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Introduction to Income Statement

The income statement is one of the major financial statements used by accountants and business owners. (The other major financial statements are the balance sheet, statement of cash flows, and the statement of stockholders' equity.) The income statement is sometimes referred to as the profit and loss statement (P&L), statement of operations, or statement of income. We will use income statement and profit and loss statement throughout this explanation. The income statement is important because it shows the profitability of a company during the time interval specified in its heading. The period of time that the statement covers is chosen by the business and will vary. For example, the heading may state:

"For the Three Months Ended December 31, 2011" (The period of October 1 through December 31, 2011.) "The Four Weeks Ended December 27, 2011" (The period of November 29 through December 27, 2011.) "The Fiscal Year Ended June 30, 2012" (The period of July 1, 2011 through June 30, 2012.)

Keep in mind that the income statement shows revenues, expenses, gains, and losses; it does not show cash receipts (money you receive) nor cash disbursements (money you pay out). People pay attention to the profitability of a company for many reasons. For example, if a company was not able to operate profitably—the bottom line of the income statement indicates a net loss—a banker/lender/creditor may be hesitant to extend additional credit to the company. On the other hand, a company that has operated profitably—the bottom line of the income statement indicates a net income— demonstrated its ability to use borrowed and invested funds in a successful manner. A company's ability to operate profitably is important to current lenders and investors, potential lenders and investors, company management, competitors, government agencies, labor unions, and others. The format of the income statement or the profit and loss statement will vary according to the complexity of the business activities. However, most companies will have the following elements in their income statements: A. Revenues and Gains 1. Revenues from primary activities 2. Revenues or income from secondary activities 3. Gains (e.g., gain on the sale of long-term assets, gain on lawsuits) B. Expenses and Losses 1. Expenses involved in primary activities 2. Expenses from secondary activities 3. Losses (e.g., loss on the sale of long-term assets, loss on lawsuits) If the net amount of revenues and gains minus expenses and losses is positive, the bottom line of the profit and loss statement is labeled as net income. If the net amount (or bottom line) is negative, there is a net loss.

service revenues and sales revenues are shown at the top of the income statement in the period they are earned or delivered. For companies providing services. The primary activities of a manufacturer are producing the products and selling them.   . and distributers the revenues generating from their primary activities are referred to as sales revenues or sales. By knowing the difference between receipts and revenues. the March income statement will not show revenues for this transaction. (Keep in mind that all of the examples below assume the accrual basis of accounting. revenues occur (and are reported) when the service is performed (earned). the revenues from their primary services are referred to as service revenues or fees earned. The primary activities of a company that provides services involve acquiring expertise and selling that expertise to clients.000 service on January 31 and gave the customer until March 10 to pay for the service. not 30 days later when the consulting company receives the cash from the client. the retailer has a January receipt—not January revenues. but it does not have revenues because it did not earn the money from performing a service or from a sale of merchandise. revenues occur when money is earned. it has sales revenues because it sold merchandise. not in the period when the cash is collected. The primary activities of a retailer are purchasing merchandise and selling the merchandise. Revenues and Gains 1.000 from its bank by signing a promissory note due in 90 days.000 at the time of the loan. For retailers. the attorney has a receipt. This company will report $400 in revenues on December 31—not because the company had a cash receipt on December 31. Revenues from primary activities are often referred to as operating revenues. Let's reinforce the distinction between revenues and receipts with a few more examples. If merchandise is sold in December. but does not have revenues until some of the research is done. If a company provided a $1. not when the cash is received 30 days later. the company has both a receipt and revenues for that day—it has a cash receipt because it received cash. If a company sells an item to a buyer who immediately pays for it with cash. if a consulting company asks clients to pay within 30 days of receiving their service. (Some people use the word income interchangeably with revenues. Revenues and Gains . When the retailer receives the check in January for the December sale. Similarly.receipts occur when cash is received. wholesalers.) A company performs a $400 service on December 31 and receives the $400 on the very same day (December 31). manufacturers.) It's critical that you don't confuse revenues with receipts.A.000 before beginning to research the client's case. The company will have a receipt of $10. revenues occur (and are reported) when the merchandise is sold to the buyer. When the money is actually received in March. Put simply. If an attorney requires a client to prepay $1.000. but because the service was performed (earned) on that day. we make certain that revenues from a transaction are reported only once—when the primary activities have been completed (and not necessarily when the cash is collected). if a retailer gives customers 30 days to pay.)  A company borrows $10. the sale is reported on the December income statement. (In March the company will report a receipt of cash and a reduction/collection of an accounts receivable. Under the accrual basis of accounting. For example. the company's January income statement will show revenues of $1.

