• The Income Statement reports a business’ revenues, expenses and net income or (net loss) for a specific time period
*summaries the results of a business’ operating decisions that managers made during the period.
• These operating activities stem from planning and operating decisions made during the period evaluating as well
shows the relationship between manager’s decisions and the results of those decisions
*by comparing the information, users can evaluate manager’s ability over the longer term
• The accumulated totals are used to report net income on the Income Statement
• The revenue and expense accounts are then closed to Owners’ Equity so the recording and accumulation process can begin again for the next financial period
External users need accounting information that lets them compare a business’ actual operating performance over several years.
BY comparing the information, they can get the sense of the business’ future operating performance.
A retail business includes two sections: operating income section and other item section
Operating Income includes all the revenues earned and expenses incurred in the primary operating activities of the business.
Operating income section includes *1 revenues
*Revenues are the amounts earned and result in increase in assets (cash or accounts receivable) or decrease in liabilities (unearned revenues)Sales revenue
Whether a customer buys goods for cash or on credit, retail business use Sale Revenue account to record the transaction.
• Revenues are recorded using the accounting equation usually by increasing Revenue (as part of Owners’ Equity) and increasing Assets (Cash or Accounts Receivable) with the same amount
• Sometimes the business has sales policies which can affect the amount of revenue recorded
• Used to attract customers and increase sales
• Commonly discounts from the invoice price are offered for large quantities or for prompt or immediate cash payment
Sales returns and allowances
• Retail businesses often have a sales return policy
• Customers are able to return goods for refund if they are damaged or unacceptable in some other way
Credit memo lists the customers’ name and address, how the original sale was made, the reason for the sales return or allowance, the items that were returned or on which the allowance was given, and the amount of the return or allowance
Net Sales Revenue
• Net Sales Revenue is Sales Revenue for the period less all discounts, returns and allowances for the period
• Expenses are the costs a business incurs to provide goods or services to its customers during an accounting period
• Major expense of a retailing business is Cost of Goods Sold (COGS)
• Inventory systems deal with how inventory and COGS are recorded.
• We consider two types of inventory system –
Perpetual Inventory System
• A perpetual inventory system keeps a continuous record of the cost of inventory on hand and the cost of inventory sold
• Perpetual inventory systems are commonly used by retailers via optical scanners linked to computerised accounting systems
• Need to confirm the ‘theoretical’ inventory on hand as determined by the perpetual system. This is done by a periodic physical count of inventory
Periodic Inventory System
It does not keep a continuous record of the inventory on hand and sold, but determines the inventory at the end of each accounting period by physically counting it.It must physically count its inventory at year-end.
It must counts *Inventory (generally referred to as stocktaking) immediately after the last working day of its financial or fiscal year. This is a difficult and time-consuming task/
COST OF GOODS SOLD =Cost of Beginning inventory Cost of Net purchase-Cost of ending inventory
COST OF GOODS SOLD =Cost of goods available for sale- Cost of ending Inventory
Selling expenses are the operating expenses related to the sales activities of a business. Includes: sales salaries expense, advertising expense and delivery expense (sometimes called transportation-out)CALCULATING THE COST AND THE AMOUNT OF INVENTORYAASB 2 also states that inventories shall be measured at the lower of cost and net realisable value4 cost flow assumptions:
First in First Out (FIFO)
Last in First Out (LIFO)
1 Specific Identification involves the identification of the actual units of inventory purchased and sold. Makes sense for high value inventory with unique identifiers, e.g. luxury cars or jewellery. Time consuming and costly where inventory consists of many small value units.Average Cost involves combining the cost of all the units available for sale, calculating the average cost per unit then allocating that cost between COGS and ending inventory. Again many situations where this assumption maps to the physical flow of inventory e.g. oil, grain.Working capital: basic concepts
• A business’ working capital is the excess of its current assets over its current liabilities( current assets – current liability)
Working Capital = Current assets- Current liabilities
• the operating cycle of a business is the average time it takes a business to use cash to buy or produce goods or services for sale, to sell those goods or services to customers and to collect cash from its customersWorking capital and internal controlsLimitations of Financial RatiosBusiness Activity StatementsEvaluating Profitability
1. Return on total assets = (Net Income Interest Expense)/Average Total Assets
2. Return on owners’ equity = Net Income/Average Owners’ Equity
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