Chapter 3
The Income Statement
PowerPoint Author:
Brandy Mackintosh, CA
Copyright © 2016 by McGraw-Hill Education
Learning Objective 3-1
Describe common operating
transactions and select
appropriate income statement
account titles.
3-2
Operating Activities
Operating activities include buying goods and
services from suppliers and employees and
selling goods and services to customers and
then collecting cash from them.
3-3
Income Statement Accounts
Time Period Assumption:
dividing the company’s long life into shorter chunks of time
such as months, quarters, and years.
3-4
Cash Basis Accounting
Cash basis accounting
records revenues when cash
is received and expenses
when cash is paid.
3-5
Learning Objective 3-2
Explain and apply the revenue
and expense recognition
principles.
3-6
Accrual Basis Accounting
Accrual Basis
Accounting
GAAP/IFRS
Records revenues when they are
earned and expenses in the same
period as the revenues to which they
relate, regardless of the timing of
cash receipts or payments.
3-7
Revenue Recognition Principle
Timing of Reporting Revenue versus Cash Receipts
Revenue Recognition Principle
Revenues are recognized when they are
earned.
3-8
Expense Recognition Principle (“Matching”)
Timing of Reporting Expenses versus Cash Payments
Record expenses in the same period as the
revenues with which they can be reasonably
associated.
3-9
Learning Objective 3-3
Analyze, record, and summarize
the effects of operating
transactions using the accounting
equation, journal entries, and
T-accounts.
3-10
The Expanded Accounting Equation
3-11
SonicGateway’s Accounting Records
(a) Sell games for Cash.
In September, SonicGateway sold $3,000 of games at its online store.
1 Analyze
=
Assets
Liabilities
+
(a) Cash +$3,000
2
Sales
Revenue (+R) +$3,000
Record
(a) Cash (+A)
Sales Revenue (+R, +SE)
3
3,000
3,000
Summarize
dr +
Cash (A)
Beg. Bal. 20,700
(a)
3,000
3-12
Stockholders’ Equity
cr -
dr -
Sales Revenue (R, SE)
cr +
0 Beg. Bal.
3,000
(a)
SonicGateway’s Accounting Records
(b) Receive cash for future services.
SonicGateway issued three $100 gift cards at the beginning of September.
1 Analyze
=
Assets
(b) Cash +$300
2
Liabilities
Unearned
Revenue
Record
300
300
Summarize
dr +
Cash (A)
Beg. Bal. 20,700
(a)
3,000
(b)
300
3-13
Stockholders’ Equity
+$300
(b) Cash (+A)
Unearned Revenue (+L)
3
+
cr -
dr -
Unearned Revenue (L)
cr +
0 Beg. Bal.
300
(b)
SonicGateway’s Accounting Records
(c) Sell apps on credit.
SonicGateway sold $9,000 of apps in the App Store and on Google Play.
1 Analyze
=
Assets
+
Liabilities
(c) Accounts
Receivable +$9,000
2
Sales
Revenue (+R)
9,000
9,000
Summarize
dr +
Accounts Receivable (A)
Beg. Bal.
(c)
3-14
+$9,000
Record
(c) Accounts Receivable (+A)
Sales Revenue (+R, +SE)
3
Stockholders’ Equity
0
9,000
cr -
dr -
Sales Revenue (R, SE)
cr +
0 Beg. Bal.
3,000
(a)
9,000
(c)
SonicGateway’s Accounting Records
(d) Receive payment on account.
SonicGateway received checks totaling $8,500 from Apple and Google,
on account.
1 Analyze
=
Assets
Liabilities
+
Stockholders’ Equity
(d) Cash +$8,500
Accounts
Receivable -$8,500
2
Record
(d) Cash (+A)
Accounts Receivable (-A)
3
8,500
Summarize
dr +
Cash (A)
Beg. Bal. 20,700
(a)
3,000
(b)
300
(d)
8,500
3-15
8,500
cr -
dr +
Accounts Receivable (A)
Beg. Bal.
(c)
0
9,000
8,500
cr (d)
SonicGateway’s Accounting Records
(e) Pay cash to employees.
SonicGateway wrote checks to employees totaling $7,800 for wages related to
hours worked in September.
