Chapter 3

The Income Statement

PowerPoint Author:
Brandy Mackintosh, CPA, CA

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 Learning Objective 3-1

Describe common operating

transactions and select
appropriate income statement
account titles.

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 Operating Activities
Operating activities include buying goods and
services from suppliers and employees, and
selling goods and services to customers and
then collecting cash from them.

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 Income Statement Accounts

Time Period
Assumption:
dividing the
company’s long life
into shorter chunks
of time such as
months, quarters,
and years.

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 Cash Basis Accounting

Cash basis accounting

records revenues when cash
is received and expenses
when cash is paid.

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 Learning Objective 3-2

Explain and apply the revenue

and expense recognition
principles.

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 Accrual Basis Accounting

Accrual Basis
Accounting

GAAP/IFRS
Records revenues when they are
earned and expenses in the same
period as the revenues to which they
relate, regardless of the timing of
cash receipts or payments.

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 Revenue Recognition Principle
Timing of Reporting Revenue versus Cash Receipts
Revenue Recognition Principle
Revenues are recognized when the seller provides
goods or services to its customers in the amount the
seller expects to be entitled to receive.

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 Five-Step Model for Reporting Revenue

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 Revenue Recognition Principle, 2
Timing of Reporting Revenue versus Cash Receipts

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 Expense Recognition Principle (“Matching”)
Timing of Reporting Expenses versus Cash Payments
Record expenses in the same period as the revenues with
which they can be reasonably associated.

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 Learning Objective 3-3

Analyze, record, and summarize

the effects of operating
transactions using the accounting
equation, journal entries, and
T-accounts.

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 The Expanded Accounting Equation

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 Noodlecake’s Accounting Records (a)
(a) Sell games for Cash.
In September, Noodlecake sold $3,000 of games at its online store.
1 Analyze
Assets = Liabilities + Stockholders’ Equity
(a) Cash +$3,000 Sales
Revenue (+R) +$3,000

2 Record
(a) Cash (+A) 3,000
Sales Revenue (+R, +SE) 3,000

3 Summarize
dr + Cash (A) cr - dr - Sales Revenue (R, SE) cr +
Beg. Bal. 20,700 0 Beg. Bal.
(a) 3,000 3,000 (a)

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 Noodlecake’s Accounting Records (b)
(b) Receive cash for future services.
Noodlecake issued three $100 gift cards at the beginning of September.
1 Analyze
Assets = Liabilities + Stockholders’ Equity
(b) Cash +$300 Deferred
Revenue +$300

2 Record
(b) Cash (+A) 300
Deferred Revenue (+L) 300

3 Summarize
dr + Cash (A) cr - dr - Deferred Revenue (L) cr +
Beg. Bal. 20,700 0 Beg. Bal.
(a) 3,000 300 (b)
(b) 300

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 Noodlecake’s Accounting Records (c)
(c) Sell apps on credit.
Noodlecake sold $9,000 of apps in the App Store and on Google Play.

1 Analyze
Assets = Liabilities + Stockholders’ Equity
(c) Accounts Sales
Receivable +$9,000 Revenue (+R) +$9,000

2 Record
(c) Accounts Receivable (+A) 9,000
Sales Revenue (+R, +SE) 9,000

3 Summarize
dr + Accounts Receivable (A) cr - dr - Sales Revenue (R, SE) cr +
Beg. Bal. 0 0 Beg. Bal.
(c) 9,000 3,000 (a)
9,000 (c)

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 Noodlecake’s Accounting Records (d)
(d) Receive payment on account.
Noodlecake received checks totaling $8,500 from Apple and Google,
on account.
1 Analyze
Assets = Liabilities + Stockholders’ Equity
(d) Cash +$8,500
Accounts
Receivable -$8,500

2 Record
(d) Cash (+A) 8,500
Accounts Receivable (-A) 8,500

3 Summarize
dr + Cash (A) cr - dr + Accounts Receivable (A) cr -
Beg. Bal. 20,700 Beg. Bal. 0
(a) 3,000 (c) 9,000 8,500 (d)
(b) 300
(d) 8,500