the gain will appear in a section on the income statement labeled as "nonoperating gains" or "other income". Don't confuse revenues with receipts— Revenues (operating and nonoperating) occur when a sale is made or when they are earned.500. the cost of the car was being depreciated on the company's accounting records and as a result. or lawsuits result from a transaction that is outside of the primary activities of most businesses. . Since this retailer is not in the business of buying and selling cars.000 before you agree to schedule the work for January. This means that the company must report a gain equal to the amount of the difference—in this case. A gain occurs when the proceeds are more than the book value.000. As a result the revenues are reported on the income statement separate from its primary activity of sales or service revenues.) Your consulting company will report the $1. when a retail business earns interest on some of its idle cash.500). 3. nonoperating revenues are reported on the profit and loss statement during the period when they are earned.500 service in January. Although your consulting company has a receipt of $1. Instead. the sale of the car is outside of the retailer's primary activities. so to be on the safe side you ask for an immediate partial payment of $1. (In December your company will record a liability of $1. Consider this example: Assume that a clothing retailer decides to dispose of the company's car and sells it for $6. Receipts occur when cash is received/collected. not when the cash is collected. Over the years. A gain is reported on the income statement as the net of two amounts: the proceeds received from the sale of a long-term asset minus the amount listed for that item on the company's books (book value).000 of services in January. These are the amounts a business earns outside of purchasing and selling goods and services.000. Revenues from secondary activities are often referred to as nonoperating revenues.000 received for the car (the proceeds from the disposal of the car) will not be included with sales revenues since the account Sales is used only for the sale of merchandise. As is true with operating revenues. it does not have revenues in December. the money received for the car ($6. The $6.000) was greater than the net amount shown for the car on the accounting records ($3. This gain should not be reported as sales revenues. or earns rent from some vacant space. 2. a new client asks your consulting company to provide a $2. Revenues are frequently earned and reported on the income statement prior to receiving the cash.000 in December. the gain is reported as $2. these revenues result from an activity outside of buying and selling merchandise.000 of revenues when it performs $1. On December 10. The gain is reported in the period when the disposal occurred. You are uncertain as to whether or not this client is credit worthy. nor should it be shown as part of the merchandiser's primary activities. For example. Gains such as the gain on the sale of long-term assets.

The other expenses involved in their primary activities will either be grouped together as operating expenses or subdivided into the categories "selling" and "administrative. In the same way. the cost of goods sold and expenses are matched to sales and/or the accounting period when they are used. not the period in which they are paid. some expenses occur afterthe company has paid for them. utilities. regardless of when the commission is actually paid.000 in each of the years 2012 through 2041. wages earned by employees. a company might pay $20. The income statements or profit and loss statements of merchandisers and manufacturers will use a separate line for the cost of goods sold. office salaries expense. Under the accrual basis of accounting sales commissions expense should appear on the income statement in the same period that the related sales are reported. However. This payment will reduce the company's cash and its liability to the bank.. the cost of goods sold is matched with the related sales on the income statement.000 to the bank to reduce its bank loan. and sales commissions). and depreciation expense. Costs used up (or expiring) in the accounting period shown in the heading of the income statement are also considered to be expenses of that period. Cash payments do not always mean that an expense has occurred. employee bonuses and vacations. but it is not an expense. Some expenses are matched against sales on the income statement because there is a cause and effect linkage—the sale of the merchandise caused the cost of goods sold and the sales commission expense. For example. 2011 but it will record depreciation expense of $10. even if the utility's meters are not read until January 1 and the bill is paid on February 1. The above examples reflect the matching principle and show that under the accrual basis of accounting. The company paid cash for the building on December 31. let's say a company buys a building on December 31." . For example. 2011 for $300. Other expenses are not directly linked to sales and as a result they are matched to the accounting period when they are consumed or used—examples include utilities expense.B.g. expenses on the income statement are likely to be reported at different times than the cash expenditures/disbursements. regardless of when the supplier of the merchandise is paid. they are reported as expenses as soon as they occur. Some expenses such as advertising expense and research and development expense can neither be linked with sales nor a specific accounting period and as a result. For example. The building is assumed to have a useful life of 30 years. It is common for expenses to occur before the company pays for them (e. Expenses and Losses 1. the utilities used in a retail store in December should appear on the December income statement. Expenses involved in primary activities are expenses that are incurred in order to earn normal operating revenues. Under the accrual basis of accounting.000 (excluding the cost of land).