1 Analyze
=
Assets
Liabilities
(e) Cash -$7,800
2
+
Stockholders’ Equity
Salaries & Wages
Expense (+E)
-$7,800
Record
(d) Salaries and Wages Expense (+E, -SE)
Cash (-A)
3
7,800
Summarize
dr +
Cash (A)
Beg. Bal. 20,700
(a)
3,000
(b)
300
(d)
8,500
3-16
7,800
7,800
cr (e)
dr + Salaries & Wages Expense (E, SE) cr Beg. Bal.
(e)
0
7,800
SonicGateway’s Accounting Records
(f) Pay cash in advance.
On September 1, SonicGateway paid $7,200 in advance for
September, October, and November rent.
1 Analyze
=
Assets
Liabilities
+
Stockholders’ Equity
(f) Cash
-$7,200
Prepaid
Rent
+$7,200
2
Record
(f)
3
Prepaid Rent (+A)
Cash (-A)
7,200
Summarize
dr +
Cash (A)
Beg. Bal. 20,700
(a)
3,000
(b)
300
(d)
8,500
3-17
7,200
7,800
7,200
cr (e)
(f)
dr +
Beg. Bal.
(f)
Prepaid Rent (A)
0
7,200
cr -
SonicGateway’s Accounting Records
(g) Incur cost to be paid later.
SonicGateway displayed Facebook sidebar ads in
September and received a bill for $500 to be paid in October.
1 Analyze
=
Assets
Liabilities
(g) Accounts
Payable + $500
2
+
Stockholders’ Equity
Advertising
Expense (+E)
Record
(g) Advertising Expense (+E, -SE)
Accounts Payable (+L)
3
500
500
Summarize
dr -
Accounts Payable (L)
cr +
10,200 Beg. Bal
(g)
500
3-18
-$500
dr + Advertising Expense (E, SE) cr Beg. Bal.
(g)
0
500
SonicGateway’s Accounting Records
(h) Pay cash for expenses.
SonicGateway was notified by its bank that an automatic monthly payment of $600
was transmitted to its utility company for electricity use in September.
1 Analyze
=
Assets
(h)
2
Liabilities
+
Cash -$600
Stockholders’ Equity
Utilities
Expense (+E)
Record
(h) Utilities Expense (+E, -SE)
Cash (-A)
3
600
600
Summarize
dr +
cr -
Cash (A)
Beg. Bal. 20,700
(a)
3,000
(b)
300
(d)
8,500
3-19
-$600
7,800
7,200
600
(e)
(f)
(h)
dr +
Utilities Expense (E, SE)
Beg. Bal.
(h)
0
600
cr -
Learning Objective 3-4
Prepare an unadjusted trial
balance.
3-20
Unadjusted Trial Balance
Cash Ledger Account
3-21
Review of Revenues
3-22
Review of Expenses
3-23
Learning Objective 3-5
Evaluate net profit margin,
but beware of income
statement
limitations.
3-24
Net Profit Margin
Net
Profit
Margin
=
=
=
Net Income
Revenue
$3,100
$12,000
0.258
or 25.8%
Net income = Revenues – Expenses
= $12,000 - $8,900
= $3,100
3-25
Income Statement Limitations
NI  Cash
NI   Value
NI  Exact
3-26
Chapter 3
Solved Exercises
M3-2, M3-3, M3-4, M3-5, M3-13, M3-14
Copyright © 2016 by McGraw-Hill Education
M3-2 Identifying Accrual Basis Revenues
The following transactions are July activities of Bill’s Extreme Bowling
Inc., which operates several bowling centers. If revenue is to be
recognized in July, indicate the amount. If revenue is not to be
recognized in July, explain why.
Activity
3-28
Amount or Explanation
a.
Bill’s collected $12,000 from
customers for services related
to games played in July.
$12,000
b.
Bill’s billed a customer for $250
for a party held at the center on
the last day of July. The bill is to
be paid in August.
$250
c.
The men’s and women’s
bowling leagues gave Bill’s
advance payments totaling
$1,500 for the fall season that
starts in September.
No revenue is earned in July.
The revenues will be earned
when fall bowling service is
provided (i.e., when the games
are played).
d.
Bill’s received $1,000 from credit
sales made to customers last
month (in June).
No revenue is earned in July.
The cash collections in July
related to revenues earned in
June.
