Income statement or Profit & Loss Account
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Income statement or Profit Loss Account Revenues: Inflows (creation) of assets- cash or accounts receivable- that result from the sale of goods and services to customers Expenses: Outflows (consumption) of resources that were required in
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Income statement or Profit & Loss Account<br>
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Revenues: Inflows (creation) of assets- cash or accounts receivable- that result from the sale of goods and services to customers
Expenses: Outflows (consumption) of resources that were required in order to generate these revenues
What is profit then ?
Net Income is more formally used<br>
Expenses: Outflows (consumption) of resources that were required in order to generate these revenues
What is profit then ?
Net Income is more formally used<br>
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3-5 Basic Concepts (This Session) Accounting period.
Conservatism.
Realization.
Matching.
Consistency.
Materiality.<br>
Conservatism.
Realization.
Matching.
Consistency.
Materiality.<br>
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Accounting period concept Net income for the entire duration of the firm is easy to measure, but?
Measures activities for a specified period of time called accounting period
Remember Revenue is an increase in retained earnings, expense is a decrease
Revenues- Expense= Net income
Income not the same as increase in cash<br>
Measures activities for a specified period of time called accounting period
Remember Revenue is an increase in retained earnings, expense is a decrease
Revenues- Expense= Net income
Income not the same as increase in cash<br>
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The conservatism concept Recognizes revenues (increase in retained earnings) only when they are reasonably certain.
Recognise expenses (decrease in retained earnings) as soon as they are reasonably possible
In nutshell, anticipate all losses, not gains<br>
Recognise expenses (decrease in retained earnings) as soon as they are reasonably possible
In nutshell, anticipate all losses, not gains<br>
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Application to revenue recognition Pre collected revenue<br>
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Accounts receivable<br>
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Realization concept Amount of revenue that should be recognized from sale
Rvenue can only be recognized after it has been earned.
E.g., Advance payment for goods. A customer pays $1,000 in advance for a custom-designed product<br>
Rvenue can only be recognized after it has been earned.
E.g., Advance payment for goods. A customer pays $1,000 in advance for a custom-designed product<br>
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Matching concept Requires that the expenses incurred during a period be recorded in the same period in which the related revenues are earned
A salesman earns a 5% commission on sales shipped and recorded in January. The commission of $5,000 is paid in February
When the expense will recognize ?
January
Like wise depreciation also<br>
A salesman earns a 5% commission on sales shipped and recorded in January. The commission of $5,000 is paid in February
When the expense will recognize ?
January
Like wise depreciation also<br>
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Consistency concept
Materiality concept<br>
Materiality concept<br>
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Accrual vs Cash Basis The table below summarizes the broad difference between the two method:<br>
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Why Profit and Loss Account The profits are the compensation derived by an entrepreneur for the capital invested and risks incurred in running a firm.
It is a major financial statement showing a company’s earnings and expenses over a given period of time.
The profit and loss account is a part of the final accounts drawn up at the end of the accounting period.
Profits earned are also one of the chief indicators of the efficiency of a business.<br>
It is a major financial statement showing a company’s earnings and expenses over a given period of time.
The profit and loss account is a part of the final accounts drawn up at the end of the accounting period.
Profits earned are also one of the chief indicators of the efficiency of a business.<br>
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Measurement of Income Comparing the revenue from sales against the cost of resources parted with for earning that revenue.
The net difference in this comparison, represents the net income or profit. Identify realized revenues Identify related costs Match identified revenues and expired costs Determination of Net Profit (Loss)<br>
The net difference in this comparison, represents the net income or profit. Identify realized revenues Identify related costs Match identified revenues and expired costs Determination of Net Profit (Loss)<br>
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Accrual Principle It is a generally accepted accounting principle (GAAP).
It evaluates every transaction in terms of its impact on owner(s) equity.
It Implies recognized revenue results in increase in owner(s) equity and expired costs or recognized expense results in decrease in owner(s) equity.
are not necessarily the same as change in the cash position Net income arises from events that change owner(s) equity in a specified period .<br>
It evaluates every transaction in terms of its impact on owner(s) equity.
