Monday, September 8, 2014

Income Statement

contd. from Accounting Basics

1.3 Income  Statement

Mr. Das tells you that an income statement will show how profitable TOD has been during the time interval shown in the statement's heading (For example FY 2008-2009).This period of time might be monthly, quarterly, or yearly or whatever you choose. While reporting profitability, two things are considered

1. Revenues- amount earned
2. Expenses- Amount spent to earn revenues.

The two terms “revenue” and “expenses” are broad terms which we shall explore below.

1.2.1 Revenues 

Main revenue for TOD is in terms of sales of the Food Items. TOD should record revenues when they are earned under “accrual basis of accounting” and not when company receives the money which is generally done under “cash method of accounting”. Recording revenues when they are earned is the result of one of the basic accounting principle known as the revenue recognition principle.

 Let us try to understand this concept. Suppose you sell 1,000 Food Items in July for Rs. 100 per Thali, you have earned Rs. 100,000 for that month. You ask consumers to pay by August 10 as per payment terms. Even if customers did not pay by August 5, “accrual basis of accounting” require that Rs. 100,000 be recorded as July revenue because Food Items were sold in that month. When you match revenue with expenses, TOD’s income statement shows how profitable it was in July. When you receive Rs. 100,000 on August 5, you will have to make an accounting entry to show the money was received. This receipt will not be considered to be August revenues, since the sales were already reported as revenues in July when they were earned. Rs. 100,000 will be recorded in July as a reduction in Accounts Receivable because in July you had made an entry to Accounts Receivable and to Sales.

1.2.2 Expenses 

After understanding about “revenue”, let’s turn our attention to another part of income statement i.e. “expenses”. The income statement for July should show expenses incurred in July regardless of when actual payment happened. For example, if you pay salaries for July to delivery boys worth Rs. 20000 on August 2 , this expense needs to be shown in July income statement. In this case actual date of payment does not matter. This recording of expenses with the related revenues is based on basic accounting principle known as the matching principle.

Showing expense matching with revenue result in measuring profitability of the company during a given time period.

Another item of expenditure is interest expense on money borrowed by you. For example if you borrow Rs. 10,000,00 on July 1 from Bank and your company TOD agrees to pay 10 % per annum or Rs. 100000 per year and if this interest should be paid on July 1 of every year. Even though interest payment is yearly, you can see that in reality, a small percentage of interest expense is incurred each and every day. If you prepare quarterly income statements then interest for a quarter should be reported i.e Rs 100000/4. This means you will have to match Rs. 25000 of interest expense with quarterly revenue. Interest expense is a cost necessary to earn revenue. We have made things easy here. Actually income statement is complex matter than what we discussed. The difference between revenue and expenses is often referred as bottom line and labeled as Net income or Net Loss


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