The Income Statement: Concepts and Analysis

THE INCOME STATEMENT: CONCEPTS AND ANALYSIS

Review Questions (see the next page for answers)

1. Which financial statement shows how much:

1. inventory a company has on hand?
2. the company paid out in cash for new property?
3. of current period earnings is retained in the company?
4. the company’s income tax expense was for the period?
5. the company reported for marketing expenses for the year?
6. the company still owes for marketing expenses at the end of the year?
7. is the management’s forecast of next year’s earnings?

1. What is the underlying event reflected by each of the following journal entries?

1. Dr. Cash                          $50,000  

Cr. Accounts Receivable        $50,000

1. Dr. Cash                         $30,000

Cr. Short Term Debt                $30,000

1. Dr. Inventory                         $25,000

Cr. Cash                        $5,000

Cr. Accounts Payable                $20,000

1. Dr. Accounts Payable         $3,000

Cr.        Inventory                $3,000

Answers to Review Questions

1. Balance Sheet
2. Cash Flow Statement
3. Statement of Shareholders’ Equity
4. Income Statement
5. Income Statement
6. Balance Sheet
7. It will not show up in any financial statement.

1. Collected 50,000 in cash for sales made in prior periods.
2. Borrowed short term debt of $30,000.
3. Purchased $25,000 worth of inventory. $5,000 is paid in cash; the remainder is purchased on account.
4. Returned $3,000 worth of inventory and reduced payables by the same amount.

Definition of income

Income is defined as the change in the shareholders’ equity of a firm during a period arising from transactions with external parties (other than the firm’s owners).

From the accounting identity:

Assets = Liabilities + Shareholders’ equity,

we have:

Shareholders’ equity = Assets – Liabilities,

and, over any given period of time:

ΔShareholders’ equity = ΔAssets - ΔLiabilities

From this relation, we see that income can alternatively be defined as the change in net assets (assets less liabilities) during a period arising from transactions with external parties.

Definition of revenues and expenses

Revenues are inflows of net assets or equivalently, increases in shareholders’ equity, from selling goods and providing services.