It Implies recognized revenue results in increase in owner(s) equity and expired costs or recognized expense results in decrease in owner(s) equity.
are not necessarily the same as change in the cash position Net income arises from events that change owner(s) equity in a specified period .<br>
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Illustration… Ali Mehdi Khan starts his business on 1st July. He took a loan of INR 1,00,000 from bank @ 12% per annum for purchasing plant and machinery, on the same day. The machine has a life of 10 years with no scrap value. He also paid INR 60,000; three months rent in advance. Try to find revenue and expenses for the Month of July
Explanation: Bank borrowing does not represent revenue – increase in cash is offset by an increase in liabilities.
Interest (INR 1000) depreciation (INR 833) are accrued expenses for July.
Rent expense for July will be INR 20,000.<br>
Explanation: Bank borrowing does not represent revenue – increase in cash is offset by an increase in liabilities.
Interest (INR 1000) depreciation (INR 833) are accrued expenses for July.
Rent expense for July will be INR 20,000.<br>
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Illustration… Khan had received order worth INR 2,00,000 in the month of June itself (even before starting his business). He started the production accordingly; the total production cost was INR 1,20,000; sales of merchandise to its customers from 2nd July to 31st July are as follows:
Total Sales = INR 95,000 (Cash Sales 25,000 and Credit Sales to Rajesh INR 70,000).
Sales for June:
Nil – Because revenue is recognized only when goods are sold to the customers and not on receiving the order or on incurring the production cost.<br>
Total Sales = INR 95,000 (Cash Sales 25,000 and Credit Sales to Rajesh INR 70,000).
Sales for June:
Nil – Because revenue is recognized only when goods are sold to the customers and not on receiving the order or on incurring the production cost.<br>
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Solution Sales for July:
INR 95,000
Accounting equation would be:
Cash + Debtors = Liabilities + Owner(s) Equity
25,000 + 70,000 = 0 + 95,000
When Rajesh pays INR 70,000 in August
Sales does not occur.
Cash would increase by INR 70,000; and the debtors would decrease. The amount of owner(s) equity remains same.<br>
INR 95,000
Accounting equation would be:
Cash + Debtors = Liabilities + Owner(s) Equity
25,000 + 70,000 = 0 + 95,000
When Rajesh pays INR 70,000 in August
Sales does not occur.
Cash would increase by INR 70,000; and the debtors would decrease. The amount of owner(s) equity remains same.<br>
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Accounting Period A convenient segment of time to collect, summarize and report all information on the material changes in owner(s) equity during the period.
Realization and Accrual principle will have to be applied in the context of the accounting period.
Links in the information chain which makes up the life of the enterprise.<br>
Realization and Accrual principle will have to be applied in the context of the accounting period.
Links in the information chain which makes up the life of the enterprise.<br>
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Asset that becomes expenses Inventories:
Become expenses when they are sold
Cost incurred on inventory
Prepaid expense
Unexpired Cost
Railway Ticket booked on March 21 for April 1 journey
Long term assets:
Life of assets expire over the period
Depreciation<br>
Become expenses when they are sold
Cost incurred on inventory
Prepaid expense
Unexpired Cost
Railway Ticket booked on March 21 for April 1 journey
Long term assets:
Life of assets expire over the period
Depreciation<br>
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The Point is that Matching:
Deducting from the revenues of a period, the cost of goods sold or other expenses that can be identified with such revenues of that period on the basis of cause and effect relationship..<br>
Deducting from the revenues of a period, the cost of goods sold or other expenses that can be identified with such revenues of that period on the basis of cause and effect relationship..<br>
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Matching Revenues and Expenses The entire process of periodic earnings measurement, it is process of matching expenses with revenues.
It means deducting from revenues of a period the cost of goods sold or other expenses that can be identified with such revenues, or of that period, on the basis of a cause and effect relationship.
It involves the subtraction of expenses of a period, from the realized revenues of the period.
It determine the profit or loss earned or suffered during the accounting period.
The expenses to be matched against the revenues of the period will be all those costs expiring during the accounting period.<br>
It means deducting from revenues of a period the cost of goods sold or other expenses that can be identified with such revenues, or of that period, on the basis of a cause and effect relationship.
It involves the subtraction of expenses of a period, from the realized revenues of the period.
It determine the profit or loss earned or suffered during the accounting period.
