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FINANCIAL ACCOUNTING

Measuring Business Income

Prepared by:
Raza Saeed,
FCMA, MBA, ACIS, CIA, DAIBP
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Learning Objectives
After studying this chapter, you should be able to
• Explain the nature of income, revenue and expenses.
• Apply the realization and matching principles in recording
revenue and expenses.
• Apply the rule of debit and credit in recording revenue and
expenses.
• Define and record depreciation expense
• Describe and prepare Income Statement and Owners Equity
Statement and related them with Balance Sheet
• Explain the purpose served by the closing entries
• Distinguish between accrual and cash basis of accounting
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Net Income
• Basic Objective of any business:
• An increase in Owner’s Equity resulting from profitable operation of
the business
• An income statement which summarize the profitability of
the business entity over a period if time.

• Net Income is determined by comparing:


• The sale price of the goods and services rendered by the business
with
• The cost of good and services used up in the business operation
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Income Statement
Robert Real Estate Company
Income Statement
For the month ended October 31, 20------
Revenue
Sales Commissions earned $10, 640
Expenses
Advertising Expenses $630
Salaries Expenses 7,100
Telephone Expenses 144
Depreciation Expenses - Buildings 150
Depreciation Expenses – Office Equipment 45 8,069
Net Income $2,571
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Revenue
The price of goods and services rendered during a given
accounting period
Gross increase in owner’s equity resulting from operation
of the business

Realization principle:
Record revenue at the time services are rendered to the
customers or
Goods sold are delivered to customers
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Expenses
• Expenses are the costs of the goods and the services
used up in the process of earning revenue.
• Expenses always cause decrease in owner’s equity

• Matching principle:
• In measuring net income for a period, revenue should be offset by
all the expenses incurred in producing that revenue.
• Offsetting expenses against revenue on the basis of “cause and
effect”
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Debit and Credit Rule


for Revenue and Expenses
Owners Equity Revenue & Expenses

Increase in owners equity are Revenue increases owners equity;


recorded by credits therefore revenue are recorded by a
credits

decrease in owners equity are Expenses decreases owners


recorded by debits equity; therefore expenses are
recorded by a debits
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Recording Revenue and expenses Transactions

• Transaction – a
• October 1, Paid $360 for publication of advertising
describing various houses offered for sale

Analysis Rule Entry


The cost of advertising is an Expenses decrease owners Debit : Advertising Expenses
expenses equity and are recorded by $ 360
debits
The asset cash was decrease in assets are Credit : Cash $ 360
decreased recorded by credits
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Recording Revenue and expenses Transactions

• Transaction – b
• October 6, Earned and collected commission of $ 2,250
by selling residence previously listed by a client.

Analysis Rule Entry


The asset cash was increased Increase in assets are Debit : Cash $ 2,250
recorded by debits

Revenue was earned Revenue increase owners Credit : Sales Commission


equity and are recorded by Earned $ 2,250
Credits'
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Recording Revenue and expenses Transactions

• Transaction – C
• October 16, Newspaper advertising was purchased at a
price of $270, payment to be made within 30 days.

Analysis Rule Entry


The cost of advertising is an Expenses decrease owners Debit : Advertising Expense.
expense. equity and are recorded by $ 270
debits
Account Payable, a liability, Increase in liabilities are Credit : Accounts Payable
was incurred recorded by Credits' $ 270
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Recording Revenue and expenses Transactions

• Transaction – d
• October 20, A commission of $ 8,390 was earned by
selling a client’s residence. The sale agreement
provided that commission would be received within 60
days.
Analysis Rule Entry
The asset in the form of Increase in assets are Debit : Accounts Receivable.
Accounts Receivable was recorded by debits $ 8,390
acquired.
Revenue was earned Revenue increase owners Credit : Sales Commission earned
equity and are recorded by $8,390
Credits'
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Recording Revenue and expenses Transactions

• Transaction – e
• October 25, Roberts withdrew $2,800 for personal use.

Analysis Rule Entry


Withdrawal of assets by Decreases in owners equity Debit : James Roberts -Drawings
owner decreases the Owner’s are recorded by debits $ 2,800
Equity
The asset cash was decrease in assets are Credit : Cash
decreased recorded by credits $2,800
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Recording Revenue and expenses Transactions

• Transaction – f
• October 30, Roberts found that he did not need all of
$2,800 withdrawn on October 25, and he re-deposited
$1,000 of this amount in the company’s bank account.

