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Chapter 5 Income Measurement and the Income Statement
The Revenue Recognition Principle
N Revenues J Increases in economic resources resulting from ordinary activities such as the sale of
goods, rendering of services, or Z}}ZL][ZZ}
N Revenue recognition principle J Revenues are recognized in the income statement when they
o Time-of-sale method J The method used by merchandising and manufacturing
industries to recognize revenue when goods are sold.
o Percentage-of-completion method J The method used by contractors to recognize
revenue before the completion of a long-term contract.
o Production method J The method in which revenue is recognized when a commodity is
produced rather than when it is sold.
o Instalment method J The method in which revenue is recognized at the time cash is
The Matching Principle and Expense Recognition
N Matching Principle J The revenues for the period are associated with the costs of generating
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
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.
The Format and Content of the Income Statement
N Single-step income statement J An income statement in which all expenses are added together
and expenses or associate them with anything.
N Multiple-step income statement J An income statement that shows classifications of revenues
and expenses as well as important subtotals.
o Net Sales J Sales revenue less sales returns and allowances and sales discounts.
o Gross Profit J Sales less cost of goods sold, also termed gross margin.
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o Cost of goods available for sale J Beginning inventory plus cost of goods purchased.
o Cost of goods sold J 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.
N Operating Expenses and Income from Operations J Income from operations is the difference
between gross profit and total operating expenses. A healthy income from operations can
indicate a healthy financial future.
N Other Revenues and Expenses and Income before Income Taxes J Any outflow or inflow of
assets resulting from non-operating activities.
N 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
N 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.
N Indirect method used to prepare the Operating Activities category of the cash flow
o It is necessary to make adjustments to net income for th