M3-3 Identifying Accrual Basis Expenses
The following transactions are July activities of Bill’s Extreme
Bowling, Inc., which operates several bowling centers. If an
expense is to be recognized in July, indicate the amount. If an
expense is not to be recognized in July, explain why.
Activity
3-29
Amount or Explanation
a.
Bill’s paid $1,500 to plumbers
for repairing a broken pipe in the
restrooms.
$1,500
b.
Bill’s paid $2,000 for the June
electricity bill and received the
July bill for $2,500, which will be
paid in August.
$2,500 was incurred as an
expense in July. The $2,000
was an expense in June and is
not an expense in July.
c.
Bill’s paid $5,475 to employees
for work in July.
$5,475
M3-4 Recording Accrual Basis Revenues
For each of the transactions in M3-2, write the journal entry using
the format shown in the chapter.
3-30
a. Cash (+A)
Service Revenue (+R, +SE)
12,000
b. Accounts Receivable (+A)
Service Revenue (+R, +SE)
250
12,000
250
c. Cash (+A)
Unearned Revenue (+L)
1,500
d. Cash (+A)
Accounts Receivable (A)
1,000
1,500
1,000
M3-5 Recording Accrual Basis Expenses
For each of the transactions in M3-3, write the journal entry using
the format shown in the chapter.
a. Repairs and Maintenance Expense (+E, SE)
Cash (A)
1,500
b. Accounts Payable (–L)
Cash (A)
2,000
Utilities Expense (+E, SE)
Accounts Payable (+L)
c. Salaries and Wages Expense (+E, SE)
Cash (A)
3-31
1,500
2,000
2,500
2,500
5,475
5,475
M3-13 Preparing Accrual Basis Journal Entries for Business
Activities
Quick Cleaners, Inc. (QCI) has been in business for several
years. It specializes in cleaning houses but has some small
business clients as well. Prepare journal entries for the following
transactions, which occurred during a recent month, and
determine QCI’s preliminary net income.
a. Issued $25,000 of QCI stock for cash.
b. Incurred $600 of utilities costs this month and will pay them
next month.
a. Cash (+A)
Common Stock (+SE)
b. Utilities Expense (+E -SE)
Accounts Payable (+L)
3-32
25,000
25,000
600
600
M3-13 Preparing Accrual Basis Journal Entries for Business
Activities
c. Paid wages for the current month totaling $2,000.
d. Performed cleaning services on account worth $2,800.
e. Some of Quick Cleaners’ equipment was repaired at a total
cost of $150. The company paid the full amount at the time
the repair work was done.
c. Salaries and Wages Expense (+E -SE)
Cash (-A)
2,000
d. Accounts Receivable (+A)
Service Revenue (+R +SE)
2,800
2,000
e. Repairs and Maintenance Expense (+E -SE)
Cash (-A)
Preliminary Net Income = Revenues – Expenses
= $2,800 - $2,000 - $600 - $150
= $50
3-33
2,800
150
150
M3-14 Preparing Accrual Basis Journal Entries for
Business Activities
Junktrader is an online company that specializes in matching
buyers and sellers of used items. Buyers and sellers can
purchase a membership with Junktrader, which provides them
advance notice of potentially attractive offers. Prepare journal
entries for the following transactions, which occurred during a
recent month, and determine Junktrader’s preliminary net
income.
a. Junktrader provided online advertising services for another
company for $200 on account.
b. On the last day of the month, Junktrader paid $50 cash to
run an ad promoting the company’s services. The ad ran
that day in the local newspaper.
a. Accounts Receivable (+A)
Service Revenue (+R +SE)
b. Advertising Expense (+E -SE)
Cash (-A)
3-34
200
200
50
50
M3-14 Preparing Accrual Basis Journal Entries for Business
Activities
c. Received $200 cash in membership fees for the month from
new members.
d. Received an electricity bill for $85 for usage this month. The
bill will be paid next month.
e. Billed a customer $180 for helping them sell their junk. The
customer is expected to pay by the end of next month.
c. Cash (+A)
Service Revenue (+R +SE)
d. Utilities Expense (+E -SE)
Accounts Payable (+L)
e. Accounts Receivable (+A)
Service Revenue (+R +SE)
200
200
85
85
180
Preliminary Net Income = Revenues – Expenses
= $200 + $200 + $180 - $50 - $85
= $445
3-35
180
End of Chapter 3
3-36