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Assessing Income: Revenues and Expenses
Assessing Income: Revenues and Expenses
Let’s go back to our list of transactions over our company. Work for us. We focus on the transactions classified as revenues in blue we can see that they belong to the Karen period. The assumption that we make is that these services and products were delivered into the hands of the customers within the current period. And here we can say that the revenues are realized. We can list cell services from transaction nine and sales products from transactions 11 under service and cell revenue for the current period. What kind of company book revenue when it can we call that a realized revenue.
Think about the following situations in the first one we have a retail store that sells a tailor made suit for 4000 to a new customer that pays before walking out to the store. Can the company book 4000 revenue. And the answer is yes. In the second case the company delivers services for 4000 to a new customer for which the cash payment is due within 90 days. Can the company book 4000 US revenue. And again the answer is yes in the third case we have a company that sells vintage furniture online and receives a cash payment from a new customer for a mid century bookcase. The furniture will be shipped the next year in February.
The value of the order is 4000. Can the company book 4000 is revenue. But in this case the answer is No. Why. What is the underlying logic in this case. Revenue can be recognized and so booked in the statement. Only one service is provided or products are sold. To a stage of completion. The question you need to ask yourself is the following has a service or product been delivered into the hands of the customer in the first case. What happened. The retail store that sell the tailor made sued for four thousand to a customer that pays before walking out of the store. The product. Has been delivered into the hands of the customer. So can we book into revenue. Yes.
In the second case the company performs a service for 4000 to the new customer that will pay in the next 90 days but has the product been delivered into the hands of the customer. Yes. And so can we book ad revenue. Yes. In the last case the company sells the furniture that will be shipped the next year in February. Has the bookcase been delivered into the hands of the customer. No. Can we book revenue then. No. Now let’s focus on the transactions that lead to the expenses. The ones in red. Can we say they all belong to the current period. Some of them belong to this current period but some don’t. Which ones. What is the difference.
The raw materials acquired in transaction 3 were used in the production process. Did they contribute to this current period profits of the firm. Did they help in the creation of revenues. We work under the assumption that all the raw materials were used in the production process. Therefore work for less. Our company has incurred in an expense for raw materials of 5000 then tie a balance of raw materials has been used in the production and there is no residual value. We can list raw material from transaction 3 as a raw material expense of the current period salaries were paid to compensate the work of the employees the work was performed by the employees within this current period.
Therefore we can only see the salaries as salary expense of the current period in transaction eight work for less acquirers and insurance. The yearly premium at 1000 was purchased on August the 1st as the current period ends on December thirty first. We have to compute the expense that relates only to this current period. How do we proceed. First we compute the cost of the insurance per month as a premium of 1000 is computed on a yearly basis. We take 1000.
We divide it by 12 the number of months in a year and the result feels eighty three point three then we compute the cost of insurance for the number of months of the current periods that are covered by the insurance itself. In this case five months from August the 1st until December thirty first. So we take the monthly cost of eighty three point three and we multiply it by five. The number of months. The result gives. Four hundred sixteen point five . We can list the portion of insurance from transaction eight that covers the current period as insurance expense the patient acquisition from transaction six gives the right to use it for five periods.
Therefore the right acquired with a patent will not be used up entirely during this current period during this period will only be used to one fifth of the rights acquired with a patent we compute the cost of the patent per year as the right acquired will last for five years.
We take the overall cost of 20000 and we divided by the number of years the right will be used for in this case five twenty thousand divided by five gives four thousand we can now list four thousand as a portion of the cost of the patent from transaction six that covers the current period only as patent expense in transaction 5 on April the 1st one for less makes a significant investment into a new plant. The total cost of this investment is sixty thousand and it’s estimated useful life is ten years. This means that the company estimates to use a plant not only for this current period but also for the next 10 years.
So how can we usefully describe this when analyzing the company performance. One approach is splitting the cost of the plant over its estimated useful life and allocate only one portion of the expense to the current period. In this case the total cost of sixty thousand will be split will be divided equally into ten years. This leads to a yearly cost of six thousand this technique is called depreciation. We can now allocate the portion of planned as a planned expense. And now it’s your turn to spot the error.
A fundamental role of accounting is identifying revenues and expenses. These differ from cash inflows and cash outflow and this is a key threshold concept in accounting. Think about the following problem – as a trigger: a company buys properties downtown an pays the seller in cash. Is there any expense involved? A company pays for consultancy services to ensure their budgeting process is sound: is there any expense involved? This video will introduce you to some of the most important concepts in accounting. Please, make sure you listen to it carefully and engage in the comment section with your peers. Reach us out in case anything is unclear. Happy Watching!
You can find attached below the slides in pdf version we are presenting during the video.
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