Week 4 - Income Statement and Adjusting Entries Flashcards
What does an income statement show?
How the company has performed over a period;.
How is net income calculated?
Income - expense
What is included in the income statement?
Revenue
Cost of sales
Gross profit
Administrative
expenses
Distribution expenses
Operating profit
Finance costs
Investment income
Profit before tax
Taxation
Net profit
How is gross profit calculated?
Revenue - cost of goods sold
How is operating profit calculated and what does it show?
Gross profit - operating expenses - shows profit from business operations before deduction of interest and taxes.
How is profit before tax calculated and what does it show?
Operating profit - costs of finance – shows the profit made from the ordinary course of trading, less cost of finance.
What is included in income?
Revenue + gains
What is revenue and the principles for recognition?
Income arising in the course of an entity’s ordinary activities, e.g. sales, fees, interest, dividends, royalties and rent.
Principles for recognition
* Entity has transferred promised goods or services to the customer
* Entity has received or is entitled to receive payment in exchange for promised goods or services
What is gains?
Represent other items that meet the definition of income that are not classed as revenue, e.g. gains from selling non current assets.
At which point is revenue recognised?
- From sale of goods when goods are delivered and accepted by the customer
- Services when services are provided
- Long term contracts as each distinct stage is completed
What is an expense?
Losses as well as those expenses that arise in the course of the ordinary activities of the entity. decreases in owners equity that arise when generating revenue.
How to recognise expenses (which principles and what are they)?
- Matching principle. Expenses are matched to the revenue that they help generate
- Conservatism or prudence principle. Recognise anticipated losses immediately and recognise anticipated gains only when they arise.
How to recognise interest expenses?
Must distinguish 1. Paying interest=the price that a lender charges for the use of the lender’s money and 2. Repaying the principal amount (i.e. the amount borrowed initially)
For Interest expense:
Dr Interest expense (expense account, goes to IS)
Cr Bank OR Cr Interest payable (for unpaid interest)
For Principle amount
Recording a loan:
Dr Bank (BS)
Cr Loan (BS)
Repaying the loan:
Dr Loan (BS)
Cr Bank (BS)
What are adjusting entries and what do they do?
Accounting journal entries made at the end of the accounting period after a trial balance has been prepared. Adjusting entries update the financial records for events that
have occurred, but no document for a transaction exists.
How to recognise tax expenses?
Tax expense is usually estimated at the end of the year but not paid until 4-6 months later after tax financial statements prepared. At the end of the year we will have an estimate for tax for the year but it is not paid thus creating a tax liability (tax payable).
Dr Tax expense (IS)
Cr Tax payable (SOFP)
What are examples of adjusting entries?
- Accruals/prepayments
- Depreciation
- Provisions for bad and doubtful debts
- Inventory:
* Inventory write-downs
* Cost of sales calculation
What is cash basis accounting?
Records only transactions with cash: cash receipts and cash payments. When cash is paid, expenses are recorded. As a result, revenues are only recorded when cash is received and expenses are recorded only when cash is paid.
What is accrual basis accounting?
Records effect of each transaction as it occurs - that is, revenues are recorded when earned and expenses are recorded when incurred. revenues are considered to be earned when the goods or services are provided to the customers. In accrual basis accounting, it is irrelevant when cash is received or paid.
The figures in the trial balance will usually be the amounts paid
in cash in the period, and they need adjusting for?
Outstanding amounts (=accruals) and amounts paid which relate to other periods (=prepayments) to get the correct charge in the statement of profit and loss.
What are accrued expenses and on which financial statement do they appear?
Expenses that have been incurred, but not yet recorded (not invoiced) as expenses. I.e. g+s received from suppliers, but payment has not yet been made.
Appear in the SOFP in current liabilities.
What are prepaid expenses?
Future expenses that have been paid in advance. Cash has been paid, but g/s have not been received yet.
How do we account for inventory and where do we find it?
It is found in current assets in SOFP. When goods are sold their cost becomes an expense, ‘cost of sales’, in the income statement. This expense is deducted from sales to determine gross profit.
How to calculate cost of sales (COS)?
Opening inventory + purchases - closing inventory = Cost of goods sold
What is a perpetual inventory system?
Where a company keeps a detailed record of the cost of each inventory purchase and sale. Under such system a company determines the cost of goods sold each time a sale occurs.
