GAAP Income Statement PDF

GAAP Income Statement \*For Performance task: Practice Calculation every time I pull up live reports. Before we proceed to principles, here are the 7 basic parts of an Income Statement (P&L). This is how we calculate and analyze if the business is thriving. 1. **Revenue** Total income befo...

GAAP Income Statement \*For Performance task: Practice Calculation every time I pull up live reports. Before we proceed to principles, here are the 7 basic parts of an Income Statement (P&L). This is how we calculate and analyze if the business is thriving. 1. **Revenue** Total income before any expenses are deducted. 2. **COGS** Direct cost associated with the production of goods or services sold during the period, such as raw materials or labor. \*Calculation: COGS = Beginning Inventory + Purchases -- Ending Inventory 3. **Gross Profit** The profit made after subtracting COGS from revenue, showing how efficiently the company is producing its goods or services. \*Calculation: Gross Profit = Revenue -- COGS 4. **Operating Expenses** The cost associated with running the business that are **not directly tied** to producing goods or services, such as rent, utilities and payroll. \*Calculation: Add up all Expenses such as salaries, rent, marketing, etc. 5. **Operating Income** The income from core business operations after subtracting operating expenses from gross profit. \*Calculation: Operating Income= Gross Profit -- Operating Expenses 6. **Non-operating Income and Expenses** Income or expenses NOT related to the core business operations, such as interest income, investment gains, or losses. \*Calculation: Add or subtract any non-operating items (interest income/expenses, investment gains/losses, etc.) *\*I need to dig down on this in the future.* 7. **Net Income (or Net Profit)** The final profit AFTER all expenses (including taxes and interest) are SUBTRACTED from total revenue, representing the company's overall profitability. \*Calculation: Net Income = Operating Income + Non-operating income/Expenses- Taxes and Interest **US GAAP Principles mapping them to the Income Statement** **Concept: Farming** 1. **Revenue Recognition Principle:** Income is recorded when the vegetables are delivered to the buyer, not when they're harvested. 2. **Matching Principle:** Expenses like seed, fertilizers, and water should match the revenue they generated The cost of planting and growing crops should be recorded in the same period as the sale of those crops. Please set another example in this principle using Apartments/Rental spaces 3. **Accrual Basis Accounting:** 4. **COGS:** The cost of seeds, fertilizers and other farming inputs is matched with the revenue from the specific products sold. If these costs haven't been paid yet, **they are still accrued** and recorded to ensure accuracy. 5. **Payroll:** In today\'s video I\'m gonna explain US GAAP using the income statement. So I\'ll be jumping into my computer here and I\'ll show you a typical income statement for a company and then we\'ll map each of the GAAP principles to the line items on the income statement. And I believe this is the best way to understand GAAP principles. Rather than bore you to death with definitions of GAAP principles, I\'m going to actually go through the line items on the income statement and map each of them to the GAAP principles. So we\'ll be going through line items such as revenue and how that relates to the revenue recognition principles, matching, accrual basis accounting, and so on and so forth. And then we'll go down to the income statement and show each of these line items and how they map into the GAAP principles. That\'s the topic of this video, so stick around. All right, so first a quick definition of US GAAP. US GAAP stands for Generally Accepted Accounting Principles. And these are the set of standards and rules that regulates how accountants, such as myself, create financial statements, right? So this is, as you can imagine for me as an accountant, is the air that I breathe, right? This is the reason for my existence and the way that I earn a living, and frankly, this is the way that I feed my family. All right, now we take a closer look at these gaap principles and see how they apply to each of the line items of the income statement. So what we have here is an income statement for our company, Crab Cake Inc. And this is for the month ended December 31st, 2019. As you can see here. This is a typical income statement that has revenue, cost of goods sold, and then the operating expenses, payroll, commission, rent, etc. So what we\'ll do is map each of these gaap principles to each of the line items on the income statement. So for example, for revenue. We have here the first GAAP standard that will apply. It\'s gonna be revenue recognition. So how does this apply? Basically, for revenue, we only record revenue when we earn it, right? And the way that we earn revenue is, for example, if you\'re selling a good, then it\'s based on the transfer of risk, right? So this is usually something that\'s listed in the invoice. When does the risk of having this inventory transfers? Sometimes it will say shipping point or delivery point. So basically this is the transfer of title. And if it\'s a service, how do we earn revenue from service? Is when we meet the performance obligation. So you have to look at the contract with the customer and see where the performance obligation is, determine the performance obligation, and then when you meet it, when you fulfill the performance obligation, that\'s when you can recognize the revenue. And if you receive a prepayment from a customer for a future service or a future product, this prepayment obviously is not a revenue. So this is recorded as what we call deferred revenue. So this is something that you are gonna book today as deferred revenue, which is actually a liability on the books. And then once you recognize or once you earn this revenue, that\'s when you actually go ahead and record this revenue. The example of that is Tesla. For example, Tesla sells the full self-driving software and collects the money upfront, right? but the service itself is not yet provided to the customer. The full self-driving is not available yet. So what Tesla does is record it as a deferred revenue, which is a liability on the books, and then they will go ahead and recognize that as they deliver the service, they begin to recognize some of it as revenue. And then the next gaap principle that applies here is going to be a matching principle. And the matching principle is very simple, and it says that you have to match the revenues and expenses in any given period. So if this given period is a month or a year, to be fair and represent fairly the financial performance of the company, you need to be recording the matching revenue. revenue and expenses