of goods sold Cost of goods available for sale minus ending inventory. o Gross Profit Margin = Gross Profit / Net Sales This indicates the amount of each net sales dollar left after cost of goods sold. Operating Expenses and Income from Operations Income from operations is the difference between gross profit and total operating expenses. A healthy income from operations can indicate a healthy financial future. Other Revenues and Expenses and Income before Income Taxes Any outflow or inflow of assets resulting from non-operating activities. Profit Margin = Net Income / Net Sales o The ratio of net income to net sales indicates the amount of each net sales dollar left as profit after all expenses are covered. How Sales Affect the Cash Flow Statement Direct method used to prepare the Operating Activities category of the cash flow statement: o The amount of cash collected from customers is shown as positive cash flow. Indirect method used to prepare the Operating Activities category of the cash flow statement: o It is necessary to make adjustments to net income for the changes in accounts receivable. An increase in accounts receivable is deducted because it indicates the company is tying up its cash in these accounts. A decrease is added to net income because the company actually reduced the amount owed by customers and collected cash.
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