Buad 803 Assignment 2

BUAD 803 ASSIGNMENT 2
1. Make a comparison and contrast between the income statement and the statement of
financial position.
Answer:
Here is a quick reference for the key differences between the balance sheet and income
statement.
Balance sheet Income statement
The income statement provides an

The balance sheet summarizes the
overview of the financial
Time financial position of a company at a
performance of the company over a
specific point in time.
given period.
It includes assets, liabilities and

It includes revenues, expenses and
shareholder’s equity, further
Key items gains and losses realized from the
categorized to provide accurate
sale or disposal of assets.
information.
Ratios, such as gross margins,

It helps assess financial health using
operating margins, price-to-
Financial ratios, such as current ratio, debt-
earnings and interest coverage,
analysis to-equity ratio and return on
paint a picture of financial
shareholder’s equity.
performance.
Management, investors,
Investors and lenders use it to
shareholders and others use it to
Usage determine creditworthiness and
assess the performance and future
availability of assets for collateral.
prospects of a business.
Comparison:
 Purpose: Both statements provide insights into a company's financial performance but focus on
different aspects: the Income Statement on profitability and the Statement of Financial Position
on the financial health and position at a specific time.
 Timeframe: The Income Statement covers a period, while the Statement of Financial Position
represents a specific date.
 Content: The Income Statement showcases revenue, expenses, and net income, while the
Statement of Financial Position lists assets, liabilities, and equity.
Contrast:
 Focus: The Income Statement focuses on the performance of operations, detailing revenue
generation and expenses incurred to derive profitability. The Statement of Financial Position
emphasizes the company's financial position, displaying its assets, liabilities, and equity.
 Time Aspect: The Income Statement captures activities over a period, offering insights into
performance trends. In contrast, the Statement of Financial Position is a snapshot providing a
momentary view.
 Format: The Income Statement's format starts with revenue and concludes with net income (or
loss). The Statement of Financial Position's format maintains the balance between assets and
sources of funds.
In summary, while both statements are vital in assessing a company's financial health, the
Income Statement focuses on performance over time, and the Statement of Financial Position
depicts a company's financial status at a specific date.
2. How do you treat bad debts and provisions for bad debts in the income statement?
Answers:
Bad debts and provisions for bad debts are accounting concepts used to address potential losses
from customers who may not pay their outstanding dues.
They are handled differently on the income statement:
Bad Debts Expense: This is the amount recognized as an expense in the income statement when
it's estimated that a portion of accounts receivable will not be collected. Bad debts are typically
recorded using either the direct write-off method or the allowance method.
Direct Write-Off Method: Under this method, bad debts are recognized as an expense when a
specific receivable is deemed uncollectible. The amount of the uncollectible debt is directly
written off from the accounts receivable and charged as an expense in the income statement.
Allowance Method: With this method, instead of waiting for specific debts to be deemed
uncollectible, a provision for doubtful debts (also called an allowance for bad debts) is
established based on an estimate of potential bad debts within the total accounts receivable.
This provision is recorded as an expense on the income statement, reducing the net income.
Provision for Bad Debts: The provision for bad debts is an estimated amount set aside to cover
potential losses from bad debts. It is listed as an expense on the income statement and
simultaneously reduces the carrying value of accounts receivable on the balance sheet. This
provision is usually calculated based on historical data, industry averages, economic conditions,
and the creditworthiness of customers.
On the income statement, both the bad debts expense and provision for bad debts will reduce
the reported net income for the period. These adjustments are crucial to reflect a more accurate
picture of the company's financial health by accounting for potential losses from unpaid debts.
3. How should prepaid expenses and prepaid income be treated in the statement of financial
position?
Answer:
Prepaid expenses are recorded as assets because they represent future benefits to the company,
while prepaid income is recorded as a liability because it represents an obligation to provide goods
or services in the future. Both are gradually recognized in the income statement over time as they
are utilized or provided.
These entries in the Statement of Financial Position represent a company's financial position by
acknowledging either an advance payment for future benefits (prepaid expenses) or the obligation
to deliver goods or services for which payment has already been received (prepaid income).
Prepaid expenses are recorded as assets on the balance sheet because the company has paid for
services or benefits that it will receive in the future. They are listed under the "Current Assets"
section, specifically under "Prepaid Expenses" or "Prepaid Costs."
Prepaid income is recorded as a liability on the balance sheet because the company owes the
delivery of goods or services for which it has already received payment. It is listed under the
"Current Liabilities" section, often under "Unearned Revenue" or "Deferred Income."

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BUAD 803 ASSIGNMENT 2

Balance sheet Income statement

The income statement provides an

It includes assets, liabilities and

Ratios, such as gross margins,

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