together in the income statement. So that\'s the matching principle and how it applies here. And then the other principle that applies is going to be the accrual basis accounting. And accrual basis accounting says that you have to record the revenue or the expense when you earn it or when you incur the expense, right? Whether or not you have issued an invoice or received an invoice, that\'s not what matters here. What matters is for revenue is when you earn it and for expense when you incur the expense, right? for revenue you need to accrue for revenue earned even though the invoice is not issued. So the example here is that maybe you enter a contract with a customer and that contract states that you will actually invoice them at the end of the year, but throughout the year you\'re earning revenue, right? So the accrual of revenue here means that each month you\'ll be accruing a portion of that revenue in the books even though you haven\'t issued the invoice yet. So this is the accrual basis accounting here and how it applies to revenue. The next item here is COGS and for COGS we\'ll look at the matching principle and basically the matching principle here the way it\'s gonna apply to Cost of Goods sold is that we have to match the cost with the items you sell So basically the way cost of goods sold is recorded is that when you first get the inventory That\'s recorded as an asset and then as you sell these goods the asset turns into cost, right? So always saying here with the matching principle is that we have to match the revenue So if we sell a TV for example We have to record the cost of goods sold of that particular TV, right? Not any other TV, but that particular TV. So we have to match the cost with the actual revenue. This is the matching principle and how it applies to cost of goods sold. And then for accrual basis accounting, the way that applies to cost of goods sold is that we need to accrue for unpaid costs. So basically even though you have some cost that relates to cost of goods that you haven\'t paid it yet or haven\'t received an invoice for it, you have to accrue it. And an example for that is going to be expired goods. For example, if you have some obsolete or expired, you need to record accrual for that on the books and record the cost even though you haven\'t incurred the expense yet or even though you haven\'t paid for the expense yet. So the accrual accounting applies as well to cost of goods sold. All right, so go down the income statement and then we hit operating expenses and the next item is going to be payroll. And the way that we apply the GAAP principles to payroll is that first we look at the matching principle. And the way that applies is that we need to be matching the cost with the revenue generated. And typically this involves booking the payroll for the period for the employees that were employed and help generate the revenue, right? So this makes sense, it sounds fair. You\'re recording the cost for the period that matches the revenue. This is the matching principle. And then the next principle that applies here is gonna be the accrual basis accounting. And what that\'s saying here is that you need to accrue for unpaid costs. So even though you haven\'t paid the cost, you still need to accrue for it. So this could be things like vacation, or stock-based compensation, even though these things are not paid yet, but you need to accrue a portion for it to fairly represent the performance of the company, right? So these are costs that have not been yet paid by the company. So that\'s for payroll and then as we go down and get to commission the way that we\'re gonna map commission into the gaap Principles so the first one is gonna be Revenue recognition and the way that we pay commission obviously is that when a salesman makes a sale for the company you pay him a commission Right, but basically the new revenue recognition rules will say that if the cost is incremental or basically If the commission is based on an actual deal that is sold in a period Then you have to amortize the commission over the life of the customer right and this also comes back to fairness right you are recording the transactions of the company to fairly represent the performance of the company and when a Salesman sells up an actual deal and makes let\'s say ten thousand dollars commission This is how the commission is an expense that belongs over the period of time of the life of the customer right so that customer On average is going to stay with you for five years Then you need to be amortizing or recognizing this 10,000 over the five years that this customer is going to stay with you. So this is the revenue recognition and how it applies to commissions, right? And then the other item is going to be the matching principle. And obviously, as we said, for all costs, you need to match the cost with the revenue that\'s being generated, right? This applies to all costs. And then we have the accrual basis accounting. And this principle, obviously, is saying that you need to be accruing for unpaid cost. And sometimes you have a commission earned but will be paid in the future right so still you need to accrue for it even though it\'s going to be paid in the future if it\'s earned by the salesman and as we go down the list the next item up is going to be rent expense and when we look at rent expense we map that directly into a gaap principle of the matching principle which basically says that we need to be matching the rent with the rent expense with the revenue that\'s being generated so obviously you\'re renting a space for the benefit of generating revenue so when you record the revenue of a million dollars let\'s say and you pay rent for \$100,000 you need to be recording the matching cost with the revenue being generated. And then the next item up is going to be accrual. So for rent, you need to be accruing for unpaid costs. And this is the same thing we\'ve been saying, right? So when you have any unpaid costs with rent, such as electric costs or real estate taxes, you know, these things, even though they haven\'t been paid, but if you know about the existence of these items, you need to be accruing for them on your books and records. So this is how this principle here applies to rent. will find that for travel expenses, for example, the same principles will apply matching management principle matching the cost of the revenue accrual basis accounting, we\'re going to be accruing for unpaid costs such as unpaid employee expenses. The same principles will apply as we go down to research and development and sales and marketing. Basically, you need to be mindful of the matching principle as well as the accrual-based accounting accruing for any unpaid expenses. And as you go down the list of expenses, the same principles will apply to interest