Tag Archives | income statement

Journal Entries (JEs)

See Also:
Double Entry Bookkeeping
Journal Entries For Factoring Receivables
Accounting Principles
Accounting Concepts
Adjusting Entries

Journal Entries Definition

A journal entry is a recording of a transaction into a journal like the general journal or another subsidiary journal. Journal entries for accounting require that there be a debit and a credit in equal amounts. Oftentimes, there is an explanation that will go along with this to explain the transaction.

Journal Entries Meaning

A journal entry means that a transaction has taken place whether it is a sale to a customer, buying goods from a supplier, or building a warehouse. These transactions affect both the balance sheet and income statement.

As said before, journal entry accounting requires that there be an equal debit and credit for every transaction. This is also known as double entry bookkeeping. Many journal accounts have a normal balance. For example, assets have a normal debit balance if the account is increased and it is a credit if it is decreased.


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Journal Entries Example

The following example will use both balance sheet and income statement accounts to show how they work.

Bill has been looking for a certain toy for his son. He walks into Toys Inc. to find it. After some searching, Bill finds a GI Joe for $14 and buys it to take home to his son. The toy cost Toys Inc. $9 to get the toy from its supplier. Thus, Toys inc. will record the following journal entries into the Sales Journal:

Cash………….$14

Sales Revenue…………..$14

COGS………….$9

Inventory…………………..$9

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Journal Entries

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Journal Entries

Originally posted by Jim Wilkinson on July 24, 2013. 

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Normalized Earnings

Normalized Earnings

Normalized Earnings are adjustments made to the income statement in preparation to show potential buyers of the company. When making these adjustments, eliminate expenses not usually incurred for the production of the business. To show a more realistic return on investment, the normalized expenses should not appear on the future buyer’s income statement.

Different Types of Normalized Earnings

There are multiple types of special expenses that are unusual on a typical income statement. For now, let’s categorize them into two types of normalized earnings – Type A and Type B.

Type A: Non-Recurring Gains and/or Losses

The goal of “normalizing earnings” is to provide prospective buyers a typical income statement so they know what to expect. Expenses such as a lawsuit, non-operating assets, and other abnormal items that occur once are considered expenses you can eliminate when normalizing earnings.

Type B: Discretionary Expenses

Do not record certain expenses at fair market value price. Adjust these expenses so the buyer of a company does not assume these expenses incur regularly. If you include these expenses, then as the current company owners, you should specify that these expenses or earnings are not generating/generated by business. Examples include vacation homes, car rentals, startup costs, and unreasonably high bonuses.

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Normalized Earnings Example

For example, Laura Johnson is the CEO and founder of X company, and now wants to sell it. Her current business generated over $2 million last year, according to her income statement.

Normalized Earnings

Type A: Laura experienced a lawsuit and lost $250,000. Because this was one-time event, remove the lawsuit expense for adjustment purposes.

Type B: Laura’s sales team had a sales contest to boost revenue for the year 15%. As a result, two salespeople gained extremely high bonuses totaling to a $100,000 additional salary.

By normalizing these earnings, EBITDA increases by $350,000, earnings that the buyer can potentially make without those extra costs.

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Normalized Earnings

See Also:
Key Performance Indicators (KPI’s)
Collection Effectiveness Index (CEI)
How Does a CFO Bring Value to a Company?
Multiple of Earnings
Continuous Accounting: The New Age of Accounting
Budgeting 101: Creating Successful Budgets

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Realized and Unrealized Gains and Losses

Realized and Unrealized Gains and Losses Explanation

In accounting, there is a difference between realized and unrealized gains and losses. Realized income or losses refer to profits or losses from completed transactions. Unrealized profit or losses refer to profits or losses that have occurred on paper, but the relevant transactions have not been completed. You can also call an unrealized gain or loss a paper profit or paper loss, because it is recorded on paper but has not actually been realized.

