income statement

Accrual accoun2ng can produce large discrepancies

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Unformatted text preview: nses. •  Academic research shows that CEOs & CFOs view earnings to be the most important measure of firm performance reported to outsiders (Graham, Harvey, and Rajgopal 2005). 5 How should we measure performance? Very Different!!! •  NET INCOME=REVENUES - EXPENSES •  Two Bases of Accoun<ng : –  Cash- based accoun.ng recognizes revenue when cash is received from customers and expenses when cash is paid for resources. –  Accrual accoun.ng recognizes revenue when it is earned and expenses when they are incurred. •  Accrual accoun2ng can produce large discrepancies between the firm’s reported income and the amount of cash generated by opera2on 6 How should we measure performance? 7 Let’s take a closer look at the cash basis Donald and Joanne Allen open a hardware store on Jan. 1, Year 1. •  Jan 1: The firm rents a store building and pays two months’ rent of $4,000 in advance. •  Jan 1: The firm pays the premium of $2,400 for property and liability insurance coverage for the year ending December 31, Year 1. •  Jan 15: Firm acquires merchandise cos2ng $40,000, of which it purchases $26,000 for cash and $14,000 on account for payment in February. •  During Jan: Sales to customers total $50,000, of which $34,000 is for cash and $16,000 is on account for collec2on in February and March. •  During Jan: The cost of the merchandise sold during January was $32,000. •  Jan 20: The firm paid $5,000 in salaries to various employees. 8 Cash basis: Cash inflow- Cash ouolow=Income Income Statement for the month of January of Year 1: Cash inflow: Cash ouolow: Total Ouolows Net...
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This document was uploaded on 03/06/2014 for the course 15 15.502 at MIT.

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