Income Statement

Key Things To Know

Revenues:

Provide goods or services to customers in return for an asset (cash)

The revenue principle: 4 criteria that must be met for revenue to be recognized

1) Delivery of goods has occurred or a service has been rendered

2) Persuasive evidence of arrangement for customer payment

3) The price is fixed and determinable

4) Collection is reasonably assured

Revenue is NOT recognized when cash is received.

Expenses:

Use an asset to generate revenues, “incurred” when

1) an asset is used up

2) a service is provided to the company that must be paid for

Expenses are recognized when incurred, NOT when they are paid

(Recognize means to record and report in the financial statements)

The Matching Principle:

Expenses incurred to generate revenues must be recognized in the same period as the revenue

examples:

Wages and salary expense is recorded for the period the employees work to produce revenues

Depreciation expense is recorded for the period the long term asset is used to produce revenues

Interest expense is recorded for the period the money is used to produce revenues

Utility expense is recorded for the period the utilities are used to produce revenues

Bad debt expense is recorded in the period the sale occurred

Revenues are recorded when earned and expenses are recorded when incurred to produce the revenues.

Accrual Basis of Accounting:

Revenues are recorded when earned and expenses are recorded when incurred.

When the cash is received or paid DOES NOT Matter

Format of the Single Step Income Statement: For a period of time

List all revenues and subtotal, list all expenses and subtotal:

Sales
Interest income
Rent income
Total revenues

Cost of Goods sold
Selling expenses
Administrative expenses
Interest expense
Rent expense
– Total expenses

= Net Income

Format of the Multi-Step Income Statement: For a period of time

Sales
– Cost of Goods Sold
= Gross Profit
– Operating Expenses:
General and Administrative
Selling
Research & Development
Restructuring
= Operating Income
+ – Other Revenues & Expenses:
Interest Income or Expense
Rent Income
Unusual Gains and Losses
Realized/Unrealized Gains/Losses on Investments
Gain/loss on Sale of an Asset
= Income Before Taxes:
– Tax Expense
= Income from Continuing Operations
+ – Discontinued Operations:

= Net Income

Terms related to the income statement:

Gross Profit:

Sales price less the cost to buy or manufacture the goods sold

This is the profit made from selling inventory only.

This profit is used to pay operating expenses

Operating Expenses:

Directly related to day to day business operations

Related to:

1) Selling – sales employees, marketing, advertising

2) Administrative – expenses to run the organization

3) Research & Development – to develop new products

4) Restructuring of operations – to reduce future expenses

Operating Income:

Sales less Cost of Goods Sold less Operating expenses

This is what is earned from day to day business that is expected to continue in the future as the business continues

Other Revenues/Expenses:

The result of a transaction that is not part of your primary day to day business

Examples:

Interest expense: a cost of borrowing money

Gains/Losses: resulting from selling assets you no longer use or disposal or destruction of an asset

Rent Income: earn from leasing excess space, not your primary business

Interest income: earn from excess cash, not your primary business

Dividend income: earn from investing excess cash when investing is not your primary business

Tax Expense:

Reported separately. Not an expense that management can control since it is government-mandated.

Income from Continuing Operations:

An indication of income that can be earned in future years – used for trend analysis

Discontinued Operations:

Selling or disposing of a major part of the business
– product line -geographic area

Net Income:

Total earnings of the company for this period

Cash Basis vs. Accrual Basis

Cash Basis:

Revenues: record when cash is received for providing goods or services

Expenses: record when cash is paid for something provided to the company
– can be an asset or a service

Accrual Basis:

Revenues: recorded when earned, the goods or services are provided

Expenses: recorded when incurred; use up an asset or a service was provided to the company

GAAP requires the accrual basis of accounting in order to follow the matching principle

When cash is paid or received does not matter

Revenues are recorded when earned

Expenses are recorded when incurred