The income statement, sometimes called an earnings statement or profit and loss statement, reports the profitability of a business organization for a stated time. In accounting, we measure profitability for a period, such as a month or a year, by comparing the revenues earned with the expenses incurred to produce these revenues. The income statement is the first financial statement prepared, as you will need the information from this financial statement for the remaining financial statements. The income statement contains the following:
- Revenues are the inflows of cash resulting from the sale of products or the rendering of services to customers. We measure revenues by the prices agreed on in the exchanges in which a business delivers goods or renders services.
- Expenses are the costs incurred to produce revenues. Expenses are costs of doing business (typically identified as accounts ending in the word expense).
- Net income is often called the earnings of the company. When expenses exceed revenues, the business has a net loss.
revenues − expenses = net income
Below is a sample income statement from the fictional company, Metro Courier Inc.
Revenue |
||
---|---|---|
Service revenue |
$ 60,000 |
|
Total revenues |
$ 60,000 |
|
Expenses |
||
Salary expense |
$900 |
|
Utility expense |
$1, 200 |
|
Total expenses |
$2,100 |
|
Net income ($60,000 – $2,100) |
$ 57,900 |
The main content of an income statement is rather straightforward: a listing of all revenues earned and expenses incurred by the reporting organization during the period specified. Revenue figures disclose increases in net assets (assets minus liabilities) that were created by the sale of goods or services resulting from the primary operations of the organization. For IBM, revenues are derived from the sale and servicing of computers and the like (a total of nearly $104 billion in 2008) while, for Papa John’s International, the reported revenue figure (a bit over $1.1 billion) measures the sale of pizzas and related items.
Conversely, expenses are decreases in net assets incurred by a reporting company in hopes of generating revenues. For example, salaries paid to salespeople for the work they have done constitute an expense. The cost of facilities that have been rented is also an expense as is money paid for utilities, such as electricity, heat, and water.
For example, IBM reported selling, general, and administrative expenses for 2008 of $23.4 billion. That was just one category of its expenses disclosed within the company’s income statement. During the same period, Papa John’s reported salaries and benefits as an expense for its domestic company-owned restaurants of $158.3 million. Financial accounting focuses on providing information about an organization, and both of these figures should help decision-makers begin to glimpse a portrait of the underlying company. Accounting is often said to ensure transparency—the ability to see straight through the words and numbers to gain a vision of the company and its operations.
An income statement also reports gains and losses for the same time period. A gain is an increase in the net assets of an organization created by an occurrence outside its primary or central operations. A loss is a decrease in net assets from a similar type of incidental event.
When Apple sells a computer to a customer, it reports revenue, but if the company disposes of a piece of land adjacent to a warehouse, it reports a gain (if sold above cost) or a loss (if sold below cost). Selling computers fall within Apple’s primary operations, whereas selling land does not. If Pizza Hut sells a pepperoni pizza, the transaction brings in assets. Revenue has been earned and should be reported. If this same company disposes of one of its old stoves, the result is reflected as either a gain or loss. Pizza Hut is not in the business of selling appliances. This classification split between revenues and expenses, and gains and losses help provide decision-makers with a more precise portrait of what happened to the company during the reporting period.
An example of an income statement for a small convenience store is shown in the figure below. Note that the name of the company, the type of financial statement, and the time period reflected are apparent. Although this is only an illustration, it is quite similar to the income statements created by virtually all business organizations in the United States and many other countries.
Revenues |
||
---|---|---|
Sales of groceries |
$1,400,000 |
|
Expenses |
||
Cost of goods sold |
$900,000 |
|
Salary |
$120,000 |
|
Rent |
$20,000 |
|
Advertising |
$30,000+ |
|
Insurance |
$15,000 |
|
Others |
$25,000 |
|
Total expenses |
($1,110,000) |
|
Operating income |
$290,000 |
|
Other gains and losses |
||
Gain on sale of delivery truck |
$5,000 |
|
Loss on sale of land behind building |
($15,000) |
($10,000) |
Income before income taxes |
$280,000 |
|
Income tax expense |
($50,000) |
|
Net income |
$230,000 |
A review of this sample income statement raises several questions. The meaning of balances, such as salary expense, rent expense, advertising expense, and the like are relatively clear. These figures measure specific outflows or decreases in the company’s net assets that were incurred in attempting to generate revenue.
The difference in revenue and cost of goods sold is often referred to as the company’s gross profit, gross margin, or markup. It is one of the reported figures studied carefully by decision-makers. For this year, Davidson Groceries earned a gross profit of $500,000 ($1.4 million in revenues less $900,000 cost of goods sold). Its gross profit was 35.7 percent of sales ($500,000/$1.4 million).
For the year ending January 30, 2009, Lowe’s Companies Inc., the home improvement company, reported net sales revenues of $48.2 billion along with the cost of sales of $31.7 billion. Thus, Lowe’s earned a gross margin (the company’s term) during that period of $16.5 billion. Sales of merchandise ($48.2 billion) exceeded the cost of those same goods ($31.7 billion) by that amount. Its gross profit percentage was 34.2 percent ($16.5 million/$48.2 million). Any potential investor or creditor will find such numbers highly informative, especially when compared with the company’s prior years or with competing enterprises. For example, for the year ending February 1, 2009, the Home Depot Inc., a major competitor of Lowe’s Companies, reported net sales of $71.3 billion, cost of sales of $47.3 billion, and gross profit (the company’s term) of $24.0 billion. Its gross profit percentage was 33.7 percent ($24.0 million/$71.3 million). Such information allows decision-makers to compare these two companies and their operations.
In the Income Statement table above, revenues and expenses are listed first to arrive at an operating income figure, which is followed by gains and losses. This sequencing is appropriate since revenues and expenses relate to the primary or central operations of the business and gains and losses are created by more incidental events. Why then is income tax expense listed last, by itself, on the income statement and not with the other expenses?
State and federal income taxes cost businesses in the United States considerable sums of money each year. Exxon Mobil Corporation reported income taxes of $36.5 billion at the bottom of its 2008 income statement. The income tax figure is segregated in this manner because it is not an expense in a traditional sense. As previously described, an expense—like cost of goods sold, advertising, or rent—is incurred to generate revenues. Income taxes do not create revenues at all. Instead, they are caused by the company’s revenues and related profitability. Although referring to income taxes as an expense is common, probably a more apt title is income taxes assessed by the government. The financial impact is the same as an expense (an outflow or decrease in net assets); thus, income tax expense is often used for labeling purposes. However, because the nature of this expense is different, the reported income tax figure is frequently isolated at the bottom of the income statement, separate from true expenses.
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Financial Statements from Financial Accounting by Lumen Learning is available under a Creative Commons Attribution 4.0 International license. UMGC has modified this work and it is available under the original license.
3.1 The Construction of an Income Statement from Financial Accounting by the University of Minnesota Libraries Publishing is an adaptation of a work whose original author and publisher request anonymity and is available under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International license. © 2015, University of Minnesota. UMGC has modified this work and it is available under the original license.
Financial Accounting: Multi-Step Income Statement by Dave Alldredge from YouTube is available under a Creative Commons Attribution 3.0 Unported license. UMGC has modified this work and it is available under the original license.
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