Operating Decisions andthe Income Statement

Chapter 3

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

Group Project 1

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website• Answer questions.

The Operating CyclePurchase or manufacture products or

supplies on credit.

Purchase or manufacture products or

supplies on credit.

Deliver product or provide service to

customers on credit.

Deliver product or provide service to

customers on credit.

Pay suppliers.

Pay suppliers.

Receive payment from customers.

Receive payment from customers.

Begin

Assets, liabilities, revenues, and expenses should be recognized when the transaction that causes them occurs,

not necessarily when cash is paid or received.

Assets, liabilities, revenues, and expenses should be recognized when the transaction that causes them occurs,

not necessarily when cash is paid or received.

Required by - GenerallyAcceptableAccountingPrinciples

Required by - GenerallyAcceptableAccountingPrinciples

Accrual Accounting

Revenue PrincipleRecognize revenues when . . .

Delivery has occurred or services have been rendered.

There is persuasive evidence of an arrangement for customer payment.

The price is fixed or determinable.Collection is reasonably assured.

Recognize revenues when . . .Delivery has occurred or services have

been rendered.There is persuasive evidence of an

arrangement for customer payment. The price is fixed or determinable.Collection is reasonably assured.

Revenue Principle

If cash is received before the company delivers goods or services, the liability

account UNEARNED REVENUE is recorded.

Cash received before revenue is earned -

CashReceived

Cash (+A) xxx Unearned revenue (+L) xxx

Revenue Principle

When the company delivers the goods or services UNEARNED REVENUE is reduced

and REVENUE is recorded.

Cash received before revenue is earned -

CashReceived

Company Delivers

Cash (+A) xxx Unearned revenue (+L) xxx

Revenue will be recorded when earned.

Revenue Principle

CASH COLLECTED (Goods or services due to

customers)over time will

become

REVENUE (Earned when goods or services provided)

Rent collected in advance Rent revenue

Unearned air traffic revenue Air traffic revenue

Deferred subscription revenue Subscription revenue

Typical liabilities that becomerevenue when earned include . . .

Revenue Principle

When cash is received on the date the revenue is earned, the following entry is made:

CashReceived

Company Delivers

Cash (+A) xxx Revenue (+R) xxx

AND

Revenue Principle

If cash is received after the company delivers goods or services, an asset ACCOUNTS RECEIVABLE is recorded.

Cash received after revenue is earned -

Accounts receivable (+A) xxx Revenue (+R) xxx

Company Delivers

Revenue Principle

CashReceived

Accounts receivable (+A) xxx Revenue (+R) xxx

Cash received after revenue is earned -

Company Delivers

When the cash is received the ACCOUNTS RECEIVABLE is reduced.

Cash will be collected.

Revenue Principle

CASH TO BE COLLECTED

(Owed by customers)

and already earned as

REVENUE (Earned when

goods or services provided)

Interest receivable Interest revenue

Rent receivable Rent revenue

Royalties receivable Royalty revenue

Assets reflecting revenues earned butnot yet received in cash include . . .

The Matching Principle

Resources consumed to earn

revenues in an accounting period should be recorded

in that period, regardless of when

cash is paid.

Resources consumed to earn

revenues in an accounting period should be recorded

in that period, regardless of when

cash is paid.

The Matching Principle

If cash is paid before the company receives goods or services, an asset account,

PREPAID EXPENSE is recorded.

Cash is paid before expense is incurred -

$Paid

Prepaid expense (+A) xxx Cash (-A) xxx

The Matching Principle

ExpenseIncurred

When the expense is incurred PREPAID EXPENSE is reduced and an EXPENSE is

recorded.

Cash is paid before expense is incurred -

$Paid

Prepaid expense (+A) xxx Cash (-A) xxx

Expense will be recorded when incurred.

The Matching Principle

When cash is paid on the date the expense is incurred, the following

entry is made:

CashPaid

ExpenseIncurred

Expense (+E) xxx Cash (-A) xxx

AND

The Matching Principle

If cash is paid after the company receives goods or services, a liability PAYABLE is

recorded.

Cash paid after expense is incurred -

Expense (+E) xxx Payable (+L) xxx

ExpenseIncurred

The Matching Principle

CashPaid

When cash is paid the PAYABLE is reduced.

Cash paid after expense is incurred -

ExpenseIncurred

Expense (+E) xxx Payable (+L) xxx

Cash will be paid.

The Matching Principle

CASH PAID FORas used over

time becomes EXPENSE

Supplies inventory Supplies expense

Prepaid insurance Insurance expense

Buildings and equipment Depreciation expense

Typical assets and their relatedexpense accounts include. . .

A = L + SEA = L + SEASSETS

Debit for Increase

Credit for Decrease

LIABILITIES

Debit for

Decrease

Credit for Increase

RETAINED EARNINGS

Debit for

Decrease

Credit for Increase

CONTRIBUTED CAPITAL

Debit for

Decrease

Credit for Increase

Next, let’s see how Revenues and

Expenses affect Retained Earnings.

