Study Guide- Cash and Accrual Formulas Pertaining to Income Statements An income statement summarizes the income and

expenses during a specific period of time and shows the profit or loss from the period. An income statement provides insight into management efficiency and for this reason is a key financial statement for managers. The cash approach implies that income and expenses will be reported when the cash is received or paid. Many businesses report net income on using the cash basis. An accrual approach says income and expenses are reported when they are earned or incurred regardless of when the cash transaction takes place. If a cash-based income statement is used, the net income can be either understated or overstated depending on the business transactions. Cash based income statements understate the net profit if the following occurs: Revenue is generated but not converted to cash. An increase in accounts receivable is an example. Expenses paid during the period were incurred during prior or later years. Examples would be a decrease in accounts payable or an increase in prepaid expenses. Cash based income statements overstate the net income for a period if: Revenue from prior years is converted to cash. Expenses are incurred this year but are not paid in cash until a later year An accrual income statement is the most accurate approach in reporting net income. Cash record systems are used to generate accrual income statements by adjusting cash revenue for changes in inventory and adjusting cash expense accounts for changes in accrued expenses. The adjustments reflect the amount changes in these accounts from the beginning and ending balance sheets for the year. Two financial statements that can be generated from any accounting package are the balance sheet and the income statement (profit and loss statement). A balance sheet is the snapshot of a business at a given point in time and shows what the business owns and owes, assets and liabilities. The income statement shows the revenue earned and expenses used to generate that revenue. Most accounting software can generate reports on a cash and accrual basis. Accrual reports provide the most accurate financial picture of the business and should be used in the analysis process. Heres list of the uses of an income statement: Summarizes revenues and expenses Determine profit and loss Explains changes in owners equity Calculates financial measures such as profitability, financial and operational efficiency Support loan applications and refinancing

ABM 141 Unit 2 Study Guide Accrual Income Statements

Study Guide: Cash and Accrual Formulas continued Formulas for determining a cash and accrual income statement are: (cash accounting) Cash revenue - cash expenses = net cash income - depreciation = net inc. from operations +/-gain/loss from sales of assets = net cash income (accrual accounting) cash revenue + changes in inventory = Gross business revenue - cash expenses - depreciation + or non-cash expenses adjustments = net inc. from business operations +/-gain/loss from sale of assets = Accrual net business income

As you see in the formulas, an accrual income statement makes adjustments to the cash revenues and cash expenses. Documents needed in the developed of accrual income statements are a cash profit and loss and beginning and ending balance sheets for the given period. The cash profit and loss provides the cash amount while the balance sheets provide the data for inventory adjustments and the accrued expenses adjustments. Gross revenue is the total revenue generated by the business in a given period of time. It is calculated by adding the cash revenue and the inventory adjustments (ending minus beginning). This amount is important to determine as it shows the true revenue generated by the business. Gross revenue is also used in calculating income statement ratios. To make it easier to see the changes in inventory and which financial statements to pull the information from consider this version of the accrual method formula.

ABM 141 Unit 2 Study Guide Accrual Income Statements

Study Guide: Cash and Accrual Formulas Continued Cash Revenue Minus Cash Expenses Equals Net Cash Incomes Additions: From Current Yr. End (Ending Bal. Sht.) Accounts Receivable Prepaid Expenses Inventory on Hand From Prior Yr (Beginning Bal. Sht.) Accounts Payable Accrued Expenses Equals Total Additions Subtractions: From Prior Yr. (Beginning Bal. Sht) Accounts receivable Prepaid Expenses Inventories On Hand From Current Yr. End (Ending Bal. Sht) Accounts Payable Accrued Expenses Equals Total Subtractions Equals Accrual Net Income Before Depreciation Subtract Depreciation Equals Net Income From Operations Gain/Loss on Sale of Capital Assets Equals Accrual Net Income

ABM 141 Unit 2 Study Guide Accrual Income Statements