Study Guide Accrual income statements ABM 141 Unit 2.pdf

8/12/2019 Study Guide Accrual income statements ABM 141 Unit 2.pdf

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ABM 141 Unit 2 Study Guide Accrual Income Statements 1

Study Guide- Cash and Accrual Formulas Pertaining to Income Statements

An income statement summarizes the income and expenses during a specific period of time andshows the profit or loss from the period. An income statement provides insight into management

efficiency and for this reason is a key financial statement for managers. The cash approach

implies that income and expenses will be reported when the cash is received or paid. Manybusinesses report net income on using the cash basis. An accrual approach says income and

expenses are reported when they are earned or incurred regardless of when the cash transaction

takes place. If a cash-based income statement is used, the net income can be either understatedor overstated depending on the business transactions. Cash based income statements understate

the net profit if the following occurs:

Revenue is generated but not converted to cash. An increase in accounts receivableis an example.

Expenses paid during the period were incurred during prior or later years. Exampleswould be a decrease in accounts payable or an increase in prepaid expenses.

Cash based income statements overstate the net income for a period if:

Revenue from prior years is converted to cash.

Expenses are incurred this year but are not paid in cash until a later yearAn accrual income statement is the most accurate approach in reporting net income. Cash record

systems are used to generate accrual income statements by adjusting cash revenue for changes ininventory and adjusting cash expense accounts for changes in accrued expenses. The

adjustments reflect the amount changes in these accounts from the beginning and ending balance

sheets for the year.Two financial statements that can be generated from any accounting package are the

balance sheet and the income statement (profit and loss statement). A balance sheet is the

snapshot of a business at a given point in time and shows what the business owns and owes,assets and liabilities. The income statement shows the revenue earned and expenses used to

generate that revenue. Most accounting software can generate reports on a cash and accrualbasis. Accrual reports provide the most accurate financial picture of the business and should be

used in the analysis process. Heres list of the uses of an income statement:

Summarizes revenues and expenses Determine profit and loss Explains changes in owners equity Calculates financial measures such as profitability, financial and operational

efficiency

Support loan applications and refinancing


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Study Guide: Cash and Accrual Formulas continued

Formulas for determining a cash and accrual income statement are:

(cash accounting) (accrual accounting)Cash revenue cash revenue- cash expenses + changes in inventory

= net cash income = Gross business revenue

- depreciation - cash expenses

= net inc. from operations - depreciation+/-gain/loss from sales of assets + or non-cash expenses adjustments

= net cash income = net inc. from business operations

+/-gain/loss from sale of assets= Accrual net business income

As you see in the formulas, an accrual income statement makes adjustments to thecash revenues and cash expenses. Documents needed in the developed of accrual

income statements are a cash profit and loss and beginning and ending balancesheets for the given period. The cash profit and loss provides the cash amount

while the balance sheets provide the data for inventory adjustments and the

accrued expenses adjustments. Gross revenue is the total revenue generated bythe business in a given period of time. It is calculated by adding the cash revenue

and the inventory adjustments (ending minus beginning). This amount is

important to determine as it shows the true revenue generated by the business.

Gross revenue is also used in calculating income statement ratios. To make iteasier to see the changes in inventory and which financial statements to pull the

information from consider this version of the accrual method formula.


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Study Guide: Cash and Accrual Formulas Continued

Cash Revenue

Minus Cash Expenses

Equals Net Cash Incomes

Additions:

From Current Yr. End (Ending Bal. Sht.)Accounts Receivable

Prepaid Expenses

Inventory on Hand

From Prior Yr (Beginning Bal. Sht.)

Accounts PayableAccrued Expenses

Equals Total Additions

Subtractions:

From Prior Yr. (Beginning Bal. Sht)

Accounts receivablePrepaid Expenses

Inventories On Hand

From Current Yr. End (Ending Bal. Sht)Accounts Payable

Accrued Expenses

Equals Total Subtractions

Equals Accrual Net Income Before DepreciationSubtract Depreciation

Equals Net Income From Operations

Gain/Loss on Sale of Capital Assets

Equals Accrual Net Income