Income Statement

Answers to Practice Problem 1 – Income Statement – Reporting revenues and expenses 

You must go through each transaction and determine what was earned and what was incurred (used up or provided to the company) in January.

The amount that is earned or incurred ONLY in January will be reported on the January income statement.  Cash paid or received doe NOT matter.

1)  Customers paid the company $480,000 for one year of legal service to be earned equally over the year.

$480,000 / 12 months = $40,000 earned each month 
The amount earned is the amount recorded as revenue
When the cash is received does not matter

2)  Employees worked and the company incurred $14,000 in salaries for the month of January.

The amount incurred in January is the expense for January

3)  The company paid $12,000 for salaries to employees during January.

How much is paid is not reported under the accrual basis
This is ignored – the amount incurred (see 2) during the period is reported.

4)  The December utility bill of $1,200 was paid in January

This was incurred in December and will be reported as a December expense.   This will not be reported in January.  When it is paid does not matter.

5)  The January utility bill of $2,500 was received but not paid.

This was incurred in January and will be reported as a January expense
When the utility bill will be paid does not matter.

6)  The company purchased office furniture for $32,000 in January that is expected to be used for the next 8 years.

The cost of using the asset for the month of January only will be expensed in January.  The cost of using a long term asset is called depreciation expense 

$32,000 / 8 years = $4,000 per year / 12 months = $333 per month

7)  The company incurred $800 of interest expense in January that won’t be paid until March.

The amount incurred in January will be reported as an expense in January.  When the expense is paid does not matter.

8)  Liability insurance in the amount of $3,600 to cover six months was paid for in January

The amount incurred only for the month of January will be expensed in January.    $3,600 / 6 months = $600 for one month

9)  Rent for the first three months of the year was paid in January in the amount of $6,000.

Only the cost of the rent for January will be expensed in January
The total amount paid in January does not matter. It is not the expense for January

$6,000 / 3 months = $2,000 for one month of January

10)  Supplies costing $2,000 were purchased in January and supplies costing $275 were used up in January.

Only the cost of the asset that was used up during January will be expensed in January.   Expense the $275 used up. The rest, $1,725, is an asset and has future benefit.

Prepare the income statement – use the single step format since there is no cost of goods sold and this is a service company

Prepare a multi-step income statement in proper format.

Answers to Practice Problem 2 – Prepare a Multi-Step Income Statement                            

Write the standard format first and then write in the accounts and amounts

Accrued expenses is a liability that is reported on the balance sheet
Salaries payable is a liability that is reported on the balance sheet
Prepaid expenses is an asset that is reported on the balance sheet
Dividends paid is not an expense and is not reported on the income statement
Dividends paid is a reduction to retained earnings.

Accumulated depreciation is a contra-asset account that is reported on the balance sheet.   It is for all prior years and is not the same as depreciation expense which is the expense related to using the asset for this year only.

Multi-Step Income Statement:

Unusual only is reported in the “other” category

Selling a major product line is a discontinued operation

Tax expense = Income before tax   x   40%