Chapter 3 Revenue and Expense

Recognition and the Income Statement

A Elements on the Income Statement
B Cash Basis vs. Accrual Basis Accounting
C Recognizing Revenues & Expenses
 Revenue Principle
 Matching Principle
 Examples
D Preparing Financial Statements
 Income Statement
 Statement of Stockholders’ Equity
 Balance Sheet

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 A. Elements on the Income Statement
Revenues
Increases in assets or settlement of
liabilities from ongoing operations.

Expenses
Decreases in assets or increases in
liabilities from ongoing operations.

Gains
Increases in assets or settlement of
liabilities from peripheral transactions.

Losses
Decreases in assets or increases in
liabilities from peripheral transactions.
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 Papa John’s Primary Papa John's International, Inc. and Subsidiaries
Consolidated Statement of Income
Operating Activity is
For the Year Ended December 31, 2006
selling pizza and selling (dollars in thousands)
franchises.
Revenues
Restaurant and commissary sales $ 884,000
Franchise royalties and development fees 117,000
Total revenues 1,001,000
Costs and expenses
Cost of sales 425,000
Operating Activities Salaries and benefits expense 164,000
General and administrative expenses 314,000
Total costs and expenses 903,000
Operating income 98,000
Other revenues and gains (expense and losses)
Investment income 1,000
Peripheral Activities Interest expense (3,000)
Income before income taxes 96,000
Income tax expense 33,000
Net income $ 63,000
Earnings per share $ 1.96

This is a multiple-step or classified Income Statement with important subtotals.

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 Papa John's International, Inc. and Subsidiaries
Consolidated Statement of Income
Papa John’s Primary For the Year Ended December 31, 2006
Operating Expenses (dollars in thousands)

Revenues
Restaurant and commissary sales $ 884,000
Cost of sales Franchise royalties and development fees 117,000
(used inventory) Total revenues 1,001,000
Costs and expenses
Cost of sales 425,000
Salaries and benefits expense 164,000
General and administrative expenses 314,000
Salaries and Total costs and expenses 903,000
benefits to Operating income 98,000
employees Other revenues and gains (expense and losses)
Investment income 1,000
Interest expense (3,000)
Other costs (like Income before income taxes 96,000
advertising, Income tax expense 33,000
Net income $ 63,000
insurance, and
depreciation) Earnings per share $ 1.96

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 Papa John's International, Inc. and Subsidiaries
Consolidated Statement of Income
For the Year Ended December 31, 2006
(dollars in thousands)

Revenues
Restaurant and commissary sales $ 884,000
Franchise royalties and development fees 117,000
Total revenues 1,001,000
Costs and expenses
Cost of sales 425,000
Salaries and benefits expense 164,000
Corporations are General and administrative expenses 314,000
taxable entities. Total costs and expenses 903,000
Operating income 98,000
Income tax expense
Other revenues and gains (expense and losses)
computed as Income Investment income 1,000
Before Income Taxes Interest expense (3,000)
× Tax Rate (Federal, Income before income taxes 96,000
State, Local and Income tax expense 33,000
Foreign). Net income $ 63,000
Earnings per share $ 1.96

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 Papa John's International, Inc. and Subsidiaries
Consolidated Statement of Income
For the Year Ended December 31, 2006
(dollars in thousands)

Revenues
Restaurant and commissary sales $ 884,000
Franchise royalties and development fees 117,000
Total revenues 1,001,000
Costs and expenses
Cost of sales 425,000
Salaries and benefits expense 164,000
General and administrative expenses 314,000
Total costs and expenses 903,000
Operating income 98,000
Other revenues and gains (expense and losses)
Investment income 1,000
Earnings Per Share Interest expense (3,000)
Income before income taxes 96,000
Net Income Income tax expense 33,000
Net income $ 63,000
Weighted Average
Number of Common Earnings per share $ 1.96
Shares Outstanding

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 B. Cash Basis vs. Accrual Basis

Cash Basis
Accounting

Not GAAP

Revenue is recorded Expenses are recorded

when cash is received. when cash is paid.

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 Accrual Accounting
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 -
Generally
Acceptable
Accounting
Principles
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 Accrual Basis vs. Cash Basis
 Advantages of using accrual accounting:

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 Accrual Basis vs. Cash Basis
FastForward paid $2,400 for a 24-month insurance
Example: policy beginning December 1, 2007.
Insurance Expense 2007
Jan Feb Mar Apr

$ - $ - $ - $ -
May Jun Jul Aug

$ - $ - $ - $ -
Sep Oct Nov Dec

$ - $ - $ - $ 2,400

On the cash basis the entire $2,400 would be

recognized as insurance expense in 2007. No
insurance expense from this policy would be recognized
in 2008 or 2009, periods covered by the policy.
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 Accrual Basis vs. Cash Basis
Insurance Expense 2007
Jan Feb Mar Apr

$ - $ - $ - $ -
May Jun Jul Aug

$ - $ - $ - $ -
On the accrual basis
Sep Oct Nov Dec
$100 of insurance
$ - $ - $ - $ 100
Insurance Expense 2008
expense is recognized in
$
Jan
100 $
Feb
100
Mar
$
Apr
100 $ 100
2007, $1,200 in 2008,
May Jun Jul Aug and $1,100 in 2009. The
$ 100 $ 100 $ 100 $ 100
Sep Oct Nov Dec expense is matched with
$ 100 $ 100 $ 100 $ 100

Insurance Expense 2009

the periods benefited by
Jan Feb Mar Apr the insurance coverage.
$ 100 $ 100 $ 100 $ 100
May Jun Jul Aug
$ 100 $ 100 $ 100 $ 100
Sep Oct Nov Dec
$ 100 $ 100 $ 100 $ -
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 C. Recognizing Revenues & Expenses
Revenue Principle
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.

