Chapter 2 Lecture


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CHAPTER 2 CLASS NOTES MEASURING INCOME TO ASSESS PERFORMANCE The time period for the financial statements that we have discussed earlier can be a month, quarter, or a year. The ending date of the time period is the date of the balance sheet date and the last day of the period for the other statements. Be careful that you clearly understand the period of time covered by the financial statements in any problem that you complete for homework or on an examination To understand income measurement, one must understand the basic operating cycle . For example, a manufacturer or retailer will start the cycle with cash, then purchase inventory at cost, sell the inventory at a sales price, and convert the sales price back into cash. The difference between the sales price and cost is the income. The cycle is then repeated over and over again, the more times, the more income. The cycle is often called the cash to cash cycle. A key concept is when to recognize revenue. The easy answer is when it is earned. However, the accountant must determine exactly when is the revenue earned. It is usually realized when all of the tasks needed to earn the revenue have been completed by the seller, i.e. at the time the sale is completed and goods delivered or the time the service has been rendered. As we have said before, there are exceptions in accounting for specific circumstances—in the determination of revenue there are special rules for construction accounting, franchise accounting, etc. We may sell for cash or sell on credit, the latter results in accounts receivable, i.e. someone owes you money to be paid later. Another key concept is the recognition of an expense. An expense is recognized when it is incurred or when the obligation for incurring now exists. The expense is incurred because the business has received the benefit of the goods or services needed to run their operations. The expense can also be recorded if the company is obligated to a future act
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