Analysis Rule Entry


The asset cash was Decreases in owners equity Debit : Cash $ 1,000
increased are recorded by debits

Deposit of owner increases increase in Owner 'Equity are Credit : James Roberts, Capital
the Owner’s Equity recorded by credits $1,000
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Recording Revenue and expenses Transactions

• Transaction – g
• October 31, Paid Salaries of $ 7,100 to employees for
services rendered during the month of October.

Analysis Rule Entry


Salaries of employees are an Expenses decrease Debit : Salaries Expense. $ 7,100
expense. owners equity and are
recorded by debits
The asset Cash was decreased decrease in assets are Credit : Cash $ 7,100
recorded by Credits'
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Recording Revenue and expenses Transactions

• Transaction – h
• October 31, A telephone bill for October amounting to
$ 144 was received. Payment was required by
November 10.
Analysis Rule Entry
The cost of telephone services Expenses decrease Debit : Telephone Expense. $ 144
is an expense. owners equity and are
recorded by debits
Account Payable, a liability, Increase in liabilities Credit : Accounts Payable $ 144
was incurred are recorded by
Credits'
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General Journal for October Transaction


General Journal Account #
Date Account Title and Explanation LP Debit Credit
20----

Oct 1 Advertising Expenses 70 360


Cash 1 360
Paid for newspaper advertising
6 Cash 1 2,250
Sales Commission Earned 60 2,250
Earned and collected commission by selling
residence for client
16 Advertising Expenses 70 270
Accounts Payable 32 270
Purchased Newspaper advertising; payable within
30 days
20 Accounts Receivable 4 8,390
Sales Commission Earned 60 8,390
Earned commission by selling a client’s residence.
Commission to be received in 60 days
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General Journal for October Transaction


General Journal Account #
Date Account Title and Explanation LP Debit Credit
20----

Oct 25 James Roberts, Drawings 51 2,800


Cash 1 2,800
Withdrawal of cash by the Owner
30 Cash 1 1,000
James Robert’s Capital 51 1,000
Additional investment by the owner
31 Salaries Expenses 72 7,100
Cash 1 7,100
Paid Salaries for October
31 Telephone Expenses 74 144
Accounts Payable 32 144
To record liability for Telephone Expenses
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Ledger Accounts after posting


Cash Account # 1
Date Explanation Ref Debit Credit Balance
20----

Sept 1 180,000 180,000

3 141,000 39,000

5 15,000 24,000

20 1,500 25,500

30 3,000 22,500

Oct 1 360 22,140

6 2,250 24,390

25 2,800 21,590

30 1,000 22,590

31 7,100 15,490
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Ledger Accounts after posting


Accounts Receivable Account #04
Date Explanation Ref Debit Credit Balance
20----

Sept 10 1 11,000 11,000

20 1,500 9,500

Oct 20 8,390 17,890

Land Account # 20
Date Explanation Ref Debit Credit Balance
20----

Sept 3 1 141,000 141,000

10 11,000 130,000
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Ledger Accounts after posting


Building Account #22
Date Explanation Ref Debit Credit Balance
20----

Sept 5 1 36,000 36,000

Office Equipment Account # 25


Date Explanation Ref Debit Credit Balance
20----

Sept 14 1 5,400 5,400


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Ledger Accounts after posting


Accounts Payable Account #32
Date Explanation Ref Debit Credit Balance
20----

Sept 5 1 21,000 21,000

14 5,400 26,400

30 3,000 23,400

Oct 16 2 270 23,670

31 2 144 23,814

James Robert’s Capital Account #50


Date Explanation Ref Debit Credit Balance
20----

Sept 1 1 180,000 180,000

Oct 30 2 1,000 181,000


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Ledger Accounts after posting


James Robert’s Drawing Account #51

Date Explanation Ref Debit Credit Balance


20----

Oct 25 2 2,800 2,800

Sales Commission Earned Account #60


Date Explanation Ref Debit Credit Balance
20----

Oct 6 2 2,250 2,250

20 2 8,390 10,640
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Ledger Accounts after posting