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 Noodlecake’s Accounting Records (e)
(e) Pay cash to employees.
Noodlecake wrote checks to employees totaling $7,800 for wages related to hours
worked in September.
1 Analyze
Assets = Liabilities + Stockholders’ Equity
(e) Cash -$7,800 Wages
Expense (+E) -$7,800

2 Record
(e) Wages Expense (+E, -SE) 7,800
Cash (-A) 7,800

3 Summarize
dr + Cash (A) cr - dr + Wages Expense (E, SE) cr -
Beg. Bal. 20,700 Beg. Bal. 0
(a) 3,000 7,800 (e) (e) 7,800
(b) 300
(d) 8,500

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 Noodlecake’s Accounting Records (f)
(f) Pay cash in advance.
On September 1, Noodlecake paid $7,200 in advance for
September, October, and November rent.
1 Analyze
Assets = Liabilities + Stockholders’ Equity
(f) Cash -$7,200
Prepaid
Rent +$7,200

2 Record
(f) Prepaid Rent (+A) 7,200
Cash (-A) 7,200

3 Summarize
dr + Cash (A) cr - dr + Prepaid Rent (A) cr -
Beg. Bal. 20,700 Beg. Bal. 0
(a) 3,000 7,800 (e) (f) 7,200
(b) 300 7,200 (f)
(d) 8,500

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 Noodlecake’s Accounting Records (g)
(g) Incur cost to be paid later.
Noodlecake displayed online ads in
September and received a bill for $500 to be paid in October.
1 Analyze
Assets = Liabilities + Stockholders’ Equity
(g) Accounts Advertising
Payable + $500 Expense (+E) -$500

2 Record
(g) Advertising Expense (+E, -SE) 500
Accounts Payable (+L) 500

3 Summarize
dr - Accounts Payable (L) cr + dr + Advertising Expense (E, SE) cr -
10,200 Beg. Bal Beg. Bal. 0
500 (g) (g) 500

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 Noodlecake’s Accounting Records (h)
(h) Pay cash for expenses.
Noodlecake was notified by its bank that an automatic monthly payment of $600
was transmitted to its utility company for electricity use in September.
1 Analyze
Assets = Liabilities + Stockholders’ Equity
(h) Cash -$600 Utilities
Expense (+E) -$600

2 Record
(h) Utilities Expense (+E, -SE) 600
Cash (-A) 600

3 Summarize
dr + Cash (A) cr - dr + Utilities Expense (E, SE) cr -
Beg. Bal. 20,700 Beg. Bal. 0
(a) 3,000 7,800 (e) (h) 600
(b) 300 7,200 (f)
(d) 8,500 600 (h)

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 Noodlecake’s T-Accounts

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 Learning Objective 3-4

Prepare an unadjusted trial

balance.

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 Unadjusted Trial Balance
Cash Ledger Account

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 Review of Revenues

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 Review of Expenses

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 Learning Objective 3-5

Evaluate net profit margin,

but beware of income
statement limitations.

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 Net Profit Margin
Net
Profit = Net Income
Margin Revenues

$3,100
=
$12,000

= 0.258
or 25.8%

Net income = Revenues – Expenses

= $12,000 - $8,900

= $3,100

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 Income Statement Limitations

NI  Cash

NI   Value

NI  Exact
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 Chapter 3
Solved Exercises

M3-3, M3-4, M3-5, M3-6, M3-14, M3-15

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 M3-3 Identifying Accrual Basis Revenues
The following transactions are July activities of Bill’s Extreme Bowling,
Inc., which operates several bowling centers. If revenue is to be
recognized in July, indicate the amount. If revenue is not to be
recognized in July, explain why.
Activity Amount or Explanation
a. Bill’s collected $12,000 from $12,000
customers for services related
to games played in July.
b. Bill’s billed a customer for $250 $250
for a party held at the center on
the last day of July. The bill is to
be paid in August.
c. The men’s and women’s No revenue is earned in July.
bowling leagues gave Bill’s The revenues will be earned
advance payments totaling when fall bowling service is
$1,500 for the fall season that provided (i.e., when the games
starts in September. are played).
d. Bill’s received $1,000 from No revenue is earned in July.
credit sales made to customers The cash collections in July
last month (in June). related to revenues earned in
June.