Record realized income or losses on the income statement. These represent gains and losses from transactions both completed and recognized. Unrealized income or losses are recorded in an account called accumulated other comprehensive income, which is found in the owner’s equity section of the balance sheet. These represent gains and losses from changes in the value of assets or liabilities that have not yet been settled and recognized. Now, look at the following realized and unrealized gains and losses examples.

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Realized – Unrealized Examples

Example 1

If a company owns an asset, and that asset increases in value, then it may intuitively seem like the company earned a profit on that asset. For example, a company owns $10,000 worth of stock. Then the stock value rises to $15,000. On paper, the company made a paper profit of $5,000. However, the company cannot record the $5,000 as income.

This unrealized gain will not be realized until the company actually sells the stock and collects the cash. Until the stock is sold, the company only records the paper profit of $5,000 as an unrealized profit in the accumulated other comprehensive income account in the owners’ equity section of the balance sheet.

Once the company actually sells the stock, the unrealized gain is realized. Only after the stock is sold, the transaction is completed, and the cash is collected, can the company report the income as realized income on the profit and loss statement.

Example 2

Similarly, if a company owns an asset, and that asset decreases in value, then it may intuitively seem like the company incurred a loss on that asset. For example, a company owns $10,000 worth of stock. Then the stock value plunges to $5,000. On paper, the company suffered a paper loss of $5,000. However, the company cannot record the $5,000 as a loss on the income statement.

This paper loss will not be realized until the company actually sells the stock and takes the actual loss. Until they sell the stock, only record the paper loss of $5,000 as an unrealized loss in the accumulated other comprehensive income account in the owners’ equity section of the balance sheet.

Once the company actually sells the stock, the unrealized loss becomes realized. Only after the stock is sold, the transaction is completed. Then the cash changes hands. Finally, the company reports the loss as a realized loss on the income statement.

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realized and unrealized gains and losses

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realized and unrealized gains and losses

See Also:
Accounting Income vs Economic Income
Capital Gains
Proforma Earnings
Operating Income
Net Income
Asset Market Value vs Asset Book Value

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Retained Earnings

Retained Earnings

Retained earnings (RE) refers to the portion of a company’s net income that is reinvested in the company. It is also the amount of profit left over after the company pays dividends to its stockholders.

Record RE in the owners’ equity section of the balance sheet. The account is cumulative. So, add profits and subtract losses from the account each accounting period. The RE account links the income statement and the balance sheet. If the account is negative, then it is either accumulated deficit, accumulated losses, or retained losses.

Calculating Retained Earnings

To calculate retained earnings, start with the value of the RE account from the previous period. Then add net income for the period and subtract dividends paid. In conclusion, the result is the new value of this account.

New RE = Prior RE + Net IncomeDividends 

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retained earnings

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retained earnings

See Also:

Accounting Income vs Economic Income
Realized and Unrealized Gains and Losses
Operating Income
Overhead Definition

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Restructuring Expense

See Also:
How to Estimate Expenses for an Annual Budget
Administration Expenses

Restructuring Expense Definition

Restructuring expense is defined as the cost a company incurs during corporate restructuring. They are considered nonrecurring operating expenses and, if a company is undergoing restructuring, they show up as a line item on the income statement.

Restructuring Charges Meaning

The term, restructuring expenses, is also a footnote in the financial statements that describes the details relevant to the restructuring charges. These charges often include cash costs, accrued liabilities, asset write-offs, and employee severance pay due to layoffs. Restructurings may occur during a major reconfiguration of business operations or during a change in upper-level management at a company.

Big Bath Charges

Financial statement analysts pay special attention to restructuring charges. This is because they may reflect past or ongoing problems with the company’s business operations or corporate structure. Also, managers have considerable leeway in deciding when to record restructuring charges and what to include in the restructuring charges. Companies then may deliberately report a large restructuring expense to manipulate current earnings. The practice of taking a very large restructuring charge is known as taking a “big bath.” The idea is to take a big hit to earnings in the current period in order to make future period earnings appear more profitable. Big Bath Charges are more common in public corporations than private companies.