Advertising Expenses Account #70
Date Explanation Ref Debit Credit Balance
20----

Oct 1 2 360 360

16 2 270 630

Salaries Expenses Account #72


Date Explanation Ref Debit Credit Balance
20----

Oct 31 2 7,100 7,100

Telephone Expenses Account #74


Date Explanation Ref Debit Credit Balance
20----

Oct 31 2 144 144


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Robert Real Estate Company


Trial Balance
October 31, 20------
Cash $ 15,490
Accounts Receivable 17,890
Land 130,000
Building 36,000
Office Equipment 5,400
Accounts Payable 23,814
James Robert Capital 181,000
James Robert Drawings 2,800 .
Sales Commission Earned 10,640
Advertising Expenses 630
Salaries Expenses 7,100
Telephone Expenses 144
$215,454 $215,454
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Adjusting Entries
• Allocation of cost of assets to expense over a span of
several accounting period
• Made at the end of the accounting period
• Depreciation – systematic allocation of the cost of an
assets to expenses over the accounting periods making
up asset’s useful life.
• Office Building $3,600 estimated useful life 20 years
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General Journal-Adj. Entry


General Journal Account #
Date Account Title and Explanation LP Debit Credit
20----

Oct 31 Depreciation Expense-Building 76 150


Accumulated Depreciation–Building 23 150
To record depreciation for October . Cost $36,000
/240 Months = $150 per month

Robert Real Estate Company


Partial Balance Sheet
October 31, 20------
Building (at Cost) $ 36,000
Less: Accumulated Depreciation 150 $35,850
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General Journal-Adj. Entry


General Journal Account #
Date Account Title and Explanation LP Debit Credit
20----

Oct 31 Depreciation Expense-Office Equipment 78 45


Accumulated Depreciation– Office 26 45
Equipment
To record depreciation for October . Cost $ 5,400
/120 Months = $ 45 per month

Robert Real Estate Company


Partial Balance Sheet
October 31, 20------
Office Equipment (at Cost) $ 5,400
Less: Accumulated Depreciation 54 $4,346
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Robert Real Estate Company


Adjusted Trial Balance
October 31, 20------
Cash $ 15,490
Accounts Receivable 17,890
Land 130,000
Building 36,000
Accumulated depreciation: Building 150
Office Equipment 5,400
Accumulated depreciation: Office Equipment 45
Accounts Payable 23,814
James Robert Capital 181,000
James Robert Drawings 2,800 .
Sales Commission Earned 10,640
Advertising Expenses 630
Salaries Expenses 7,100
Telephone Expenses 144
Depreciation Expense – Building 150
Depreciation Expenses –Office Equipment 45
$215,649 $215,649
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Income Statement
Robert Real Estate Company
Income Statement
For the month ended October 31, 20------
Revenue
Sales Commissions earned $10, 640
Expenses
Advertising Expenses $630
Salaries Expenses 7,100
Telephone Expenses 144
Depreciation Expenses - Buildings 150
Depreciation Expenses – Office Equipment 45 8,069
Net Income $2,571
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Statement of Owners Equity


Robert Real Estate Company
Statement of Owners Equity
For the month ended October 31, 20------
James Roberts Capital – September 30, 20----- $180,000
Add: Net Income for October 2,571
Additional Investment by the owner 1,000
Sub-total 183,571
Less: Withdrawal by the Owner 2,800
James Roberts Capital – October 31, 20----- 180,771
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Robert Real Estate Company


Balance Sheet
October 31, 20------
Assets
Cash $15,490
Accounts Receivable 17,890
Land 130,000
Building 36,000
Accumulated depreciation: Building 150 35,850
Office Equipment 5,400
Accumulated depreciation: Office Equipment 45 5,355
Total Assets $204,585
Liabilities & Owners Equity
Liabilities:
Accounts Payable 23,814
Owner’s Equity:
James Robert Capital-October -31, 20----- 180,771
Total Liabilities & Owner’s Equity $204,585.
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Closing the Temporary Accounts


• Temporary or nominal accounts
• Revenue, Expenses and Drawing Accounts

• Permanent or real accounts


• Owner Capital Account & other Balance Sheet Accounts

• Closing and Closing entries


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General Journal-Closing Entry