An accountant is not allowed the luxury of waiting until things are known with certainty. The income statement covers a past period of time. In order to recognize revenues when they are earned. and losses. For example. the expenses shown on the income statement reflect old costs. The income statement does not show cash receipts and cash disbursements. This is less than the $3. Losses such as the loss from the sale of long-term assets. Expenses Do Not Equal Economic Reality. however. The income statement or profit and loss statement shows revenues. rather than the primary activities of buying/producing and selling. Using Estimates. assume that a company is operating a forty-year-old manufacturing plant that had a cost of $400. but if it does not produce a similarly successful item for thenext holiday season. Instead. or match expenses with revenues. 3. Additional Considerations Additional Considerations Then vs. recognize expenses when they are incurred. interest expense is a nonoperating expense because it involves the finance function of the business. and the loss experienced on the sale of the car ($700) will not be included in operating expenses. accountants must often use estimates. or the loss on lawsuits result from a transaction that is outside of a business's primary activities. prohibits showing the depreciation based on the cost of a new plant. expenses. the $700 loss will appear in a section on the income statement labeled "nonoperating gains or losses" or "other income or losses".000 per year. The cost principle. For example. a company supplying a high-demand fad item for the recent holiday season may have had a great year financially.2. Expenses from secondary activities are referred to as nonoperating expenses.000.000 today and the depreciation expense on the new plant might be $130. Now.800.500 amount shown in the company's accounting records. A loss is reported as the net of two amounts: the amount listed for the item on the company's books (book value) minus the proceeds received from the sale. The single-step format uses only one subtraction to arrive at net income. Single-Step Income Statement A single-step income statement is one of two commonly used formats for the income statement or profit and loss statement. For example. . Since this retailer is not in the business of buying and selling cars (the sale of the car is outside of the operating activities of buying and selling clothing). A loss occurs when the proceeds are less than the book value. the money received for the car will not be included in sales revenues. The cost of a new plant might be $4. and the past may or may not be indicative of the future. Let's assume that a clothing retailer decides to dispose of the company's car.000. gains. The loss is reported in the time period when the disposal occurs. The proceeds from the disposal are $2. The depreciation expense for this plant may be zero on the current income statement because the plant was depreciated over 30 years. it may experience a poor year financially. Because of the cost principle and inflation.

000 $ 18." "Quarter Ended May 31.000 $ 18.500 2. 2012 Revenues & Gains Sales Revenues Interest Revenues Gain on Sale of Assets Total Revenue & Gains Expenses & Losses Cost of Goods Sold Commissions Expense Office Supplies Expense Office Equipment Expense Advertising Expense Interest Expense Loss from Lawsuit Total Expenses & Losses Net Income $100. followed by the title "Income Statement.000 Multiple-Step Income Statement . Income Statement For the Five Months Ended May 31.000 90.000 3.Net Income = (Revenues + Gains) – (Expenses + Losses) An extremely condensed income statement in the single-step format would look like this: Sample Products Co.500 2.500 90.000 108." The third line tells the reader the time interval reported on the profit and loss statement. or "Five Weeks Ended May 31".000 5." "Month Ended May 31.000 75. Income Statement For the Five Months Ended May 31.000 3.000 The heading of the income statement conveys critical information. Since income statements can be prepared for any period of time. you must inform the reader of the precise period of time being covered." "Five Months Ended May 31. (For example. 2012 Revenues & Gains Expenses & Losses Net Income $108.) A sample income statement in the single-step format would look like this: Sample Products Co.000 5.000 500 1. an income statement may cover any one of the following time periods: "Year Ended May 31. The name of the company appears first.

The multiple-step income statement also shows the gross profit (net sales minus the cost of goods sold). Income Statement For the Five Months Ended May 31. Here is a sample income statement in the multiple-step format: Sample Products Co.500) 6. The multiple-step profit and loss statement segregates the operating revenues and operating expenses from the nonoperating revenues.500 7.000 5.000 3. because it uses multiple subtractions in computing the net income shown on the bottom line. we see that there are three steps needed to arrive at the bottom line Net Income: .000 3.000 25. 2012 Sales Cost of Goods Sold Gross Profit Operating Expenses Selling Expenses Advertising Expense Commissions Expense Administrative Expenses Office Supplies Expense Office Equipment Expense Total Operating Expenses Operating Income Non-Operating or Other Interest Revenues Gain on Sale of Investments Interest Expense Loss from Lawsuit Total Non-Operating Net Income $100. gains.000 Using the above multiple-step income statement as an example.500 2.000 12. nonoperating expenses. and losses.000 6.000 2.000 (500) (1.000 $ 18.000 75.An alternative to the single-step income statement is the multiple-step income statement.000 13.000 5.

