Copyright 2004 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
PowerPoint Presentation Materials
For
Financial Accounting:
A New Perspective
by
Dr. Joseph Otto
6-1
CHAPTER 6
The Income Statement
HISTORY OF INCOME
STATEMENT
Recommended by




Italian Luca Pacioli (1494)
Englishman Simon Stevin (1607)
Scotsman Robert Colinson (1683)
American James Arlington Bennett (1820)
Income statement appeared early 1800’s

Popularized by railroads
Accepted after 1930
6-3
ELEMENTS OF INCOME
STATEMENTS
Revenues

Increase in retained earnings
Expenses

Decreases in retained earnings
Gains & Losses
 Gains are increases in retained
earnings
 Losses are decreases in retained
earnings
6-4
CMU
Income Statement
For year ending 12/31
Revenues
Sales
Service
Interest
Expenses
Cost of goods sold
Other
Net income
6-5
$86,600
600
300
$30,000
27,500
$87,500
57,500
$30,000
REVENUE TRANSACTIONS:
Cash Sales
Revenue transaction
Goods, services exchanged for cash
Transaction
Assets =
Cash sale
Cash
+20
6-6
Liabilities + Equity
Sales
+20
REVENUE TRANSACTIONS:
Credit Sales
Revenue transaction
Goods, services exchanged for promise to pay
Transaction
Assets =
Credit sales
A/R
+379
6-7
Liabilities + Equity
Sales
+379
Credit Card Sales 1
If treated as increase to cash
Merchant charged discount (2%, $5.78)
No information about fee
Transaction
Assets =
Credit card
sale
($289.00)
Cash
283.22
6-8
Liabilities + Equity
Sales
283.22
Credit Card Sales 2
If treated as increase to cash
Treat fee as Sales contra account
Transaction
Assets = Liabilities +
Credit card sale Cash
(289.00)
283.22
6-9
Equity
Sales
289.00
S. Disc.
<5.78>
Credit Card Sales 3
If treated as increase to cash
Treat fee as miscellaneous expense
Transaction
Credit card sale
($289.00)
6-10
Assets = Liabilities + Equity
Sales
Cash
289.00
283.22
Misc
exp
<5.78>
Summary Credit Card Sales
Credit card sales are treated as cash unless

Merchant does not have means to receive payment
electronically
More information is better
Record fee as
Contra sales account (sales discount)
 Miscellaneous expense

6-11
REVENUE IDENTIFICATION,
EXPLANATION: Transaction M
Transaction M Assets = Liabilities +
$63,200 made
to customers
throughout year
6-12
Equity
REVENUE IDENTIFICATION,
EXPLANATION: Transaction N
Transaction N
$20,000 of
revenue earned
on account
(credit sales)
during year
6-13
Assets =
Liabilities + Equity
REVENUE IDENTIFICATION,
EXPLANATION: Transaction O1
Transaction O1
$275 interest
earned on
$6,000 savings
@ 5% interest
during year
6-14
Assets =
Liabilities +
Equity
REVENUE ANALYSIS:
Transaction M
Transaction M
$63,200 made to
customers
throughout year
6-15
Assets = Liabilities
+
63,200
Equity
63,20
0
REVENUE ANALYSIS:
Transaction N
Transaction N
$20,000 of
revenue earned
on account (credit
sales) during year
6-16
Assets = Liabilities + Equity
20,000
19,400
600
REVENUE ANALYSIS:
Transaction O1
Transaction O1
$275 interest
earned on $6,000
savings @ 5%
interest during
year
6-17
Assets = Liabilities
+
275
Equity
275
EXPENSE
TRANSACTIONS
Asset vs. Expense
Capitalize as asset when

