Review: Typical Accounting Titles
• The balance sheet
Inventory (to be sold)
Quiz Time… What type of Account?
Reports operating performance for a specific time period.
Provides information about what happened between balance sheet periods (did our business activities generate more resources than they used this year?).
Remember, the balance sheet and the income statement are linked:
Assets=Liabilities + Equity
= Liabilities + Contributed Capital + Earned Capital
=Liabilities + Contributed Capital + Retained Earnings
=Liabilities + Contributed Capital + Beginning RE + NI -Dividends
=Liabilities + Contributed Capital + Beginning RE + Revenues-Expenses-Dividends
Walmart 2013 10-K I/S
Walmart 2013 10-K B/S
Cash is not the same as net income Net Income
• Net Income (or Earnings) = Revenues – Expenses.
• Academic research shows that CEOs & CFOs view earnings to be the most important measure of firm performance reported to outsiders (Graham, Harvey, and Rajgopal 2005).
• Measure of profitability from an accountant’s perspective • Components taken from Retained Earnings
Revenue (Sales Revenue or Service Revenue)
Expenses (Wage expense, interest expense)
Gains (Gain on disposition of assets)
Losses (Loss on disposition of assets)
• NOT a measure of cash collected or paid
Components of Net Income: Revenue
• Measure of economic benefit generated by sale of products or providing of services
– What if a customer pays you in advance? Is that revenue? • Comprised of transactions involving both cash and credit
• Typically shown net of an estimated allowance for returns and non-collectible accounts
Components of Net Income: Expenses
• Measure of economic sacrifices incurred to earned revenues • Expenses measure the assets consumed in generating revenue. • Assets are unexpired costs, and expenses are expired costs of “gone assets.”
• Cost of Goods Sold (COGS) => Cost of product being sold
• Selling, General, and Administrative Expenses (SG&A) =>
Advertising and overhead expenses
• Magnitude usually small
• Not central to operating activities
• Examples include: interest expense or income,
Gains or losses on asset sales
How should we measure performance? • Net Income = Revenues – Expenses
• 2 Bases of Accounting:
1. Cash-based accounting
Recognizes revenue when cash is received from customers and expenses when cash is paid for resources
2. Accrual accounting
Recognizes revenue when it is earned and expenses when they are incurred
Accrual accounting can produce large discrepancies between the firm’s reported income and the amount of cash generated by operation
– Cash by any other name is still cash
– Our bank statement reflects cash inflows and outflows • What is the problem with cash?
Example: Cash Basis
Year 1: Buy inventory for $10,000 cash. No sales made.
Year 2: Sell $5,000 worth of inventories for $8,000 in cash, the rest of inventory for
$10,000 on credit.
Year 3: Receive cash from…