Chap 4_Measuring Income.pptx

Measuring Income CHAPTER-4 Income Measurement Basics Net profit/ Losses Revenue and Gains- Increase equity Expenses and losses - Decrease equity Accrual System and Cash System Accrual System Records revenues when they are earned regardless of when cash is received. Record expenses when they are in...

Measuring Income CHAPTER-4 Income Measurement Basics Net profit/ Losses Revenue and Gains- Increase equity Expenses and losses - Decrease equity Accrual System and Cash System Accrual System Records revenues when they are earned regardless of when cash is received. Record expenses when they are incurred regardless of when cash is paid Cash system Record revenues when cash is received and record expenses when cash is paid Income measurement principles Revenue recognition principle for measuring revenue (e.g. Receipt of sale or service order does not construe sale) Revenue recognition is simultaneous with an increase in an asset or a decrease in a liability Quiz 4.3 Matching principle for measuring expenses Expenses be recognized in the reporting period in which revenue is earned Compare accomplishment with effort Cause and effect relationship e.g. COGS and sales commission can be matched with sales revenue. Allocation in systematic manner – depreciation Expenses such as employee training, R&D and brand buildinghave unpredictable outcomes. Hence, amount spent on such activities are expenses as incurred.  Income Measurement Mechanics- the Adjustment process Deferred Revenue Accrued Revenue Deferred Expense Accrued Expense Summary of Adjusting entries Financial statements of Service organizations and Merchandising Organisations Financial Statements of a Service Organization  Statement of Profit and Loss 1) Natural format As per the Schedule III of Companies Act 2013 2) Functional format Items are grouped as per the activities of the business. Merchandising Companies – Accounting Cycle Cash Receive Buy Cash Inventory Trade Receivabl Inventory e Sell Inventory 15  Income measurement for a Merchandising Organisation  The statement of profit and loss of a merchandising organisation has three components:  Revenue from sales  Cost of goods sold  Operating expenses 16  Vijay Electronics Ltd Statement of Profit and Loss Revenue from sales …………………………… 439120 Cost of goods sold …………………………… 298700 Gross Profit ………………………………….. 140420 Operating Expense …………………………… 76800 Selling Expenses …………………………….. 52300 Administrative Expenses …………………… 24500 Profit before interest and tax ……………….. 63620 Interest Expense ……………………………… 4700 Profit before tax ………………………………. 58920 Income tax ……………………………………. 26000 Net Profit …………………………………….. 32920 17 Natural format- Merchandising Organisation Working Income measurement for a Merchandising Organisation  Revenue : sale of goods – on cash or credit  Cost of goods sold : Total cost of merchandise sold during the period  Gross profit: Cost of goods sold – Sales  Gross profit ratio: expressed percentage of sales  Operating Expenses : To run the business  Selling Expenses : selling and distribution of goods  Administrative expenses : Accounting, corporate, etc  Interest expense : interest on borrowing 21 Sales Returns and Allowances Possible when customers are allowed to return goods which are found to be unsatisfactory Sales Return : Merchandise returned by the buyer as unsatisfactory or defective. Sales Allowance : A deduction from the original invoice price when the customer keeps merchandise but is dissatisfied with 22  Sales Returns and Allowances Sales return and allowances are recorded as debits, because they cancel a portion of the sales revenue Sales discounts and Sales returns and allowances are Contra Revenue accounts. Date Description Debit Credit Sales Returns / Allowances XXX Trade Receivables/ Cash XXX 23 Recording and Reporting Sales Gross sales Less: Sales discounts Less: Sales returns and allowances Net sales 24  Trade Discounts It is a percentage reduction granted to a customer from the specified list price or catalogue price. Trade discounts enable firms to quote different prices to different types of customers and grant quantity discounts Not recorded on either seller’s or buyer’s books!! 25 Trade Discounts - example FastBan, FastBan,Inc. Inc.offers offersaa 30% 30% trade tradediscount discount ifif you you purchase purchaseat atleast least 1,000 1,000ofof their their most most popular popular product product known knownas asZippy. Zippy. Each EachZippy Zippy has hasaa list list price priceof of $5.25. $5.25. Quantity sold 1,000 Price per unit $ 5.25 Total 5,250 Less 30% discount (1,575) Invoice price $ 3,675 26 Cash Discount (Sales discount/ Purchase discount) A deduction from the invoice price granted to induce early payment of the amount due OR Discounts for early payments Credit terms : 2/10, n/45 Buyer will get 2 per cent discount of the invoice amount for paying with in 10 days of the invoice date or take 45 days and pay the full invoice amount without discount. If the invoice is due at the end of the month, the terms will be “2/eom” 27 Cash Discount - Terms 3/15,n/30 Discount Discount Number Number ofof Otherwise Otherwise In In This This Percent Percent Days Days ,, Net Net (or (or Number Number of of Discount Discount All) All) is is Due Due Days Days is is Available Available 28 Sales Discount / Cash Discount On January 1, 2015, Ankita bought goods for Rs. 1000 with terms 2/10, n/30. Date Description Debit Credit Jan 1 Trade Receivables 1000 Sales 1000 On payment Date Description Debit Credit Jan 1 Cash 980 Sales Discount 20 Trade Receivables 1000 29 Inventory System Perpetual Periodical Inventory Inventory System System occasional keeps track of physical count inventory to measure the balances level of continuously inventory 30  Calculation of Cost of Goods Sold Beginning Inventory + Purchases - Purchase Discounts - Purchase Returns and Allowances + Transportation-in = Cost of Goods Available for Sale - Ending Inventory = Cost of Goods Sold 31 Cost of Goods sold Vijay Electronics Limited Statement of Profit and Loss For the year Ended December 31, 20X2 Merchandise Inventory 31 47300 December 20X1 Net Purchases 312300 Freight in 28100 Net Cost of Purchases 340400 Cost of goods available for sale 387700 Merchandise Inventory 89000 Cost of Goods sold 298700 32 Test your understanding  Complete the following relationships : a. Cost of goods sold + Gross Profits = Net sales ? b. Operating Profit + Operating Expenses = Gross Profit ? c. Cost of goods available for sale – Net cost of purchases = Beginning? Inventory d. Ending Inventory + Cost of goods sold = Cost of Goods available ? for sale e. Net cost of purchases – Net Purchases = Freight In ? 