Basic Accounting
Concepts: The
Income Statement
Part One: Financial Accounting
Robert N. West
© The
VEMBA
McGraw-Hill
Accounting
Companies, Inc., 1999
Basic Business Financial Flows
Collection
activities
Cash
Accounts
receivable
Slide 3-1
Purchasing or
production
activities
Inventories
Earnings
activities
Robert N. West
© VEMBA Accounting
Basic Concepts
• Money
•
•
•
•
Robert N. West
measurement
Entity
Going concern
Cost
Dual aspect
Slide 3-2
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
© VEMBA Accounting
Basic Concepts
Let’s take a look at
our summer camps
income statement for a
few summer months.
Slide 3-3
Revenues
$122,400
Less expenses:
Food
$42,756
Wages
46,935
Rental
12,000
Other costs 5,472
Total exp.
107,163
Net income
$ 15,237
Accounting Period Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
Slide 3-4
Revenues
$122,400
The accounting period
concept allows us to find
Less expenses:
out how we did for a specific
Food
$42,756
period of time.
Wages
46,935
Rental
12,000
Other costs 5,472
Total exp.
107,163
Net income
$ 15,237
Accounting Period Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
• Money
•
•
•
•
Robert N. West
measurement
Entity
Going concern
Cost
Dual aspect
Slide 3-5
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
© VEMBA Accounting
Basic Concepts
Slide 3-6
Aspects of the conservatism concept:
 Recognize revenues (increases in retained
earnings) only when they are reasonably
certain.
 Recognize expenses (decreases in retained
earnings) as soon as they are reasonably
possible.
Robert N. West
© VEMBA Accounting
Basic Concepts
In December, customers
pay for a year’s
subscription to a
magazine that they will
begin receiving in
January.
Slide 3-7
When should the
revenue be
recognized?
Conservatism Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
In December, customers
pay for a year’s
subscription to a
magazine that they will
begin receiving in
January.
Slide 3-8
Revenue is
recognized when
the service is
performed--thus
in the year the
magazine service
is provided.
Conservatism Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
• Money
•
•
•
•
Robert N. West
measurement
Entity
Going concern
Cost
Dual aspect
Slide 3-9
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
© VEMBA Accounting
Basic Concepts
Slide 3-10
Joe makes credit sales of merchandise
amounting to $100,000.
Realization Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
Slide 3-11
If experience indicates that 3 percent of credit
sales will eventually become bad debts, then
revenue for the period is $97,000.
Sorry Joe,
I can’t pay.
Realization Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
• Money
•
•
•
•
Robert N. West
measurement
Entity
Going concern
Cost
Dual aspect
Slide 3-12
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
© VEMBA Accounting
Basic Concepts
Today is
March
19
Slide 3-13
On March 19, an
item of inventory
costing $1,000 is
received.
Matching Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
Today is
April
Slide 3-14
On April 16, the
vendor is paid in full.
16
Matching Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
Today is
May
9
Slide 3-15
On May 9, the item of
merchandise is sold
for $1,500.
When should the
merchandise be an
expense to the firm?
Matching Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
Today is
May
9
Slide 3-16
On May 9, the item of
merchandise is sold
for $1,500.
In May, when the
merchandise is sold.
Matching Concept
Robert N. West
© VEMBA Accounting
Basic Concepts
Slide 3-17
Types of transactions that need to be considered in
distinguishing between amounts that are properly
considered as expenses of a given accounting period
and the expenditures made in connection with the
item.
 Expenditures that are also expenses
 Beginning assets that become expenses
 Expenditures that are not yet expenses
 Expenses not yet paid
Robert N. West
© VEMBA Accounting
Basic Concepts
• Money
•
•
•
•
Robert N. West
measurement
Entity
Going concern
Cost
Dual aspect
Slide 3-18
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
© VEMBA Accounting
Basic Concepts
LIFO
Robert N. West
Slide 3-19
The consistency concept:
Once an entity has decided
on one accounting
method, it should use the
same method for all
subsequent events of the
same character (unless it
has a sound reason to
change methods).
© VEMBA Accounting
Basic Concepts
• Money
•
•
•
•
Robert N. West
measurement
Entity
Going concern
Cost
Dual aspect
Slide 3-20
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
© VEMBA Accounting
Basic Concepts
Slide 3-21
A dozen pencils were purchased
for the office secretary. These
pencils are assets to the firm
and technically should be
expensed each time one is used.
Materiality allows the firm to
expense the pencil either at the
time of purchase or when an
inventory is taken of office
supplies at period-end.
Materiality
Robert N. West
© VEMBA Accounting
Income Statement
Slide 3-22
GARDEN CORPORATION
Income Statement
For the Year Ended December 31, 1998
Net sales
Cost of sales
Gross margin
Research and development expense
Selling, general, and administrative expenses
Operating income
Other revenues (expenses):
Interest expense
Interest and dividend revenues
Royalty revenues
Income before income taxes
Provision for income taxes
Net income
Robert N. West
$75,478,221
52,227,004
23,251,217
2,158,677
8,726,696
12,356,844
(363,000
)
43,533
420,010
12,466,387
4,986,555
$ 7,479,832
© VEMBA Accounting
Statement of Retained Earnings
Slide 3-23
Statement of Retained Earnings
Retained earnings at the beginning of year
Add: Net income
Deduct: Dividends ($4 per common share)
Retained earnings at end of year
Robert N. West
$16,027,144
7,479,832
(4,390,000
$19,116,976
© VEMBA Accounting
Chapter 3
The End
Robert N. West
© VEMBA Accounting