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Unformatted text preview: Chapter 03 - Reporting Operating Results on the Income Statement Chapter 3 Reporting Operating Results on the Income Statement ANSWERS TO QUESTIONS 1. Net Income = Revenues - Expenses. Each element is defined as follows: Revenues the amounts a business charges its customers for goods or services . Expenses any costs of operating the business, incurred to generate revenues in the period covered by the income statement. Net Income = A total that is calculated by subtracting expenses from revenues. 2. The time period assumption assumes that the long life of a company can be divided into shorter time periods, such as months, quarters, and years. This assumption allows management to evaluate a companys financial performance on a timely basis. 3. Accrual basis accounting requires recording revenues when earned and expenses when incurred, regardless of the timing of cash receipts or payments. Cash basis accounting records revenues when cash is received and expenses when cash is paid. 4. Using cash basis accounting for your personal finances is acceptable because your cash inflows and outflows tend to occur close in time to the activities that cause those cash flows. Cash basis accounting does not work as well for businesses because most of them use credit for their transactions, and recording the transactions on a cash basis would not describe the financial results of the businesss activities as well as accrual basis accounting. 5. To recognize an accounting transaction means to measure and record the transaction in the accounting system. Revenues are recognized when they are earned, and expenses are recognized when they are incurred to generate revenues. 6. Under accrual basis accounting, revenues are recognized when they are earned. In general, revenues are earned when the company has done what it has promised to do, regardless of when the cash is received. 3-1 Chapter 03 - Reporting Operating Results on the Income Statement 7. The matching principle requires that expenses be recorded when incurred in earning revenue. For example, the cost of employee wages is recorded in the same period that the employees work to generate revenues for the company; this may differ from the period when the employees are actually paid. 8. Revenues increase net income, which increases retained earningsa stockholders equity account. Expenses decrease net income, causing a decrease in retained earningsa stockholders equity account. 9. Revenues increase stockholders equity and expenses decrease it. Stockholders equity accounts are increased with credits and decreased with debits. Thus, revenues are recorded as credits and expenses as debits. 10. Item Increase Decrease Revenues Credit Debit Expenses Debit Credit 11. Item Debit Credit Revenues Decrease Increase Expenses Increase Decrease 12. Items on the income statement relate only to the current period and do not have a lingering financial impact beyond the current period. Balance sheet items, on...
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