Accounting Information & Data - Part 3: The Income Statement PDF

Understanding accounting information and data Part 3: The Income Statement The income statement ▪ P&L = profit or loss statement (IFRS) ▪ A part of Comprehensive Income Statement ▪ The income statement is a summarization of the company’s revenue and expense transactions for a period....

Understanding accounting information and data Part 3: The Income Statement The income statement ▪ P&L = profit or loss statement (IFRS) ▪ A part of Comprehensive Income Statement ▪ The income statement is a summarization of the company’s revenue and expense transactions for a period. ▪ Measures the performance of the company over a period of time. ▪ The income statement is like the “film” of the “activity” of the business during a given period Calculating net income ▪ Over a given period: Revenues - expenses = Net income ▪ Net income > 0: profit  increase in the book value of the company (enrichment) ▪ Net income < 0: loss  decrease in the book value of the company (impoverishment ) Revenue ▪ Revenue is the price of goods sold and services rendered during an accounting period. ▪ Causes owners’ equity to increase. ▪ Results in an increase in cash or accounts receivable. ▪ Represents the gross increase in owners’ equity resulting from operation of the business. ▪ Realization Principle: ▪ revenue should be recognized at the time goods are delivered or services are rendered. Expenses Expenses are the costs of the goods and services used up in the process of earning revenue. ▪ Examples include the cost of salaries, advertising, rent, utilities, and depreciation of long-term assets. ▪ Causes a decrease in owners’ equity. ▪ Results in either a decrease in assets or an increase in liabilities (accounts payable). ▪ The Matching Principle: refers to the concept of offsetting expenses against revenue on a basis of cause and effect. ▪ Expenses are incurred for the purpose of producing revenue. ▪ In order to measure net income for a period, revenue should be offset by all the expenses incurred in producing that revenue. Accrual Basis of Accounting ▪ Accrual basis of accounting has two basic requirements: 1. Revenue is recognized in the period when it is earned 2. Expenses are recognized in the period when they are incurred Net income and cash flows ▪ Revenues and expenses are accounted for when earned or incurred, and not when the related cash flows are received or paid out. ▪ Revenues (≠ cash inflows) ▪ Expenses (≠ cash outflows) Income statement (French presentation, horizontal format, Expenses by nature) EXPENSES REVENUES OPERATING EXPENSES OPERATING REVENUES Purchases ± change in inventories (=COGS) Sales External services other revenues Taxes Salary expenses FINANCIAL EXPENSES FINANCIAL REVENUES Interest expenses Interest or share incomes Loss on sale of securities Gain on sale of securities Foreign currency transaction losses Foreign currency transaction gains EXTRAORDINARY (OR EXCEPTIONAL) EXTRAORDINARY (OR EXPENSES EXCEPTIONAL) REVENUES Thefts Grants and subsidies Fines  Income statement (international presentation, Vertical format, Expenses by function*) other possible name +Revenues - Cost of sales =Gross profit Gross margin - Distribution expense Marketing & Selling expense - Administrative expense General & Adm exp +other operating income - other operating expense =Operation Profit Earning Before Interest and Taxe (EBIT) - Finance cost +Finance income +/- Other income/expense =Profit befor taxe Earning Before Taxe (EBT) - Income tax expense =Net Profit * International standards accept also the classification of expense by nature)  Income statement (International presentation, vertical format) Ex: LVMH Income Statement Transactions Illustrated ▪ In the following slides, we will continue our analysis of Overnight Auto Service by examining their transactions related to: ▪ Revenue ▪ Expense  Summary of January 31 Entry 1 ▪ Jan. 31 Recorded revenue of $2,200, all of which was received in cash. Balance sheet Income statement Asset Liabilities & Equity Expenses Revenues Gross Depreciati value on Net Book value repair service Cash 2,200 revenue 2,200 Summary of January 31 Entry 2 ▪ Paid employees’ wages earned in January, $1,200. Balance sheet Income statement Asset Liabilities & Equity