33 Compute the missing amounts from the information available Case Case Case Case Case 1 2 3 4 5 Sales 79000 4370 F 96100 1390 63500 0 0 C Beginning Inventory 2400 850 8500 280 9600 A K Net cost of purchases 58900 3470 79400 1471 87400 0 G 0 Cost of goods available for 61300 3555 87900 1499 97000 sales 0 I 0 L Ending Inventory 4700 960 D 2300 110 2000 Cost of Goods sold 56600 3459 85600 1488 95000 E 0 0 M Gross Profit 22400 9110 10500 (980) J (3150 0) Operating Expenses B 16800 9470 H 9200 1720 4000 Net Profit / Loss 5600 (360) 1300 (270 (3550 34 Net cost of Purchases Net cost of purchases = Purchases less discounts and purchase returns and allowances plus transport and handling costs on the purchases. Import duties, purchase taxes, VAT, service tax, form part of the cost of the purchases 35  Purchase Returns Post Date Description Ref Debit Credit Trade Payables XXX Purchases Returns XXX Purchase Discounts The terms for a Purchase of goods Rs. 1000 on January 3 are 2/10, n/30 If the payment is made latest by January 13, 2 percent discount If not no cash discount 36 Purchase Discounts Journal Entries Post Date Description Ref Debit Credit Jan 3 Purchases 1000 Trade Payables 1000 Post Date Description Ref Debit Credit Jan 13 Trade Payables 1000 Cash 980 Purchase Discounts 20 37 Transportation Costs Transportation-In / Freight in Inward freight costs of acquiring Freight In ismerchandise. part of cost of goods sold! Transportation Out/Delivery Expense Outgoing freight costs that must be paid by the seller- Selling expense. 38 Freight on Purchases  Cost of Transportation is included in the cost of merchandise  Normal balance of Freight In account is debit  Net cost of purchase is calculated by Post adding the Freight In with Date Description Ref the purchase Debit Credit Freight In XXX Cash XXX 39 Freight In  Freight In – Adjunct Account  Adjunct Account : Balance is added to the balance of another account  Contra Account : the balance is deducted from another account 40 Freight In - FOB  Payment of freight is normally indicated in the invoice itself Free on Board (FOB) FOB FOB Shipping Destination point Buyer Seller 41 Freight In - FOB FOB Shipping Point “Free on board” at the shipping (selling) point Title passes to buyer upon shipment Buyer owns en route and... Ultimately bears the cost of the freight Assumes risk of loss in transit 42 Freight In - FOB FOB Destination “Free on board” at the destination point Seller owns en route and... Ultimately bears the cost of the freight Assumes risk of loss in transit 43 Test your understanding– FOB terms Harish in Mumbai sells glass jars FOB Pune to Raghav. He places the merchandise duly packed on a truck leaving for Pune. The truck capsizes on its way and the goods are destroyed. Who has to bear the loss? 44 Operating Expenses  Important part of the P&L statement of Merchandising business  Other than the cost of goods sold, interest, income tax  Broadly classified into Selling and administrative expenses  Selling Expenses : Sales commission, advertising, store rent, deliver expenses etc  Administrative expenses: overall management of a business 45 Key relationships : Gross Profit ratio and sales Janak company has a gross profit ratio of 40%. If the cost of goods sold is Rs. 180,000, calculate the company’s net sales. Let Net sales = 100 Gross margin = 40% Cost of goods sold = 60% Gross up the CGS amount = 180000 * 100/60 Net sales = Rs. 300000 46 Key relationships : Gross Profit ratio and sales Using Gross profit ratio to calculate ending inventory For the year ended March 31, 20XX, Vishal Company sold goods for Rs. 717,000. Its gross profit ratio is 40 per cent. The following information is available: Sales returns and allowances, Rs. 17,000; beginning inventory Rs.40,000; purchases Rs. 418,000; Purchase returns and allowances Rs. 6,000; freight in Rs. 23,000. Calculate ending inventory. 47 Key relationships : Gross Profit ratio and sales Sales 717,000 Less sales Return 17,000 Net Sales 700,000 Less Gross Profit 40% 280,000 Cost of Goods sold (a) 420,000 Beginning Inventory 40,000 Purchases 418,000 Less Purchase Return and allowances 6,000 Net Purchases 412,000 Freight In 23,000 Net cost of purchase 435,000 Cost of goods available for sale (b) 475,000 Ending Inventory (b) – (a) 55,000 48  Financial Statement Analysis: Profitability of Operations Ratio of profit to sales : to measure the profitability  Gross Profit Ratio: Ratio of gross profit to sales  Operating Profit ratio / Net margin: Ratio of operating profit to sales  Conversion ratio: Ratio of operating profit to gross profit, Measure of profit lost in transit because of operating expenses 49 Revenue from sales …………………………… 439120 Cost of goods sold …………………………… 298700 Calculate the ratios and analyse Gross Profit ………………………………….. 140420 Operating Expense …………………………… 76800 Selling Expenses …………………………….. 52300 Administrative Expenses …………………… 24500 Profit before interest and tax ……………….. 63620 Interest Expense ……………………………… 4700