MGTB05 Chapter 3 Notes

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Financial Accounting
Course Code
Daga Sandra

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MGTB05 Financial Accounting I Chapter 3—Operating Decisions and the Income Statement How Do Business Activities Affect the Income Statement? Operating Cycle  long-term objective of any business is to turn cash into more cash, this excess cash must be generated from operations not from borrowing money or selling non-current assets  cash-to-cash (operating) cycle is the length of time between the payment of cash to suppliers of inventory and to employees and the collection of cash from customers—shortening the operating cycle means higher profits and faster growth  the periodic assumption means that the long life of a company can be reported in shorter periods Elements of the Income Statement  the income statements includes three major sections:  results from continuing operations  results from discontinued operations = PROFIT  earnings per share  revenues are increases in assets or liabilities from ongoing operations of the business, result from the sale of goods or service  revenue is recognized when the significant risks and rewards of ownership have been transferred to the buyer, which is mainly upon shipment  when a company receives cash in exchange for a promise to provide goods or services in the future, that is a liability, deferred revenue, because the company still needs to provide the service, the revenue is recognized once the company provides the promised goods and services to the customer  expenditures are outflows of cash for any purpose whereas an expense results when an asset is used to generate revenue during a period or when an amount is incurred to generate revenues during a period  not all expenditures are expenses and not all expenses generate revenues  cost of goods sold is the cost of products sold to customers  difference between cost of goods sold and revenues = gross profit/gross margin  operating expenses are the usual expenses that are incurred in operating a business during a specific accounting period, either classified based on their function (e.g. marketing, distribution, etc.) or based on nature (e.g. materials, labour, etc.)  difference between gross profit and operating expenses = operating profit  any revenue, expenses, gains or losses that result from activities that are not included as part of the operating profit, are categorized as other income and expenses  gains are increases in assets or decreases in liabilities from peripheral transactions  losses are decreases in assets or increases in liabilities from peripheral transactions  difference between operating profit and non-operating items = pretax profit  income tax expense is calculated as a percentage before any constants or predetermined income tax amount, it should reflect the difference between income, which includes revenue and gains and expenses and losses  when a decision is made to discontinue a major component of a business, the profit or loss from that component, as well as any gain or loss on subsequent disposal, are disclosed separately under discontinued operations  earnings per share = profit/weighted average of shares How Are Operating Activities Recognized and Measured Accrual Accounting  profit measured on a cash basis can be misleading because it can report a higher profit if a customer pays cash in advance of receiving a good or service or if the company postponed payment of utility bills till the next period  accrual basic accounting records revenue when earned and expenses when incurred, regardless of the timing of cash recipients or payments The Revenue Principle  revenue principle: revenue from the sale of goods should
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