Understanding Financial Statements: Income Statement vs. Balance Sheet, Lecture notes of Financial Management

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Engineering and Financial Cost Analysis

The Income Statement

and Accrual Accounting

The Income Statement

• (^) Balance Sheet
  • (^) The financial condition of the company on a certain date (a snapshot on that date)
  • (^) What is OWNED and what is OWED
  • (^) The format is the Fundamental Accounting Equation
• (^) Income Statement
  • (^) The financial performance of the company over a period of time (the accounting period)
  • (^) Changes in Revenue accounts and Expense accounts ( profit or loss over the period)
  • (^) The format is Revenues - Expenses = Profit (Loss)

Revenues and Gross Profit

REVENUES – COGS = GROSS PROFIT

Operating Expenses

• (^) Operating Expenses are those expenses required for general operation of a business
• (^) Gross Profit – Total Operating Expenses = Operating Profit

What are Revenues and Expenses?

**Asset

• -**^

Liabilities

- (^) + Owners’ Equity - +

A = L + OE

INVESTED CAPITAL RETAINED EARNINGS EXPENSES REVENUES

Who Can Use the Cash Method?

• (^) Although the IRS allows all businesses to use the accrual method of accounting, most small businesses can instead use the cash method for tax purposes. The cash method can offer more flexibility in tax planning because you can sometimes time your receipt of revenue or payments of expenses to shift these items from one tax year to another.
• (^) However, some businesses must use the accrual method: corporations that are not S corporations and partnerships that have at least one corporation (other than an S corporation) as a shareholder. There are some exceptions to these restrictions — the cash method is available for farming businesses and entities (including corporations) with average annual gross receipts of less than five million dollars for all prior years.
• (^) Tax shelters may never use the cash method. If your business has inventories, you must use the accrual method, at least for sales and merchandise purchases.

ACCOUNT BALANCE

• Accounts payable $10,
• Accounts receivable 23,
• Cash 8,
• Capital Stock 25,
• Delivery equipment 22,
• Delivery expense 1,
• Delivery revenue 12,
• I nsurance expense
• Loans payable 10,
• Notes payable 3,
• Office equipment 3,
• Prepaid insurance 2,
• Rent expense 1,
• Retained earnings (on April
  • ) 8, th
• Wages expense 7,

What are the Accounting

Transactions?

1. You purchase $500 of supplies for your business.
2. You consume $100 of supplies during the accounting period. Balance Sheet or Income Statement?

What are the Accounting

Transactions?

1. Your company makes electric motors. You have

completed motors sitting on your Finished

Goods shelf waiting to be sold. They are valued

at $600 (includes the cost of labor, materials and

overhead).

2. You sell a modified motor for $1000.

Balance Sheet or Income Statement?