Restructuring Charges Example

Bubba is the chief accountant at a middle market food distribution company. Bubba has worked extremely hard to achieve his title and enjoys his work. Recently, Bubba has been notified by the board of directors of his company that they will restructure in the next quarter of operations. The company tasks Bubba with accounting for this reformation. It is Bubba’s job to make sense of all of the restructuring charges that the company experiences in this quarter.

Restructuring Charges Example & Steps

First, Bubba receives the memo that the company will convert the current inventory accounting system to an electronic, RFID (Radio Frequency Identification) based system. Here, the company places a small tag on each boxed order received from suppliers. This will occur by simply adding a tag to each box, a radio frequency signal emitter at the entrances of the distribution warehouse, and software which works as a go-between to this hardware and the company accounting software. This tag, in operations, will automatically read boxes as they enter and exit the distribution warehouse. Based on the tag placed in each box, the system will know what, how many, and when inventory is received and delivered. Once this change has occurred, the company will greatly reduce man-hours once used for processing inventories. Bubba finds invoices which total in the amount of $45,000.

Tracking System

Next, Bubba is notified that the company trucks will be equipped with a GPS (Global Positioning System) tracking system. This will allow the company to know exactly where every single truck is, reducing personal stops and protecting company equipment from theft. This system, from the records Bubba has collected, will cost the company $25,000 for hardware, software, and labor on installation.

Statements

Finally, Bubba prepares company statements. He presents these expenses as incurred, rather than showing a “Big Bath”. This will result in logical financial statements, as well as protecting Bubba’s reputation.

Bubba has completed his project to the satisfaction of the company board of directors. For this project, the board has decided to give Bubba a pay raise due to the quality of his work. It pleases Bubba to hear this. He is happy with how he ended this project.

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Restructuring Expense

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Restructuring Expense

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Research and Development

Research and Development Definition

Research and development (R&D) in business refers to activities geared towards new product development or current product improvement. It typically involves conceptualizing and designing new products and then tailoring them to meet the needs of the target market. R&D is often a line item on a company’s income statement. Technology and pharmaceutical companies often have comparatively high research and development spending because these industries are very research-intensive. Substantive spending on R&D can also be a sign that a company is growing or expanding.

Accounting Research and Development

In accounting, there is some controversy over whether research and development spending should be considered an asset with future benefits for the company or whether it should be expensed in the period when it is incurred. Some claim that because R&D is part of the process of creating new products, it should be considered an asset with future benefits to the firm and expensed when the new products are eventually sold. Others claim that research and development is a regular operating expense, and it should be expensed in the period in which it is incurred.

In the U.S., the Financial Accounting Standards Board (FASB) solved the dilemma by requiring all companies to expense R&D in the period incurred. This is the rule according to GAAP.

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Research and Development

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Research and Development

See Also:

How to Estimate Expenses for an Annual Budget
Capital Budgeting Methods

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Product Costs vs Period Costs

See Also:
Product Pricing Strategies

Product Costs vs Period Costs

In accounting, all costs incurred by a company can be categorized as either product costs or period costs. The two types of costs are recorded differently.

Product costs are applied to the products the company produces and sells. Product costs refer to all costs incurred to obtain or produce the end-products. Examples of product costs include the cost of raw materials, direct labor, and overhead. Before the products are sold, these costs are recorded in inventory accounts on the balance sheet. They are treated like assets. Product costs are sometimes referred to as “inventoriable costs.” When the products are sold, these costs are expensed as costs of goods sold on the income statement.

Period costs are the costs that cannot be directly linked to the production of end-products. Essentially, a period cost is any cost that is not a product cost. Examples of period costs include sales costs and administrative costs. Period costs are always expensed on the income statement during the period in which they are incurred.

In sum, product costs are inventoried on the balance sheet before being expensed on the income statement. Period costs are just expensed on the income statement.

Product Costs vs Period Costs

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