General Journal Account #
Date Account Title and Explanation LP Debit Credit
20----
Oct 31 Sales Commission Earned 60 10,640
Income Summary 53 10,640
To close the Sales Commission Earned

Sales Commission Earned Account #80


Date Explanation Ref Debit Credit Balance
20----
Oct 6 2 2,250 2,250
20 2 8,390 10,640
31 To Close 3 10,640

Income Summary Account #53


Date Explanation Ref Debit Credit Balance
20----
Oct 31 3 10,640 10,640
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General Journal-Closing Entry


General Journal Account #
Date Account Title and Explanation LP Debit Credit
20----
Oct 31 Income Summary 53 8,069
Advertising Expense 70 630
Salaries Expense 72 7,100
Telephone Expense 74 144
Depreciation Expense – Building 76 150
Depreciation Expense – Office Equip 78 45
To close the Expense accounts

Sales Commission Earned Account #80


Date Explanation Ref Debit Credit Balance
20----
Oct 6 2 2,250 2,250
20 2 8,390 10,640
31 To Close 3 10,640
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Closing Income Summary Account


General Journal Page 3
Date Account Title and Explanation LP Debit Credit
20----
Oct 31 Income Summary 53 2,571
James Roberts –Capital 50 2,571
To close the Income Summary Account for October by
transferring the net income to the owners Capital account

Income Summary Account #53


Date Explanation Ref Debit Credit Balance
20----
Oct 31 Revenue 3 10,640 10,640
31 Expenses 3 8,069 2,571
31 To close 3 2,571 0

James Roberts Capital Account #50


Date Explanation Ref Debit Credit Balance
20----
Oct 31 Investment by the Owner 3 180,000 180,000
31 Additional Investment by the Owner 3 1,000 181,000
31 Net Income for the year 3 2,571 183,571
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Closing Income Summary Account


Advertising Expenses Account #70
Date Explanation Ref Debit Credit Balance
20----
Oct 1 2 360 360
16 2 270 630
31 To Close 3 630 0

Salaries Expenses Account #72


Date Explanation Ref Debit Credit Balance
20----
Oct 31 2 7,100 7,100
31 To Close 7,100 0

Telephone Expenses Account #74


Date Explanation Ref Debit Credit Balance
20----
Oct 31 2 144 144
31 To Close 144 0
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Closing Income Summary Account


Depreciation Expenses –Building Account #76
Date Explanation Ref Debit Credit Balance
20----
Oct 31 2 150 150
31 To Close 3 150 0

Depreciation Expenses –Office Equip Account #78


Date Explanation Ref Debit Credit Balance
20----
Oct 31 2 45 45
31 To Close 3 45 0

Income Summary Account #53


Date Explanation Ref Debit Credit Balance
20----
Oct 31 3 10,640 10,640
31 To Close 8,069 . 2,571
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Closing Owners Drawing Account


General Journal Page 3
Date Account Title and Explanation LP Debit Credit
20----
Oct 31 James Roberts Capital 50 2,800
James Roberts –Drawings 51 2,800
To close Owners Drawing account

James Roberts Drawing Account Account #51


Date Explanation Ref Debit Credit Balance
20----
Oct 31 Withdrawal 2 2,800 2,800
31 To Close 3 2,800 0

James Roberts -Capital Account #50


Date Explanation Ref Debit Credit Balance
20----
Oct 1 Investment by owner 1 180,000 180,000
30 Additional Investment 2 1,000 181,000
31 Net Income for October 3 2,571 183,571
31 From Owner Drawing Account 2,800 180,771
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Summary of Closing Process


1. Closing of various Revenue Accounts to Income Summary

2. Closing of various Expense Accounts to Income Summary

3. Closing Income Summary Account to Owners Capital


Account

4. Closing the Owners Drawing account to Owner Capital


Account
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Robert Real Estate Company


After Closing Trial Balance
October 31, 20------
Cash $ 15,490
Accounts Receivable 17,890
Land 130,000
Building 36,000
Accumulated depreciation: Building 150
Office Equipment 5,400
Accumulated depreciation: Office Equipment 45
Accounts Payable 23,814
James Robert Capital 180,771
204, 780 204, 780.
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Thank you