MEASUREMENT OF BUSINESS INCOME

Chapter

55

Learning Objectives

Explain expenses and revenue concept Describe permanent and temporary

accounts Explain the accounting cycle

REVENUE

Are the gross increase in owner’s equity resulting from business activities entered into for the purpose of earning income

Revenues usually result in an increase in an asset.

Revenue result from the sales of goods and services, fees, interest, dividends, royalties, grants and rent.

EXPENSES

Expenses are decreases in owner’s equity that result from operating the business.

They are the costs of assets consumed or services used in the process of earning revenue

Decrease in assets or an increase in liabilities E.g: rent expense, delivery expense, supplies

expense, interest expense, salary expense, utility expense

Accounting

Recognizing Revenues and Expenses

Accrual Basis

Revenues are recognized when

earned and expenses are recognized when

incurred.

Cash Basis

Revenues are recognized when

cash is received and expenses recorded when cash is paid.

Accounting

Recognizing Revenues and Expenses

Accrual Basis

Revenues are recognized when

earned and expenses are recognized when

incurred.

Cash Basis

Revenues are recognized when

cash is received and expenses recorded when cash is paid.

Not GAAPNot GAAPNot GAAPNot GAAP

We have delivered theproduct to our customer,

so I think we should recordthe revenue earned.

We have delivered theproduct to our customer,

so I think we should recordthe revenue earned.

Recognizing Revenues and Expenses (Accrual Basis)

1. Revenue Recognition - Revenue be recorded when earned, either

Ownership has been transferred Services has been completely provided Percentage of completion method Installment method

Recognizing Revenues and Expenses (Accrual Basis)

2. Matching Principle Expenses are matched against revenues, and

recorded in the same period in which the related revenues are earned

Summaryof Expenses

Rent

Gasoline

Advertising

Salaries

Utilities

and . . . .

$1,000

500

2,000

3,000

450

. . . .

Now that we haverecognized the revenue,let’s see what expenses

we incurred togenerate that revenue.

Now that we haverecognized the revenue,let’s see what expenses

we incurred togenerate that revenue.

Example

Example – Cash Basis

On the cash basis the entire $2,400 would be recognized as insurance expense in 2006. No

insurance expense from this policy would be recognized in 2007 or 2008, periods covered by the policy.

On the cash basis the entire $2,400 would be recognized as insurance expense in 2006. No

insurance expense from this policy would be recognized in 2007 or 2008, periods covered by the policy.

Jan Feb Mar Apr

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

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

-$ -$ -$ 2.400$

Insurance Expense 2006

Example - Accrual Basis

Jan Feb Mar Apr

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

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

-$ -$ -$ 100$

Jan Feb Mar Apr

100$ 100$ 100$ 100$ May Jun Jul Aug

100$ 100$ 100$ 100$ Sep Oct Nov Dec

100$ 100$ 100$ 100$

Jan Feb Mar Apr

100$ 100$ 100$ 100$ May Jun Jul Aug

100$ 100$ 100$ 100$ Sep Oct Nov Dec

100$ 100$ 100$ -$

Insurance Expense 2006

Insurance Expense 2007

Insurance Expense 2008

On the accrual basis $100 of insurance

expense is recognized in 2006, $1,200 in 2007,

and $1,100 in 2008. The expense is matched with the periods benefited by the insurance coverage.

On the accrual basis $100 of insurance

expense is recognized in 2006, $1,200 in 2007,

and $1,100 in 2008. The expense is matched with the periods benefited by the insurance coverage.

Examples: Revenue Recognition

20 Dec 2007 : Completed work for a client and sent a bill for RM5,000 to be paid within 30 days. The accounting period for year 2007 is 1 January 2007 - 31 December 2007.

Cash basis?

Accrual basis?

Temporary Accounts

Revenues

Income Summary

Exp

ense

s

With

draw

als

Permanent Accounts

Assets

Lia

bili

ties

Ow

ner’s

Cap

ital

The closing process applies only to

temporary accounts.

The closing process applies only to

temporary accounts.

Temporary and Permanent Accounts

SourceDocuments

Journal

LedgerTrial BalanceAdjustments

AdjustedTrial Balance

Financial Statements

Closing Entries

The Accounting CycleThe Accounting Cycle