Week 3 - Income Statement Flashcards
What is the purpose of the income statement?
1) To record income generated and expenditure incurred over a given period of time- reports profitability of company’s operations over specific period of time
2) Shows net profit (or net loss)
3) Profit (if applicable) calculated used to pay dividends to shareholders/stockholders and remainder (if applicable) kept as retained earnings to finance future growth
What is the income statement also known as?
Profit and loss account
What is profit?
Difference between company’s revenues and expenses
Revenue – Expense
Why is the income statement/statement of profit and loss useful?
1) Shows how well the business has performed in the last period- allows evaluation of past performance of enterprise
2) It provides a basis for predicting future performance- helps users understand the return the entity (company/organisation) has produced and how efficiently resources have been used
3) Helps asses the risk or uncertainty of achieving future cash
What does the income statement/statement of profit and loss actually record?
1) Revenue
2) Expenses
… allowing profit to be calculated
Give examples of revenue that might be recorded in the income statement/statement of profit and loss
Revenue:
- sales of goods
- fees for services performed by the entity (organisation/business)
- interests received e.g. if entity involved in lending etc
- potential subscriptions to services offered by the entity
Give examples of expenses that might be recorded in the income statement/statement of profit and loss
Expenses:
- costs of goods sold e.g. cost of resources and manufacturing costs (labour cost, machine cost etc)
- selling and admin expenses
- interest expense e.g if entity (organisation/business) has borrowed loans from banks etc
- tax expenses e.g. corporation tax paid on profits
What is the accrual concept/basis in accounting?
The idea that:
- revenues are recognised when earned rather than when cash is received
- expenses are recognised when incurred rather than when cash is paid
How do accountants use the accrual concept?
- By dividing the economic life of a business into time periods
- typically a month, quarter (3 months) or a year
- business accounting year may be different to calendar year e.g. some entities (organisation/business) have their year end in April as opposed to December
What is the alternative to the accrual concept in accounting?
Cash basis/concept
What is the cash basis/concept in accounting?
- revenues are recognised when cash is received
- expenses are recognised when cash is paid
Out of the 2 accounting concepts (accrual and cash basis), which is more common?
Accrual concept
- cash basis accounting is NOT in accordance with the IFRS (International Financial Reporting Standards)
An entity’s (organisation/business) financial statements are prepared to the year ended 31st Dec.
They enter into a contract with another entity which starts on 1st Nov 2021.
At the end of Jan 2022, they are invoiced for the first 3 months of the contract. The bill amounts to £360.
How should the entity record this in their statements to the year ended 31st Dec 2021?
3 month contract of which 2 months occurred before year end
… split the bill into the length of the contract (£360/3 months = £120)
Multiply the monthly cost of the contract by the number of months before year end (£120 x 2 months = £240)
… £240 should be recorded in expenses as a negative (due to the fact that an increase in expenses is always negative due to the equation Revenue – Expenses – Dividends) and the £240 should be also be recorded in accruals (as a positive) which falls under liabilities (both inputs cancel each other out and
… accounts/accounting equation balance/balances … correct
NOTE accruals can be recorded as their own section under liabilities BUT sometimes can be recorded under a general heading called payables again under liabilities where all types are recorded e.g. accounts payable, income tax payable, accruals etc
What should an entity do if an invoice isn’t received at the time of year end but the accounts need to be published to Companies House (due to the company being a public limited company- plc)?
Accountants should estimate the cost of a contract initially to publish to Companies House and then changes can be made to their own accounts once the invoice/bill is received
An entity (organisation/business/company) has decided to rent a new property to accommodate some employees.
They entered into the contract with the landlord on 1st Oct 2021 – the contract stated that 1 year of rent was payable in advance.
The payment amounted to £36,000 and was paid by the entity on 1st Oct 2021.
How should this be recorded in the entity’s financial statements to the year ended 31st Dec 2021?
2 transactions would be recorded:
1) Initial payment to landlord:
- increase in expenses under equity of £36,000 (… recorded as -£36,000)
- decrease in cash under assets of £36,000
2) Payment on 1st Oct 2021 only relates to 3 months of rent to the year ended 31st Dec 2021 and … a prepayment for the remaining 9 months in 2022
… calculate the rent split (£36,000/12 = £3,000 and … £3,000 x 3 = £9,000 which is the amount that relates to the year ended 31st Dec 2021 and the remainder (£27,000) relates to the prepayment for the 9 months in 2022 …
2) Prepayment of £27,000 to be recorded
- decrease in expenses under equity by £27,000 (… positive £27,000 recorded)- REMEMBER you reduce expenses because the £27,000 expense is not for this year (year ended 31st Dec 2021) but for next year)
- increase in prepayments under assets by £27,000
… overall effect is a net decrease in assets of £9,000 and an increase in expenses of £9,000 (… -£9,000) … accounting equation balances- ALSO REMEMBER this is the cost of the contract for this year (year ended 31st Dec 2021)
NEED to show break down of transactions as above not just overall effect
