April 16, 2016

Measuring Income to Assess Performance - Review Notes

Measuring Income


Income is a measure of the increase in the “wealth” of an entity over a period of time.

Accountants have agreed on a common set of rules for measuring income and wealth.

Income is generated primarily through the operating cycle.

Operating cycle –average time taken by a firm in converting merchandize or raw material back into cash

•Income –key measure of performance and value; measure of increase in wealth over a
period of time

 –Calendar year vs. Fiscal year Operating cycle –average time taken by a firm inconverting merchandize or raw material back intocash

About 40% of large companies use a fiscal year that differs from a calendar year


Interim reports

Companies also prepare financial statements for interim periods
Interim periods may be for a month or a quarter (3-month period)



Measuring Income

Revenues
 –are increases in assets received inexchange for the delivery of goods or services to customers. Revenues increase owners' equity.•
Expenses
 –are decreases in assets as a result of goods or services being delivered to customers. Expenses decrease owners' equity.

Income
(profit, earnings) – excess of revenues over expenses in a reporting period.

Retained Earnings
 –total cumulative owners’equity generated by income or profits

Measuring Income

Cash Basis
 –revenues are recognized when a company receives cash and expenses are recognized when a company pays cash.
 –Ignores activities that increase or decrease assets other than cash

Accrual Basis
 –revenues are recorded as they are earned and expenses are recorded as they are incurred, regardless whether cash changes hands.
 –Ignores that a company can go bankrupt if it does not manage its cash properly, no matter how well it seems to be doing according to the other financial statements

Revenues Recognition
•Criteria to recognize revenues:
 –
Revenues must be earned -
All (or substantially all)of the goods or services the customer wants have been delivered to and accepted by customers –
Revenues must be realized or realizable -
Cash or a formal promise by the customer to pay cash hasbeen received for the goods or services delivered


Matching

Matching
 –the process of recognizing and recording expenses in the same period the related revenues are recognized.

• Product costs
 –are linked with productrevenues earned in that period (e.g. cost ofgoods, commissions, etc).•

Period costs
 –are linked to a period of timeitself and are recorded in the period incurred(e.g. rent, admin. salaries, etc.)

Depreciation is the systematic allocation of the acquisition cost of long-lived assets to the periods that benefit from the use of the assets.

Land is not subject to depreciation because it does not deteriorate over time


Expanded Balance Sheet Equation

(1) Assets    =    Liabilities   +   Stockholders’ Equity

(2) Assets    =    Liabilities   +   Paid-in Capital  +  Retained Earnings

(3) Assets    =    Liabilities   +   Paid-in Capital  +  Revenues - Expenses








Review Notes

http://seattlecentral.edu/faculty/moneil/A210/L2/Horngren02.htm

Presentation slides

http://wps.prenhall.com/wps/media/objects/1838/1883037/powerpoints/ch_02.ppt


Updated  16 April 2016

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