EXPENSES

Debit for

Increase

Credit for Decrease

REVENUES

Debit for

Decrease

Credit for Increase

RETAINED EARNINGS

Debit for

Decrease

Credit for Increase

Expanded Transaction Analysis Model

Dividends decrease Retained Earnings.

Net Income increases Retained Earnings.

3- 22

Papa John’s sold franchises for $400 cash. The company earned $100 immediately. The rest will be earned over several months.

Identify & Classify the Accounts1. Cash (asset).2. Franchise fee revenue (revenue).3. Unearned franchise fees (liability).

Determine the Direction of the Effect1. Cash increases.2. Franchise fee revenue increases.3. Unearned franchise fees increases.

= +Cash 400 Unearned franchise

revenue300 Franchise fees

revenue100

Stockholders' EquityLiabilitiesAssets

Debit CreditCash (+A) 400

Unearned franchise revenue (+L) 300 Franchise fees revenue (+R, +SE) 100

Description

General Journal

Papa John’s sold franchises for $400 cash. The company earned $100 immediately. The rest will be earned over several months.

The company sold $36,000 of pizzas for cash. The costs of the pizza ingredients for those sales were $9,600.

Identify & Classify the Accounts1. Cash (asset).2. Restaurant sales revenue (revenue).3. Cost of sales- restaurant (expense).4. Inventories (asset).

Determine the Direction of the Effect1. Cash increases.2. Restaurant sales revenue increases.3. Cost of sales- restaurant increases. 4. Inventories decrease.

Debit CreditCash (+A) 36,000

Restaurant sales revenue (+R, +SE) 36,000

Cost of sales - restaurant (+E, -SE) 9,600 Inventories (-A) 9,600

Description

General Journal

= +Cash 36,000 Restaurant sales

revenue36,000

Inventory (9,600) Cost of sales (9,600)

Stockholders' EquityLiabilitiesAssets

The company sold $36,000 of pizzas for cash. The costs of the pizza ingredients for those sales were $9,600.

Let’s look at E3-3

• A customer orders and receives 10 personal computers from Dell; the customer promises to pay $18,400 within three months. Answer from Dell’s standpoint. What about cost info?

Account Name Debit Credit

Accounts Receivable $18,400

Sales Revenue $18,400

• Fucillo Hyundai, Inc, sells a truck with a list, or sticker, price of $20,050 for $18,050 cash.

Account Name Debit Credit

Cash $18,050

Sales Revenue $18,050

• Bon-Ton Department Store orders 1,000 men’s shirts from Arrow Shirt Company for $15 each for future delivery. The terms require full payment within 30 days of delivery. Answer from Arrow’s standpoint.

Account Name Debit Credit

No Entry

• Arrow Shirt Company completes production of the shirts described in part c and delivers the order (answer from Arrow Shirt Company perspective)

Account Name Debit Credit

Accounts Receivable $15,000

Sales Revenue $15,000

• Arrow receives payment from Bon-Ton for the order described in part c. Answer from the perspective of Arrow Shirt Company.

Account Name Debit Credit

Cash $15,000

Accounts Receivable $15,000

• A customer purchases a ticket from American Airlines for $410 cash to travel the following January. Answer from American Airlines perspective.

Account Name Debit Credit

Cash $410

Unearned Airfare Revenue $410

• General Motors issues $20 million in new common stock

Account Name Debit Credit

Cash $20,000,000

Contributed Capital $20,000,000

• Pen State University receives $18,300,000 cash for 80,000 five-game season football tickets.

Account Name Debit Credit

Cash $18,300,000

Unearned Football Ticket Revenue $18,300,000

• Penn State plays the first football game described in part h.

Account Name Debit Credit

Unearned Football Ticket Revenue $3,660,000

Football Ticket Revenue $3.660,000

• Precision Construction Company signs a contract with a customer for the construction of a new $500,000 warehouse. At the signing, Precision receives a $50,000 deposit as a deposit on the future construction project. Answer from the perspective of Precision.Account Name Debit Credit

Cash $50,000

Unearned Construction Revenue $50,000

• On September 1, 2012, a bank lends $1,200 to a company; the note principal and $144 annual interest are due in one year (1,200 X 12%). Answer from the Bank’s perspective.

• NOW:

• In 1 year (assuming no other transactions are recorded?

Account Name Debit Credit

Note Receivable $1,200

Cash $1,200

• A popular ski magazine company receives a total of $1,980 today from subscribers. The subscriptions begin in the next fiscal year. Answer from the perspective of the magazine company:

• What do you do with each edition of the magazine that is sent out?

Account Name Debit Credit

Cash $1,980

Unearned Subscription Revenue $1,980

• Sears, a retail store, sells a $100 lamp to a customer who charges the sale on his store credit card. Answer from Sear’s perspective.

Account Name Debit Credit

Accounts Receivable $100

Sales Revenue $100