Operating Decisions and
the Income Statement
Chapter 3
McGraw-Hill/Irwin
© 2009 The McGraw-Hill Companies, Inc.
Group Project 1
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• Answer questions.
The Operating Cycle
Begin
Purchase or
manufacture
products or
supplies on credit.
Receive payment
from customers.
Pay
suppliers.
Deliver product or
provide service to
customers on
credit.
Accrual Accounting
Assets, liabilities, revenues, and expenses should be
recognized when the transaction that causes them occurs,
not necessarily when cash is paid or received.
Required by Generally
Acceptable
Accounting
Principles
Revenue Principle
Recognize revenues when . . .
Delivery has occurred or services have
been rendered.
There is persuasive evidence of an
arrangement for customer payment.
The price is fixed or determinable.
Collection is reasonably assured.
Revenue Principle
If cash is received before the company
delivers goods or services, the liability
account UNEARNED REVENUE is recorded.
Cash received before revenue is earned Cash
Received
Cash (+A)
Unearned revenue (+L)
xxx
xxx
Revenue Principle
When the company delivers the goods or
services UNEARNED REVENUE is reduced
and REVENUE is recorded.
Cash received before revenue is earned Cash
Received
Cash (+A)
Unearned revenue (+L)
Company
Delivers
xxx
xxx
Revenue will be recorded when
earned.
Revenue Principle
Typical liabilities that become
revenue when earned include . . .
CASH COLLECTED
(Goods or services due to
customers)
REVENUE
over time will (Earned when goods
become
or services provided)
Rent collected in advance
Rent revenue
Unearned air traffic revenue
Air traffic revenue
Deferred subscription revenue
Subscription revenue
Revenue Principle
When cash is received on the date
the revenue is earned, the
following entry is made:
Company
Delivers
AND
Cash
Received
Cash (+A)
Revenue (+R)
xxx
xxx
Revenue Principle
If cash is received after the company
delivers goods or services, an asset
ACCOUNTS RECEIVABLE is recorded.
Cash received after revenue is earned Company
Delivers
Accounts receivable (+A)
Revenue (+R)
xxx
xxx
Revenue Principle
When the cash is received the ACCOUNTS
RECEIVABLE is reduced.
Cash received after revenue is earned Cash
Received
Company
Delivers
Accounts receivable (+A)
Revenue (+R)
xxx
xxx
Cash will be collected.
Revenue Principle
Assets reflecting revenues earned but
not yet received in cash include . . .
CASH TO BE
COLLECTED
(Owed by
customers)
and already
earned as
REVENUE
(Earned when
goods or services
provided)
Interest receivable
Interest revenue
Rent receivable
Rent revenue
Royalties receivable
Royalty revenue
The Matching Principle
Resources
consumed to earn
revenues in an
accounting period
should be recorded
in that period,
regardless of when
cash is paid.
The Matching Principle
If cash is paid before the company receives
goods or services, an asset account,
PREPAID EXPENSE is recorded.
Cash is paid before expense is incurred $
Paid
Prepaid expense (+A)
Cash (-A)
xxx
xxx
The Matching Principle
When the expense is incurred PREPAID
EXPENSE is reduced and an EXPENSE is
recorded.
Cash is paid before expense is incurred $
Paid
Prepaid expense (+A)
Cash (-A)
Expense
Incurred
xxx
xxx
Expense will be recorded when
incurred.
The Matching Principle
When cash is paid on the date the
expense is incurred, the following
entry is made:
Expense
Incurred
AND
Cash
Paid
Expense (+E)
Cash (-A)
xxx
xxx
The Matching Principle
If cash is paid after the company receives
goods or services, a liability PAYABLE is
recorded.
Cash paid after expense is incurred Expense
Incurred
Expense (+E)
Payable (+L)
xxx
xxx
The Matching Principle
When cash is paid the PAYABLE is reduced.
Cash paid after expense is incurred Cash
Paid
Expense
Incurred
Expense (+E)
Payable (+L)
xxx
xxx
Cash will be paid.
The Matching Principle
Typical assets and their related
expense accounts include. . .
CASH PAID FOR
as used over
time becomes
EXPENSE
Supplies inventory
Supplies expense
Prepaid insurance
Insurance expense
Buildings and equipment
Depreciation expense
A = L + SE
ASSETS
Debit for
Increase
Credit for
Decrease
Next, let’s see how
Revenues and
Expenses affect
Retained Earnings.
LIABILITIES
Debit
Credit for
for
Increase
Decrease
CONTRIBUTED CAPITAL
RETAINED EARNINGS
Debit
Credit for
for
Increase
Decrease
Debit
Credit for
for
Increase
Decrease
Expanded Transaction Analysis Model
RETAINED EARNINGS
Dividends decrease
Retained Earnings.
Debit
Credit for
for
Increase
Decrease
REVENUES
Debit
Credit for
for
Increase
Decrease
Net Income increases
Retained Earnings.