Benefits extend beyond current accounting period
Record as expense


When certainty does not exist of future benefits
Examples

6-18
Depreciation, Cost of Goods Sold
EXPENSE IDENTIFICATION,
EXPLANATION: Transaction P
Transaction P
$1,000 Cash paid
for office rent
beginning 2/1
6-19
Assets = Liabilities
+
Equity
EXPENSE IDENTIFICATION,
EXPLANATION: Transaction Q1
Transaction Q1
$300 depreciation
recorded to recognize
use of equipment
sold 9/30
6-20
Assets =
Liabilities +
Equity
EXPENSE IDENTIFICATION,
EXPLANATION: Transaction R
Transaction R
$2,000 of store
equipment bought
on 1/4 for $10,000
is sold for $1,350
on 9/30
6-21
Assets = Liabilities + Equity
EXPENSE IDENTIFICATION,
EXPLANATION: Transaction S
Transaction
$8,000 cash paid
to employees for
work during year
6-22
Assets = Liabilities + Equity
EXPENSE IDENTIFICATION,
EXPLANATION: Transaction K2
Transaction K2
$2,000 cash paid
for interest on
$5,000 borrowed
7/1 @8% &
repaid 12/31
6-23
Assets =
Liabilities
+
Equity
EXPENSE IDENTIFICATION,
EXPLANATION: Transaction T
Transaction T
$4,250 paid for
miscellaneous
expenses during
year (fees, supplies,
advertising, etc.
6-24
Assets =
Liabilities +
Equity
EXPENSE IDENTIFICATION,
EXPLANATION: Transaction U
Transaction U
$30,000 Cost of
Goods Sold
determined by
taking physical
inventory 12/31
6-25
Assets = Liabilities +
Equity
EXPENSE ANALYSIS:
Transaction P
Transaction P
$1,000 Cash
paid for office
rent each
month
beginning 2/1
6-26
Assets =
<11,000>
Liabilities + Equity
<11,000>
EXPENSE ANALYSIS:
Transaction Q1
Transaction
$300 depreciation
recorded to
recognize use of
equipment sold
9/30
6-27
Assets =
<300>
Liabilities +
Equity
<300>
EXPENSE ANALYSIS:
Transaction R
Transaction R
$2,000 of store
equipment bought
on 1/4 is sold for
$1,350 on 9/30
6-28
Assets = Liabilities + Equity
1,350
<1,700>
<350>
EXPENSE ANALYSIS:
Transaction S
Transaction S
$8,000 cash paid to
employees for work
during year
6-29
Assets =
<8,000>
Liabilities +
Equity
<8,000>
EXPENSE ANALYSIS:
Transaction K2
Transaction K2
$200 cash paid for
interest on $5,000
borrowed 7/1 @
8% & repaid 12/31
6-30
Assets =
<200>
Liabilities + Equity
<200>
EXPENSE ANALYSIS:
Transaction T
Transaction
$4,250 paid for
miscellaneous
expenses during
year (fees, supplies,
advertising, etc.
6-31
Assets = Liabilities +
<4,250>
Equity
<4,250>
EXPENSE ANALYSIS:
Transaction U
Transaction U
Assets =
Liabilities + Equity
$30,000 Cost of
Goods Sold
determined by
<30,000>
<30,000>
taking physical
inventory 12/31
6-32
COMPONENTS OF SALES
TRANSACTION
Component
Accounts
Affected
Measurement
Basis
Revenue
Expense
Sales
CGS
Selling price
Historical cost
6-33
Example
Card costing
$5 is sold for
$7, a $2
profit
COLLECTIONS OF CREDIT
SALES: Transaction V
Transaction V
Assets = Liabilities + Equity
$15,000 cash is
15,000
collected from
<15,000>
customers during
year
6-34
CMU
Income Statement
For year ending 12/31
Revenues
Sales
Service
Interest
Expenses
Cost of goods sold
Other
Net income
6-35
$86,600
600
300
$30,000
27,500
$87,500
57,500
$30,000
DISTINGUISHING BETWEEN
CASH & ACCRUAL
Cash basis recognizes revenue &
expense at time of cash inflows or
outflows
Accrual basis recognizes income
independent of cash inflows/outflows
When revenues earned
 When expenses incurred

6-36
CMU
Cash Income Statement
For year ending 12/31
Cash Sales
Cash collections (I,V)
Cash collection (R)
Interest collection (O1)
Inventory payments
Other payments
(P,S,C1,T,K2)
Net Income
6-37
$63,200
21,000
1,350
275
$85,825
27,000
33,450
60,450
$25,375
ATTRACTIVENESS OF
CASH STATEMENTS
Most people believe they have
Earned salary when receive cash
 Incurred expenses when pay cash

6-38
DEFICIENCIES OF CASH
STATEMENTS
Does not accurately measure
performance of entity
Activities trigger recognition of revenue,
expense
Timing is misleading
6-39
ACCRUAL BASIS OF INCOME
MEASUREMENT: Revenues
Revenues recorded when
economic events occur

Revenues recorded when
Goods sold
 Services rendered

6-40
ACCRUAL BASIS OF INCOME
MEASUREMENT: Expenses
Expenses recorded when economic
events occur

6-41
Expenses recorded when
 Cost used to produce revenue
 Cost of assets consumed with
passage of time
MATCHING CONCEPT
2-Step process
1.
Assign revenue to accounting
period when
1.
2.
2.
Assign expenses to accounting
period when
1.
2.
6-42
Goods sold
Services rendered
Costs used to produce revenue
Costs consumed with passage of time
OWNER WITHDRAWAL
Reported in statement of owner’s equity
Not an expense
Transaction
Susan withdrew
$8,100 from
business
6-43
Assets = Liabilities
+
<8,100>
Equity
<8,100>
OWNER INVESTMENT:
CMU Becomes Partnership
Transaction
Martha Peres
contributes $10,000
of inventory for
interest in business
6-44
Assets =
10,000
Liabilities +
Equity
10,000
Owner Withdrawal
Expense

Cost of goods or services used up or
consumed to produce revenue
Withdrawal

Disinvestment by owner
Dividend
Distribution of assets to corporate
shareholders
 Similar concept to owner withdrawal

6-45
CLASSIFYING EFFECTS OF
TRANSACTIONS INTO
ACCOUNTS
Formal ledger
T-account approach
Cash
30,000
6,000
5,000
6,000
6-46
6,000
15,000
2,000
10,000
Income Statement Schedule C
Internal Revenue Service requires
Schedule C for taxpayers
Special version of income statement
 Many small businesses use tax basis
income statements
 Cash basis
 Lenders focus on borrowing

6-47
Assign #13
pg. 305-306, Questions 4, 8, 15, 19
Assign #14
pg. 306-313, Reinforcement Exercises 4, 5,
11, 14, 18, 22, pg. 314-320, Critical Thinking
Problems 3, 7, 11, 13, 21
Assign #5c
Masterson & Miller transmittals
6-48