Question

Consider a firm Theta that spends $60 to produce goods in year 1. In year 2 it sells these goods for $100, but its customers pay their bills with a delay, therefore the payment is not received until year 3. What's the amount of net income recorded on the income statement for each year?

Answer 1

Answer:

Theta

Amount of net income for each year:

Year 1 = $0

Year 2 = $40 ($100 - $60)

Year 3 = $0

Explanation:

The net income to be recorded in Theta's income statement depends on the period in which revenue is recorded.  In year 1, Theta would accumulated Ending Inventory of $60 being the cost of its finished goods inventory.  Since it has not made any sales, there is no net income to record, which is always the difference between revenue and cost of goods or services sold.  In year 2, the actual sales revenue was made and recorded in the accounts.  This is the period for Theta to calculate its profit against the cost of goods sold.  In year 3 when cash payment was received from customers, the accounts of Theta would record the receipt only in settlement of the customer debt.  This transaction does not affect the revenue or the cost of goods sold, two important elements for determining the profit made.