EXPENSES
Debit
for
Increase
Credit for
Decrease
Papa John’s sold franchises for $400 cash. The company earned $100
immediately. The rest will be earned over several months.
Identify & Classify the Accounts
1. Cash (asset).
2. Franchise fee revenue
(revenue).
3. Unearned franchise fees
(liability).
Determine the Direction of the Effect
1. Cash increases.
2. Franchise fee revenue
increases.
3. Unearned franchise fees
increases.
3- 22
Papa John’s sold franchises for $400 cash. The company earned $100
immediately. The rest will be earned over several months.
Assets
Cash
=
400
Liabilities
Unearned franchise
revenue
+
300
Stockholders' Equity
Franchise fees
100
revenue
General Journal
Description
Cash (+A)
Unearned franchise revenue (+L)
Franchise fees revenue (+R, +SE)
Debit
400
Credit
300
100
The company sold $36,000 of pizzas for cash. The costs of the pizza
ingredients for those sales were $9,600.
Identify & Classify the Accounts
1. Cash (asset).
2. Restaurant sales revenue
(revenue).
3. Cost of sales- restaurant
(expense).
4. Inventories (asset).
Determine the Direction of the Effect
1. Cash increases.
2. Restaurant sales revenue
increases.
3. Cost of sales- restaurant
increases.
4. Inventories decrease.
The company sold $36,000 of pizzas for cash. The costs of the pizza
ingredients for those sales were $9,600.
Assets
Cash
Inventory
=
Liabilities
36,000
(9,600)
+
Stockholders' Equity
Restaurant sales
36,000
revenue
Cost of sales
(9,600)
General Journal
Description
Cash (+A)
Restaurant sales revenue (+R, +SE)
Cost of sales - restaurant (+E, -SE)
Inventories (-A)
Debit
36,000
Credit
36,000
9,600
9,600
Let’s look at E3-3
• A customer orders and receives 10 personal
computers from Dell; the customer promises
to pay $18,400 within three months. Answer
from Dell’s standpoint. What about cost info?
Account Name
Debit
Accounts Receivable
$18,400
Sales Revenue
Credit
$18,400
• Fucillo Hyundai, Inc, sells a truck with a list, or
sticker, price of $20,050 for $18,050 cash.
Account Name
Debit
Cash
$18,050
Sales Revenue
Credit
$18,050
• Bon-Ton Department Store orders 1,000 men’s
shirts from Arrow Shirt Company for $15 each
for future delivery. The terms require full
payment within 30 days of delivery. Answer
from Arrow’s standpoint.
Account Name
No Entry
Debit
Credit
• Arrow Shirt Company completes production of
the shirts described in part c and delivers the
order (answer from Arrow Shirt Company
perspective)
Account Name
Debit
Accounts Receivable
$15,000
Sales Revenue
Credit
$15,000
• Arrow receives payment from Bon-Ton for the
order described in part c. Answer from the
perspective of Arrow Shirt Company.
Account Name
Debit
Cash
$15,000
Accounts Receivable
Credit
$15,000
• A customer purchases a ticket from American
Airlines for $410 cash to travel the following
January. Answer from American Airlines
perspective.
Account Name
Debit
Cash
$410
Unearned Airfare Revenue
Credit
$410
• General Motors issues $20 million in new
common stock
Account Name
Debit
Cash
$20,000,000
Contributed Capital
Credit
$20,000,000
• Pen State University receives $18,300,000
cash for 80,000 five-game season football
tickets.
Account Name
Debit
Cash
$18,300,000
Unearned Football Ticket Revenue
Credit
$18,300,000
• Penn State plays the first football game
described in part h.
Account Name
Debit
Unearned Football Ticket Revenue
$3,660,000
Football Ticket Revenue
Credit
$3.660,000
• Precision Construction Company signs a
contract with a customer for the construction
of a new $500,000 warehouse. At the signing,
Precision receives a $50,000 deposit as a
deposit on the future construction project.
Answer from the perspective of Precision.
Account Name
Debit
Cash
$50,000
Unearned Construction Revenue
Credit
$50,000
• On September 1, 2012, a bank lends $1,200 to a
company; the note principal and $144 annual
interest are due in one year (1,200 X 12%). Answer
from the Bank’s perspective.
• NOW:
Account Name
Debit
Note Receivable
$1,200
Cash
Credit
$1,200
• In 1 year (assuming no other transactions are
recorded?
• A popular ski magazine company receives a
total of $1,980 today from subscribers. The
subscriptions begin in the next fiscal year.
Answer from the perspective of the magazine
company:
Account Name
Debit
Cash
$1,980
Unearned Subscription Revenue
Credit
$1,980
• What do you do with each edition of the
magazine that is sent out?
• Sears, a retail store, sells a $100 lamp to a
customer who charges the sale on his store
credit card. Answer from Sear’s perspective.
Account Name
Debit
Accounts Receivable
$100
Sales Revenue
Credit
$100