Expenses Revenues Gross Depre Net Book value ciation value wages repair service Cash 1,000 expense 1,200 revenue 2,200 Summary of January 31 Entry 3 ▪ Paid for utilities used in January, $200 Balance sheet Income statement Asset Liabilities & Equity Expenses Revenues Gross Depre Net Book value ciation value wages repair service cash 0,800 expense 1,2 revenue 2,200 Utilities expense 0,200 February 1 Transaction ▪ Paid Daily Tribune $360 cash for newspaper advertising to be run during February. Balance sheet Income statement Asset Liabilities & Equity Expenses Revenues Gross Deprec Net Book value iation value repair service cash 0,440 wages expense 1,2 revenue 2,200 Utilities expense 0,200 Advertising expense 0,360  February 2 Transaction ▪ Purchased radio advertising from KRAM to be aired in February. The cost was $470, payable within 30 days. Balance sheet Income statement Asset Liabilities & Equity Expenses Revenues Gross Deprec Net Book value iation value Accounts wages repair service cash 0,440 payable 0,470 expense 1,2 revenue 2,200 Utilities expense 200 Advertising expense 830 February 15 Transaction ▪ Collected $4,980 cash for repairs made to vehicles of Airport Shuttle Service. Balance sheet Income statement Asset Liabilities & Equity Expenses Revenues Gross Depre Net Book value ciation value Accounts wages repair service cash 5,420 payable 0,470 expense 1,2 revenue 7,180 Utilities expense 0,200 Advertising expense 0,830  February 28 Transaction ▪ Billed Harbor Cab Co. $5,400 for maintenance and repair services Overnight provided in February. The agreement with Harbor Cab calls for payment to be received by March 10. Balance sheet Income statement Asset Liabilities & Equity Expenses Revenues Depr Gross eciati Net Book value on value Accounts wages repair service cash 5,420 payable 470 expense 1,2 revenue 12,580 Accounts Utilities receivable 5,400 expense 200 Advertising expense 830 The double-entry principle ▪ Any movement affecting an element of the balance sheet (A, L or S/H) necessitates an inverse movement (or movements) of the same amount in one or more of the other elements of the balance sheet (A, L or S/H) and/or the income statement (Rev/Exp) ▪ We always have: Total Assets = Total Liabilities (including equity) The business equation Assets = Liabilities + Shareholders’ equity Share Assets = Liabilities + capital + Net income Share Assets = Liabilities + capital + Revenues - Expenses Share Assets + Expenses = Liabilities + capital + Revenues Links between the balance sheet and the income statement BALANCE SHEET ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY Share capital [Retained] earnings INCOME STATEMENT transferred to Expenses Revenues Balance = net income (if profit; otherwise it would be on the opposite side) Net income Net Income = Revenus - Expenses ▪ Net income > 0 : profit , enrichment, increase in the book value of the company ▪ Net income < 0 : loss, impoverishment, decrease in the book value of the company  Overnight Auto Service Financial statements Balance sheet Income statement Asset Liabilities & Equity Expenses Revenues Gross Deprec Net Book value iation value Accounts wages repair service cash 5,420 payable 0,47 expense 1,2 revenue 12,580 accoun ts receiva Utilities ble 5,400 expense 0,2 Advertising expense 0,83 Total Total 12,58 Equity expenses 2,23 revenus 0 Net income 10,35 Net income 10,35 Total Total assets 10,820 liabilities 10,82 Profitability and liquidity ▪ Liquidity is the ability of the business to pay its debts as they come due. ▪ Critical to the survival of the business. ▪ A business that is not liquid may be forced into bankruptcy by its creditors. ▪ Profitability refers to a company’s ability to generate net income from the business. ▪ Profitable operations increase owner’s equity. Net income impact / cash impact ▪ Net income impact with immediate cash impact ▪ Cash sales  Sales increase (Revenus +) / Cash increase (A+) ▪ Net income impact without immediate cash impact ▪ Credit sales  Sales increase (Revenus +) / Account receivable (A+) ▪ Cash impact without Net income impact ▪ Collection of a customer payment relating to a credit sale  Account receivable decrease (A-) cash increase (A+) ▪ Purchase of fixed assets paid in cash  Fixed assets increase (A +), cash decrease (A-)