expense, depreciation and taxes, which is basically that you need to be always mindful of the matching principle and accrual-based accounting accruing for any unpaid costs on the books and records. So we talked about the gaap principles that apply to the line items on the income statement such as revenue recognition, matching principle, and accrual basis accounting. And now we\'ll talk about some additional gaap principles that don\'t apply to the individual line items on the income statement, but apply to the overall presentation of the financial statements. So we go with the principle of full disclosure, and basically what this is saying here is that we have to disclose any material information that will influence. the reader of the financial statements. So this is the full disclosure principle and this usually goes in the form of footnotes to the financial statements. So with the example that we mentioned before with Tesla, if Tesla has a deferred revenue of say a billion dollars from the sale of full self-driving software, they need to be making that disclosure and the footnotes to the financial statements. And the next principle here is historical cost and historical cost principle is saying that you need to be recording your items at their historical cost and this specifically applies to the balance sheet more than income statement so this applies to assets and liabilities which is just saying that when you record an asset whether it\'s a financial instrument or an actual physical fixed asset, you\'re recording it at its historical cost, not any other number but the historical cost. The next gaap principle is going to be the monetary unit assumption, and what the monetary unit assumption is saying is that when you record items on the income statement or on the balance sheet, you\'re only recording items that can be measured in currency. So for example, if you hire a CEO that is a star and is expected to make the company a huge success, this has no value to it, right? This may have an intangible value, but it doesn\'t have a currency or a value that can be measured in currency. So you can be recording something like that on the income statement or on the balance sheet, right? So this is the monetary unit assumption. The next principle is economic entity assumption. And this is just like fancy language for saying that you need to be keeping separate records for separate entities, right? So if you have a couple of different companies, you need to be keeping their records separately from each other. And if there is enough ownership, obviously you can consolidate the books of records. in a separate consolidation, but you need to be keeping separate records for these companies so you can track each of their performance separately. Next up is going to be the time period assumption, and this is just saying that you\'re going to report financial performance for each determined period, whether a calendar year or a fiscal year. So basically, you need to be fixing the period on your books and records, for example, a month, and when we looked at this income statement, for example, it was for the month ended December 31st 2019. So this is just saying that you need to be recording these financial transactions for a period or a definite period of time, right? So you\'re defining the month as a calendar month and defining that and that\'s the time period assumption that you\'re reporting the financial statements on. And then you have the going concern principle. And this is basically saying that, you know, any reader for the financial statements will assume that the company will continue indefinitely unless you disclose otherwise, right? So if the company, if you have any reason to think as an accountant that the company is not going to continue indefinitely, You need to be disclosing that in the full term financial statements and make it clear that there\'s a going concern for this company, right? The next item is going to be relevance Which basically says that the info must help the decision maker understand a company\'s performance So the financial statements need to be relevant what you\'re showing on it needs to be relevant to the reader So that they can make an informed decision on the financial performance of the company. The next standard is going to be reliability Which means that the information must be verifiable and objective and verifiable means that you can go back and verify the information presented in the financials by looking at the source. So for example, if we\'re looking at the cash line item, you can go back to the bank statement and verify the information is correct. And objective, what objective means is that you as an accountant are, you know, you\'re booking this information or booking the financial transaction based on evidence. So for example, if you were booking an expense, you\'re booking the expense based on an invoice from the vendor. The next standard is consistency which means that all periods financials are prepared using the same method. What this is saying here is that if you\'re going to change the method for any of your line items on the income statement or the balance sheet, for example for revenue recognition, if you have any change in accounting methodology, You need to be making a disclosure You need to be making a disclosure, making it clear to the reader all the financial statements that is a deviation. There is a change in the accounting methods. Otherwise, all the methods needs to be the same for every accounting period so that when you\'re looking at two different months or two different years, you\'re able to compare apples to apples, right? You\'re looking at the same thing. The next principle is the of conservatism which means that you\'re looking at the least optimistic option and booking that on a financial statement. So for example, if you have a lawsuit against you as a company and you have to record or disclose the potential liability from this lawsuit and on one estimate you have a million dollars of potential liability, but on another estimate you have two million dollars of potential liability. You need to be disclosing the least optimistic one which is the two million dollars in this case as your potential liability. The next and final principle is a materiality principle, which basically says that you can ignore items and standards when there\'s no effect or no material effect on the user of the financial statements. So basically, this is saying that you don\'t want to be tracking, for example, paper clips as an office, as an asset in the company, right? It\'s immaterial. So only be tracking the material stuff. If something is immaterial to the reader of the financial statements, then it can be ignored. All right, this is everything. This is how US GAAP applies to different line items on the income statement.