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 M3-4 Identifying Accrual Basis Expenses
The following transactions are July activities of Bill’s Extreme
Bowling, Inc., which operates several bowling centers. If an
expense is to be recognized in July, indicate the amount. If an
expense is not to be recognized in July, explain why.

Activity Amount or Explanation

a. Bill’s paid $1,500 to plumbers $1,500
for repairing a broken pipe in
the restrooms.
b. Bill’s paid $2,000 for the June $2,500 was incurred as an
electricity bill and received the expense in July. The $2,000
July bill for $2,500, which will be was an expense in June and is
paid in August. not an expense in July.
c. Bill’s paid $5,475 to employees $5,475
for work in July.

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 M3-5 Recording Accrual Basis Revenues
For each of the transactions in M3-3, write the journal entry using
the format shown in the chapter.

a. Cash (+A) 12,000

Service Revenue (+R, +SE) 12,000

b. Accounts Receivable (+A) 250

Service Revenue (+R, +SE) 250

c. Cash (+A) 1,500

Deferred Revenue (+L) 1,500

d. Cash (+A) 1,000

Accounts Receivable (A) 1,000

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 M3-6 Recording Accrual Basis Expenses
For each of the transactions in M3-4, write the journal entry using
the format shown in the chapter.

a. Repairs and Maintenance Expense (+E, SE) 1,500

Cash (A) 1,500

b. Accounts Payable (–L) 2,000

Cash (A) 2,000

Utilities Expense (+E, SE) 2,500

Accounts Payable (+L) 2,500

c. Salaries and Wages Expense (+E, SE) 5,475

Cash (A) 5,475

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 M3-14 Preparing Accrual Basis Journal Entries for Business
Activities
Quick Cleaners, Inc. (QCI) has been in business for several
years. It specializes in cleaning houses but has some small
business clients as well. Prepare journal entries for the following
transactions, which occurred during a recent month, and
determine QCI’s preliminary net income.

a. Issued $25,000 of QCI stock for cash.

b. Incurred $600 of utilities costs this month and will pay them
next month.

a. Cash (+A) 25,000

Common Stock (+SE) 25,000

b. Utilities Expense (+E -SE) 600

Accounts Payable (+L) 600

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 M3-14 Preparing Accrual Basis Journal Entries for Business
Activities, continued
c. Paid wages for the current month totaling $2,000.
d. Performed cleaning services on account worth $2,800.
e. Some of Quick Cleaner’s equipment was repaired at a total
cost of $150. The company paid the full amount at the time
the repair work was done.

c. Salaries and Wages Expense (+E -SE) 2,000

Cash (-A) 2,000

d. Accounts Receivable (+A) 2,800

Service Revenue (+R +SE) 2,800

e. Repairs and Maintenance Expense (+E -SE) 150

Cash (-A) 150

Preliminary Net Income = Revenues – Expenses

= $2,800 - $2,000 - $600 - $150
= $50
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 M3-15 Preparing Accrual Basis Journal Entries for
Business Activities
Junktrader is an online company that specializes in matching
buyers and sellers of used items. Buyers and sellers can
purchase a membership with Junktrader, which provides them
advance notice of potentially attractive offers. Prepare journal
entries for the following transactions, which occurred during a
recent month, and determine Junktrader’s preliminary net
income.
a. Junktrader provided online advertising services for another
company for $200 on account.
b. On the last day of the month, Junktrader paid $50 cash to
run an ad promoting the company’s services. The ad ran
that day in the local newspaper.

a. Accounts Receivable (+A) 200

Service Revenue (+R +SE) 200

b. Advertising Expense (+E -SE) 50

Cash (-A) 50
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 M3-15 Preparing Accrual Basis Journal Entries for Business
Activities, continued
c. Received $200 cash in membership fees for the month from
new members.
d. Received an electricity bill for $85 for usage this month. The
bill will be paid next month.
e. Billed a customer $180 for helping them sell their junk. The
customer is expected to pay by the end of next month.

c. Cash (+A) 200

Service Revenue (+R +SE) 200

d. Utilities Expense (+E -SE) 85

Accounts Payable (+L) 85

e. Accounts Receivable (+A) 180

Service Revenue (+R +SE) 180

Preliminary Net Income = Revenues – Expenses

= $200 + $200 + $180 - $50 - $85
= $445

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 End of Chapter 3

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