The expenses to be matched against the revenues of the period will be all those costs expiring during the accounting period.<br>
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Particularizing Revenue Broadly, it is the total amount realized from the sale of goods (or provision of services) together with earnings from interest, dividend, rents and other items of income.
It is usually referred to as ‘operating income’ and the latter, as ‘other income’ or ‘non-operating income’.
Implication of Realization Principle
If the right to receive that income is created or the time for which the income relates have expired, it is accrued income.<br>
It is usually referred to as ‘operating income’ and the latter, as ‘other income’ or ‘non-operating income’.
Implication of Realization Principle
If the right to receive that income is created or the time for which the income relates have expired, it is accrued income.<br>
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Illustration We purchase merchandise worth INR 1,00,000 during the period; sell one half of this during the period for INR 75,000. Rental for the facilities during the period was INR 20,000.<br>
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Discussion…<br>
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More on Expenses… Expenses of a given period are:
Costs and expenses of current accounting period (such as cost of material bought and sold during the same accounting period).
Costs incurred in a previous accounting period that become expenses or expired costs during this year (such as inventory purchased during the previous period, but unsold during that period and sold during this year).
Expenses of this year, the monetary outlay for which will be made during a subsequent period (such as rent due for the current accounting period, but is to be paid in the next accounting period).<br>
Costs and expenses of current accounting period (such as cost of material bought and sold during the same accounting period).
Costs incurred in a previous accounting period that become expenses or expired costs during this year (such as inventory purchased during the previous period, but unsold during that period and sold during this year).
Expenses of this year, the monetary outlay for which will be made during a subsequent period (such as rent due for the current accounting period, but is to be paid in the next accounting period).<br>
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Expense Recognition Under following circumstances:
In the period in which there is direct identification or association with the revenue of the period.
An indirect association with the revenue of the period (such as rent, salaries, insurance etc., which are not usually inventoried).
Measurable expiration of assets (unexpired costs) though not associated with the production of revenue for the current period (such as loss from flood, fire and similar events).
Assets that become expenses: inventories, prepaid expenses, and long-lived assets.<br>
In the period in which there is direct identification or association with the revenue of the period.
An indirect association with the revenue of the period (such as rent, salaries, insurance etc., which are not usually inventoried).
Measurable expiration of assets (unexpired costs) though not associated with the production of revenue for the current period (such as loss from flood, fire and similar events).
Assets that become expenses: inventories, prepaid expenses, and long-lived assets.<br>
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Profit and Loss Account Preparation It is a summary of all ‘accounts’ dealing with transactions relating to revenue and expenses.
Done by summarizing all individual accounts accumulating information on different items relating to the elements of ‘expense’ and ‘revenue’. A = L + C + R – (E + D)
Assets = Liabilities + Contributed Capital + Revenue – (Expenses + Dividends) ‘Revenue – (Expenses + Dividends or Drawings)’ is equal to the
‘Retained Earnings’.<br>
Done by summarizing all individual accounts accumulating information on different items relating to the elements of ‘expense’ and ‘revenue’. A = L + C + R – (E + D)
Assets = Liabilities + Contributed Capital + Revenue – (Expenses + Dividends) ‘Revenue – (Expenses + Dividends or Drawings)’ is equal to the
‘Retained Earnings’.<br>
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Illustration During an accounting period, Ramsons buys 12 units of inventory for INR 1,200. Another 10 units are purchased on credit for INR 1,000; 15 units of inventory were sold during the period on credit for INR 2,250. Five units of inventory were sold for cash for INR 750 during the same period.<br>
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Horizontal and Vertical format of P&L Account<br>
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Not an expense for June - not incurred
Expense for June
Expense for June
Expense for June
Expense for June
Not an expense for June - asset acquired.<br>
Expense for June
Expense for June
Expense for June
Expense for June
Not an expense for June - asset acquired.<br>
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Revenues $275,000
a. Expenses –
Cost of goods sold $164,000
Rent 3,300
Salaries 27,400
Taxes 1,375
Other 50,240
Total Expense 246,315
Net income $28,685<br>
a. Expenses –
Cost of goods sold $164,000
Rent 3,300
Salaries 27,400
Taxes 1,375
Other 50,240
Total Expense 246,315
Net income $28,685<br>