FAQ

The accrual method of accounting reports revenues on the income statement when they are earned even if the customer will pay 30 days later. At the time that the revenues are earned the company will credit a revenue account and will debit the asset account Accounts Receivable. (When the customer pays 30 days after the revenues were earned, the company will debit Cash and will credit Accounts Receivable.)

The accrual method of accounting also requires that expenses and losses be reported on the income statement when they occur even if payment will take place 30 days later. For example, if a company has a $15,000 repair done on December 15 and the vendor allows for payment on January 15, the company will report a repair expense and a liability of $15,000 as of December 15. (On January 15 the company will credit Cash and will debit the liability account.)

The accrual method of accounting, which is also known as the accrual basis of accounting, is required for large companies. (The cash method of accounting may be used by individuals and some small companies.) The accrual method and the associated adjusting entries will result in a more complete and accurate reporting of a company’s assets, liabilities, equity, and earnings during each accounting period.

A U.S. corporation’s revenues are reported on the top line of its income statement, while its earnings are reported on the bottom line (or near the bottom) of the income statement.

Revenues is the gross amount earned from selling goods or providing services during the period shown in the heading of the income statement. In other words, revenues is the amount earned before deducting the cost of goods sold, expenses, and losses.

Earnings is the net amount earned after deducting the cost of goods sold, expenses and losses. It is often presented as net earnings or net income. When a corporation’s stock is publicly-traded, the earnings must also be reported on the income statement as earnings per share (EPS) of common stock.

In accounting, periodicity means that accountants will assume that a company’s complex and ongoing activities can be divided up and reported in annual, quarterly and monthly financial statements. For example, some earth-moving equipment may require two years to manufacture but the activities will be divided up and reported in quarterly financial statements. A similar situation occurs at a company that develops complex digital systems.

Even a company that manufactures small consumer products will have ongoing activities and costs that overlap two years or more. Again, the accountants will assume that the revenues and costs can be assigned or allocated to the appropriate accounting periods. Hence, the accountants will report the company’s net income and cash flows for each accounting period (year, quarter, month, etc.) and the company’s financial position at the end of each accounting period.

Periodicity is also known as the time period assumption.

Not one of the financial statements will show a corporation’s worth. The balance sheet, income statement, statement of cash flows, and stockholders’ equity statement merely provide information to assist financial experts in forming an opinion of a corporation’s worth.

In the past, some people mistakenly thought that a corporation’s stockholders’ equity was the corporation’s worth. However, stockholders’ equity (or the owner’s equity of a proprietorship) is merely the result of subtracting the reported amount of liabilities from the reported amount of assets. Since the reported amounts reflect the cost principle and other accounting principles, the net result cannot be assumed to be the company’s worth.