AFM101 Chapter Notes - Chapter 3: Gross Margin, Gross Profit, Interest Expense
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AFM 101 - Chapter 3 Notes
HOW DO THE BUSINESS ACTIVITIES AFFECT THE STATEMENT OF EARNINGS?
The Operating Cycle
• Operating (cash-to-cash) Cycle: the time it takes for a company to pay cash to suppliers, sell
goods and services to customers, and collect cash from customers
o Begins when a company receives goods to sell, pay for them, and sells to customers
o Ends when customers pay cash to the company
o Short-term financing may be used so that businesses can pay suppliers and employees
before they receive cash from customers
• Shortening the operating cycle means higher net earnings and faster growth
• Periodicity Assumption: means that the long life of a company can be reported in shorter
periods
o To help measure net earnings for a specific period of time
o Two types of issues arise in reporting periodic net earnings to users:
▪ Recognition issues: When should the effects of operating activities be
recognized (recorded)
▪ Measurement issues: What amounts should be recognized?
Elements of the Statement of Earnings
• Includes three major sections:
o 1) Results of continuing operations
o 2) Results of discontinued operations → (Net earnings = sum of 1+2)
o 3) Earnings per share
• Continuing Operations: presents results of continuing operations
• Operating Revenues:
o Revenues: increases in assets or settlements of liabilities from ongoing operations
▪ Assets (usually cash or trade receivables) increase when revenues are earned
▪ Deferred Revenue is created when a company receives cash in advance for a for
a promise to receive goods or services in the future → a liability account is
earned
• Operating Expenses:
o Expenses: decreases in assets (or increase in liabilities) to generate revenues during the
period
▪ Different from expenditures which is any outflow of cash for any purpose
▪ Expenses only occur when an asset is used to generate revenue or when an
amount is incurred to generate revenues during a period (ex. Electricity)
o Ex. Sun-Rpe’s priar operatig epeses ilude:
▪ Cost of sales (aka cost of goods sold)
• = inventories used to produce and package the squeezed fruits and
become an expense
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