Unit 4
Preparing the
Income
Statement
Key Concepts
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Classify items as revenue or expense
Prepare an income statement
Time period principle
Matching principle
Accrual basis of accounting
Cash basis of accounting
Key Terms
• Profit in owner’s equity that results from the
successful operation of a business.
• A business sells goods and services.
– Example Goods (cameras, cars, clothes, furniture..)
– Example Services (tv repairs, transportation, internet access, hair
styling…)
• Revenue – money or the promise of money received from
the sale of goods and services
• Expenses – are the costs of items or services used up in the
routine operation of the business
– Examples: (Salaries, advertising, delivery…)
Key Terms cont.
• Net Income: is the difference between revenue and
expenses when revenue > expenses
Revenue – Expenses = Profit or Net Income
- Ex: $500 - $400 = $100
** There is a net loss when the expenses > revenue
- the use of brackets indicates a loss
Ex: $(50)
The Income Statement
• Every business prepares an income statement
which presents revenue, expenses, and net
income/loss for a specific period of time.
(accounting period)
• Fiscal period (synonym for accounting period)
– Businesses prepare statements on a yearly basis
for tax purposes
(may or may not coincide with a calendar yr)
Another Textbook Example: Page 69
The Income Statement
(Follow layout demonstrated in your textbook)
Income Statement Preparation
1) Prepare Statement Heading
- Who, What, When?
- Income: Time period, Balance sheet: on a specific date.
2) Prepare Revenue Section
- Largest revenue item listed first
3) Prepare Expenses Section
- Listed in the order in which they appear in the ledger
4) Determine Net Income or Net Loss
- (Revenue – Expenses), Double line to indicate the final
total
Facts to Remember
• For the income statement, dollar signs should
be placed:
– Beside the first figure in each column
– Beside the net income or net loss figure at the
bottom of the statement
Time-Period Principle
• Requires the definition and use of the same
period of time for the accounting period.
– Purpose: this allows the owners and other users of
financial statements to analyze and compare data for
similar periods of time.
– Is the business maintaining a consistent profit,
increasing it or doing worse than before?
– Certain time periods that are struggling? Why?
Matching Principle
• Expenses should be recorded and matched with the
revenue they help to generate during the same
accounting period.
• It is important to include only revenue earned during
that period and only expenses incurred during that
period to produce the revenue.
• Simple Rule: Expenses are recorded when the cost is
incurred, whether paid in cash or on credit.
• Errors when the Matching Principle is not applied.
– Example Page 71-72
Accrual Basis of Accounting
• A business that records revenue when earned
and expenses when incurred is using the
accrual basis of accounting.
(matches the revenue earned with the expenses
necessary to produce the revenue during the
accounting period)
Recording Revenue
• Revenue is recognized as it is earned even if
cash has not been received.
Revenue =
See Example on Page 72.
Owner’s Equity
Recording Expenses
• The transactions are recorded in the expense
accounts whether they are cash transactions
or credit transactions. (recorded as they are
incurred)
Cash Basis of Accounting
• Recognizes revenue and expenses on a cash
basis.
– Expenses are recorded only when cash is paid for
an expense.
– Revenue is recorded only when cash is received
for sales or other revenue.
** In other words, this form of accounting does not
follow the matching principle…and as a result is not
used by accountants for a business.