Accrual Basis Income Statement

Accrual Basis Income Statement

Key Things To Know

  The income statement is presented on the “accrual basis”

• The income statement reports the activities that happened during the period.
• When cash is received or paid does not matter to the income statement.

The income statement reports:

1) Goods or services provided to a customer during the period.
Report revenue in the period the goods or services are provided to the customer.

2) Services provided to the company during the period.
Report an expense in the period the service is provided to the company.

3) Assets used (up) to provide the goods or services to the customer during the period.
Report an expense in the period the asset is used.

When cash is paid or received DOES NOT MATTER to the income statement!

Report revenue when:

1) The goods or services are provided, and
2) Collection of cash is reasonably assured

Report expenses when:

1) The service is provided to the company, or
2) An asset is used (up) to provide goods or services

The Matching Principle:
All expenses incurred to produce revenue must be reported in the same time period the revenue is reported.

The income statement does not report when cash is paid or received.

Balance sheet accounts indicate when the cash occurs in a different period of time than the revenue or expense occurred.

The Use of Long-Term Assets:

Long-term assets (property, plant, equipment, intangible assets) are reported on the balance sheet as an asset when purchased.

Depreciation Expense: Long-term assets become expenses and move from the balance sheet to the income statement as they are used to produce revenues.

Long-term assets are:

• used and the asset is still available for future use
• still available for future use and have not physically gone away.

The asset continues to be reported on the balance sheet at historical cost.

Accumulated depreciation is reported on the balance sheet to show how much has been used to date (cumulative).

The depreciation expense of using the asset is reported on the income statement for the current period.

Accumulated depreciation is a contra account (negative asset) that reduces the asset and reports the cumulative cost of using the physical asset for the time that has already passed.

Important to note:

1) The depreciation expense occurs equally (using straight-line) and is spread over each year the asset is used. The expense is for one period only.

2) The cost of the machinery remains the same each year; historical cost.

3) Accumulated depreciation is used to show the total cumulative amount expensed for all years the asset has been used. Accumulated depreciation increases every year.

Intangible Assets:

The expense of using an intangible asset is reported the same way as the cost of using a physical asset.

Amortization Expense
The term used for the cost of using an intangible asset in the current period.

Accumulation amortization (also a contra account) is the total of all year’s expense and is a reduction to the asset.

2 Common Formats of the Income Statement:

1) Companies that sell goods use a multi-step income statement.

    Sales
–  Cost of Goods Sold
= Gross Profit
– Operating Expenses:
     General and Administrative
     Selling
     Research & Development
     Restructuring
= Operating Income
    Other Revenue and Expense:
+-   Interest Income or Expense
+    Rent Income
+-   Gains or Losses on Sale of Assets
= Income Before Taxes
–     Income Tax Expense                      
= Income from Continuing Operations
+ –  Discontinued Operations
=  Net Income

2) Service Companies (that may also sell goods) use a single step income statement.

    Software Revenues
+ Service Revenues
=   Total Revenues

–  Cost of Goods Sold
–  General and Administrative
–  Selling
–  Research & Development
–  Restructuring                                    
=  Operating Income
        Other Revenue or Expense:
+-    Interest Income or Expense
+      Rent Income
+-    Gains or Losses on Sale of Assets
= Income Before Taxes:
– Income Tax Expense                        
=    Income from Continuing Operations
+ –  Discontinued Operations
=     Net Income

Terms Related to the Income Statement:

Gross Profit:
Profit from selling inventory only
Sales less Cost of Goods Sold

Operating Expenses:
Directly related to primary day to day business operations
Selling, General and Administrative, Research & Development

Operating Income:
Earnings from day to day primary business
Expected to continue in future periods

Other Revenues/Expenses:
The result of transactions that are not part of day to day business with customers
(also called non-operating)

Income Tax Expense:
Taxes to be paid to the government based on a % of income before tax.

Income from Continuing Operations:
An indication of total income that may be earned in future years.
Used for projecting future earnings.

Discontinued Operations:
Selling or disposing of a major part of the business
(separate division or separate geographic area)

Net Income:
Total current period earnings of the company

Classification / Names of Common Income Statement Accounts

Operating Revenues:

Sales
Sales Revenue
Service Revenue
Service Fees

Operating Expenses:

Cost of Sales
Cost of Goods Sold (“CGS”)
Cost of Services
Selling expenses
General & Administrative expenses
Repairs & Maintenance expenses
Sales & Marketing expenses
Bad Debt expense
Utilities expense
Supplies expense
Wages expense
Salaries expense
Insurance expense
Rent expense
Depreciation expense
Advertising expenses
Restructuring expenses
Research & Development expenses
Other Operating expenses

Other Revenues and Expenses:

Rent Income
Interest Income
Investment Income
Dividend Income
Gains or Losses on Sale of Assets
Interest Expense

Income Tax Expense

Below Income from Continuing Operations:

Discontinued Operations

Earnings per Share:

             Net Income – Preferred Dividends
Average number of Common Shares of Ownership

Basic EPS:
Uses the number of common shares currently outstanding

Diluted EPS:
Uses the number of common shares that could be outstanding given all financial instruments currently owned that could be exchanged for common shares are exchanged for common shares.

Diluted EPS is the “worst case scenario” of how low EPS could be given the current commitments to issue shares and current earnings remain the same.