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 Revenue Principle
 If any of the four criteria is not met, revenue is
normally is not recognized.
 For most business, these conditions are met at
the point of delivery of goods and services,
regardless of when cash is received.

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 Revenue Principle
 When the company delivers the goods or services
We have delivered the
product to our customer,
so I think we should record
the revenue earned.

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 Revenue Principle

 Cash can be received

 in the same period as the delivery.

 in a period before the delivery.

 in a period after the delivery.

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 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 -

Cash
Received

Cash (+A) xxx

Unearned revenue (+L) xxx

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 Revenue Principle
When the company delivers the goods or
services UNEARNED REVENUE is reduced
and REVENUE is recorded.

Cash received before revenue is earned -

Cash Company
Received Delivers

Cash (+A) xxx

Unearned revenue (+L) xxx

Revenue will be recorded when

earned.

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 Revenue Principle

When cash is received on the date

the revenue is earned, the
following entry is made:
Company
Delivers
AND
Cash
Received

Cash (+A) xxx

Revenue (+R) xxx

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 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 -

Company
Delivers

Accounts receivable (+A) xxx

Revenue (+R) xxx

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 Revenue Principle

When the cash is received the ACCOUNTS

RECEIVABLE is reduced.

Cash received after revenue is earned -

Company Cash
Delivers Received

Accounts receivable (+A) xxx

Revenue (+R) xxx

Cash will be collected.

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 The Matching Principle

Matching principle
intends to record
expenses in the same
accounting period as
the revenues that are
earned as a result of
these expenses,
regardless of when
cash is paid.

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 The Matching Principle
 Revenue Recognition
Now that we have
 Matching recognized the revenue,
let’s see what expenses
Summary we incurred to
of Expenses generate that revenue.
Rent $1,000
Gasoline 500
Advertising 2,000
Salaries 3,000
Utilities 450
and . . . . ....

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 The Matching Principle
 Expenses are recorded as incurred, but cash
may be paid
 before

 during

 after

an expense is incurred.

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 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

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 The Matching Principle

When the expense is incurred PREPAID

EXPENSE is reduced and an EXPENSE is
recorded.
Cash is paid before expense is incurred -

$ Expense
Paid Incurred

Prepaid expense (+A) xxx

Cash (-A) xxx

Expense will be recorded when

incurred.

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 The Matching Principle

When cash is paid on the date the

expense is incurred, the following
entry is made:
Expense
Incurred
AND
Cash
Paid

Expense (+E) xxx

Cash (-A) xxx

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 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
Incurred

Expense (+E) xxx

Payable (+L) xxx

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 The Matching Principle

When cash is paid the PAYABLE is reduced.

Cash paid after expense is incurred -

Expense Cash
Incurred Paid

Expense (+E) xxx

Payable (+L) xxx

Cash will be paid.

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 Examples
(a) Papa John’s restaurants sold pizza to customers for $36,000 cash
and sold $30,000 in supplies to franchised restaurants, receiving
$21,000 cash with the rest due on account.

General Journal
Description Debit Credit

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 Examples
(b) The cost of the dough, sauce, cheese, and other supplies for the
restaurant sales in (a) on the previous screen was $30,000.

General Journal
Description Debit Credit

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 Examples
(c) Papa John’s sold new franchises for $400 cash, earning $100
immediately by performing services for franchisees; the rest will be
earned over the next several months.

General Journal
Description Debit Credit

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 (d) In January, Papa John’s paid $7,000 for utilities, repairs, and fuel
for delivery vehicles, all considered general and administrative
expenses incurred during the month.

General Journal

Description Debit Credit

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 D. How are Financial Statements Prepared?
Income
Revenues – Expenses = Net Income
Statement

Beginning Retained Earnings

Statement of
+ Net Income
Retained
- Dividends Declared
Earnings
Ending Retained Earnings
Balance Assets = Liabilities + Stockholders’ Equity
Sheet
Contributed Capital
Retained Earnings
Statement Change = Cash from Operating Activities
of Cash Flows in + Cash from Investing Activities
Cash + Cash from Financing Activities

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 Income Statement

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 Statement of Stockholders’ Equity

The net income ($21,800) comes from the

Income Statement we just prepared.

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 Balance Sheet

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 Key Ratio Analysis
Total Asset Sales (or Operating) Revenues
Turnover =
Ratio Average Total Assets

(Beginning total assets + ending total assets) ÷ 2

Creditors and analysts use

Measures the sales this ratio to assess a
generated per dollar of company’s effectiveness at
assets. controlling current and
noncurrent assets.

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 Total Asset Turnover Ratio

 SmartTone: 79%
 Hutchison Telecom: 47%
 City Telecom: 76%
 Sunday: 49%
 Peoples: 64%

(As of 2009)

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 Financial information of the companies
 Hong Kong
http://www.hkex.com.hk
http://hk.finance.yahoo.com/

 U.S
http://www.sec.gov/cgi-bin/srch-edgar
http://finance.yahoo.com/

 Other sources
Company website
Library

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