chap 10- reporting for profit Flashcards
(25 cards)
What do the accounting reports show?
Balance Sheet: A Report of what assets you have, what liabilities you owe, and how much of the business the owner has a claim on at a particular date.
Income Statement: A report that details revenues and expenses for the period that has just occurred and determines if the business is operating at a profit or loss.
Cash Flow Statement: A report that details the cash inflows and outflows of a small business from the period that has just occurred.
Why is it necessary to prepare an Income Statement even when the profit figure is known?
The Income Statement details the revenues earned and expenses incurred during the Period and, in the process, shows both Gross Profit and Net Profit. It shows the reasons why that profit/loss occurred, giving the owner far more information on which to base his or her decisions.
What are the sections of the income statement?
- Sales Revenue Section (cash & credit sales, less sales returns)
- Less cost of Goods Sold Section (cost of sales, period costs)
- Adjusted Gross Profit section (inventory gain/loss/writedown)
- Other Revenues (discount)
- Other Expenses
What does the top section (up to adjusted gross profit) of the income statement show?
The top section gives us all the information on the trading of inventory and allows for effective decision making regarding managing inventory.
Section 1- Revenue
Sales- The amount reported here is the balance in the sales Revenue account. It must be reported separately to other revenues as it is the main source of revenue for a small business.
Less Sales returns-
It is important to report this separately so that the owner has more information regarding how many sales returns are occurring each period. It allows the owner to assess the quality of the firm’s inventory and customer service.
SECTION 2 – Gross Profit
COGS- All costs incurred in getting goods into a condition and
location ready for sale.
COST OF SALES: The value of inventory that is sold.
OTHER PERIOD COSTS: Any other costs incurred before the sale takes place.
Explain why it is important to identify Gross Profit in the Income Statement.
It is important to identify Gross Profit to allow the owner to assess the adequacy of the firm’s mark-up, because Gross Profit expresses the relationship between selling prices and cost prices. It is also to ensure that the business makes enough gross profit to cover the other expenses. Thus ensuring the business operates at a net profit
SECTION 3 – Adjusted gross profit
- inventory gain/loss/writedown
Explain why it is important to identify Adjusted Gross Profit in the Income Statement.
It is important to identify Adjusted Gross Profit to allow the owner to measure the quality of inventory management and isolate the inventory loss or gain or writedown, so that strategies may be developed to address any problems and decisions may be made regarding managing inventory
The bottom section- other revenues and other expenses
Gives a measure of expense control
Revenues?
Increases in assets or decreases in liabilities (other than capital) that lead to an increase in owner’s equity.
Expenses
Decreases in assets or increases in liabilities (other than drawings) that lead to a decrease in owner’s equity.
Net profit
Revenue less expenses incurred and represents a net increase of the owner’s equity in the business
END OF PERIOD PROCEDURES
- Closing Revenue and Expense Accounts to the Profit and Loss Summary Account
- Transferring Profit and Loss and Drawings to the Capital Account
- Balancing Asset, Liability and Owner’s Equity Accounts and preparing the Balance Sheet.
Explain two reasons for closing the ledger.
- To transfer revenues and expenses to the Profit and Loss Summary account in order to calculate profit for the current Period.
- To reset revenue and expense accounts to zero in preparation for the next Period.
Explain how the Period assumption assists in the calculation of profit.
- The Period assumption allows the business to divide its life into periods in order to determine profit.
- This allows the owner to compare results, particularly profit, over different reporting periods.
Explain how revenues and expenses are recognised under the Accrual basis assumption.
- Revenues and expenses are recognised at the point at which the definition is satisfied.
- Under this assumption, revenues are recognised in the Period in which the expected inflow of economic benefits can be measured, or when the revenue is earned.
- Similarly, expenses are recognised when the consumption of goods and/ or services can be measured, or when the expense is incurred.
Explain how profit is calculated under the Accrual basis assumption.
The Accrual Basis Assumption requires expenses incurred for a period to be subtracted from revenues earned in the same period to accurately calculate profit.
How the Accrual basis assumption helps to ensure QC in the Accounting reports.
Applying the Accrual basis assumption ensures that the reports only include revenues earned and expenses incurred in the current period to accurately calculate profit, thereby including only information that is capable of making a difference to decision- making. Thus upholding Relevance
Steps to close the ledger
- Closing all the Revenue Accounts together
- Closing all the Expense Accounts together
- Closing the Profit and Loss Summary to the capital Account
- Closing Drawings to the capital account
- Balance the Capital Ledger Account
Profit/Loss in Profit and Loss summary account
Debit= Loss
Credit= Profit
State one reason why transactions with the owner are recorded separately in the Drawings account (rather than directly in the Capital account).
It is recorded separately so that the owner’s transactions for a particular Period can be isolated.
This is useful for decision-making so that the owner can assess the level of drawings compared to profit for that Period.
Referring to the definition of an expense, explain why the Drawings account is not closed to the Profit and Loss Summary account.
Although Drawings is a decrease in assets that reduces owner’s equity, it is expressly excluded from the definition of an expense,
as it is a transaction with the owner and not as a result of business activities.
Referring to one Qualitative characteristic, explain why Drawings are not included in the calculation of profit.
Drawings is a transaction with the owner. Thus, to include drawings in the calculation of profit would be a direct breach of Relevance.
To include Drawings is to include information that is not useful for business decision-making.
