CHAPTER 3.
BASIC ACCOUNTING CONCEPTS:
THE INCOME STATEMENT
(Changes from Eleventh Edition
The chapter has been updated. The principal addition is a discussion of the Sarbanes-Oxley Act's CEO
and CFO certification requirements, Additional topics include proforma samings, EBITDA and SEC
financial report certification and affi mation requirements,
Approach
Undoubtedly, the accrual ica is the most difficult of all basis accounting matters for the student to grasp.
‘As a matter of fact, we sometimes say that the proper recognition of revenue and expense is the omy’
important accounting problem. Although this is an exaggeration, it is not far from the truth. The text and
cases in this chipter constitute only a heginning in understanding and it is to be expected that students
will undersiand the matter thoraughly only after they have attacked it from several different angles,
Sometimes we ask the class “Suppose a company received a lawyer's bill for $1,000. Explain all the
different ways in which this bill could he recorded in the accounts.” The answer is that ifthe bill relates to
services rendered in a prior year (ar accounting period) but not recorded in that time, itis nevertheless an
expense ofthe surrent year, if itrepresents a charge for a previous year that was reconded in that year, the
payment of the bill merely represents a decrease in a liability; if it represents a charge in the curtemt year,
itis reconded as an expense; and if it represents a retainer for services ta be rendered in the following year
itis recorded as an asset, prepaid expense.
It may be desirable to introduce a number of short questions of this type in onder to hummer home the
accrual concept. It is suggested, however, that problems relating to depreciation be deferred, as this is an
intricate matter whichis pethaps est left until Chapter 7
Students should always be requized to use the word “revenue” mther than the werd “income.” They may
find it difficult ta da this because “income is still used crrancously in same published statements and in
tax forms.
Some students confuse the special meaning of “consistency” in accounting with the general meaning of
this term. In accounting, “consistency” means only that the same practice is followed this year as was
followed last year. It does not mean that, for example, the treatment of inventories is consistent with the
treatment of fixed assets
Cases
Maynard Company (B) is « straightforward problem, although studsnis may have some difficulty in
deducing how the amounts are to be transformed from the cash basis to the acerual basis.
Lone Pine Cafe (B) requires an income statement of the sume company whose balance sheet was
prepared in Chapter 2; itis fairly stmightforward
Dispensers of California introduces the entire accounting cycle, with some judgmental issues.