Cost of goods sold is subtracted from net sales to arrive at the gross profit.000 Step 3. 3.000 $18.000 + + Non-Operating Items $6. gains.000 There are three benefits to using a multiple-step income statement instead of a single-step income statement: 1. If the net amount is positive. it is labeled as net income. 2. The multiple-step income statement presents the subtotal operating income. Reporting Unusual Items ncome statements (whether single-step or multiple-step) report nearly all revenues.000 $25. Operating Income Operating Income Operating Income = = = Gross Profit $25.Step 1. The multiple-step income statement clearly states the gross profit amount.000 $12. Operating expenses are subtracted from gross profit to arrive at operating income.000 Step 2.000 – – Cost of Goods Sold $75. and losses. gains. it is labeled as net loss. expenses. . Gross Profit Gross Profit Gross Profit = = = Net Sales $100. If the net amount is negative. Many readers of financial statements monitor a company's gross margin (gross profit as a percentage of net sales). nonoperating expenses and losses is combined with the operating income to arrive at the net income or net loss. Readers may compare a company's gross margin to its past gross margins and to the gross margins of the industry. The bottom line of a multiple-step income statement reports the net amount for all the items on the income statement.000 – – Operating Expenses $13. Net Income Net Income Net Income = = = Operating Income $12. which indicates the profit earned from the company's primary activities of buying and selling merchandise. The net amount of nonoperating revenues.

an extraordinary loss would be reduced by the income tax savings associated with the loss. Discontinued operations pertains to the elimination of a significant part of a company's business. Extraordinary items includes things that are unusual in nature and infrequent in occurrence. such as the sale of an entire division of the company. Two additional examples of situations that do not qualify as extraordinary items are (1) the loss from frost damage to a Florida citrus crop and (2) the write-down of inventory from cost to a lower amount. and it is highly unlikely that a company will have both. 1.000 cannot be shown as an extraordinary item since it is not unusual in nature for a strike to occur. However. Below is an example of a single-step income statement containing an extraordinary item. (Eliminating a small portion of product line does not qualify as a discontinued operation. These unique or rare items are: 1. they do not belong in the section containing extraordinary items. (If this were a corporation. A loss due to a foreign country taking over a U. if a company suffers a $40.Sometimes rare or extraordinary events will occur during the income statement's time interval along with the normally recurring events. oil refinery in that country would be an extraordinary item. It's helpful to the reader of the statement if these unique items are segregated into a special section near the bottom of either the single-step or multiple-step income statement. . it can however be shown as a separate line item. A loss due to an earthquake in Wisconsin would certainly be extraordinary. If an item is unique and significant but it does not meet the criteria for being both "unusual and infrequent. the $40. Discontinued Operations 2.) 2. it's not unusual for items in inventory to have a current value lower than its cost. Similarly. unusual. Although these things maybe significant.000 loss due to a strike by its workers. Apparently the frost in Florida is not unusual in nature and not infrequent.000 may be shown as a separate line item. it's required that you present them in the same order as they appear above. it is rare for a company to have either one of these items." the item must remain in the main section of the income statement.S. Extraordinary Items When recording these items near the bottom of an income statement. For example. income tax expenses would be part of the income statement and an extraordinary gain would be reduced by the income tax expense associated with the gain.) See net of tax. but it must be positioned in the main portion of the income statement. The $40. and important.

000 7.000 5.000 3.000 108. The same would be true for discontinued operations. income tax expenses would be part of the income statement.000 18.500 2.500 90.500 2. the extraordinary item is separated out and added to the end of the income statement.Gain Net Income $100.000 500 1. the two unique items would be reduced by the income tax effect associated with each item.) . (If this were a corporation.000 3.000 $ 25. Below is a multiple-step income statement containing discontinued operations and an extraordinary item.000 75.000 Note that even in a single-step format shown above. 2012 Revenues & Gains Sales Interest Revenues Gain on Sale of Assets Total Revenue & Gains Expenses & Losses Cost of Goods Sold Commissions Expense Office Supplies Expense Office Equipment Expense Advertising Expense Interest Expense Loss from Lawsuit Total Expenses & Gains Income Before Extraordinary Extraordinary Item .000 5. Income Statement For the Five Months Ended May 31.Sample Products Co.

Earnings Per Share of Common Stock .000 5.000 2.000 12.Sample Products Co.000 6.000 13.500 7.000 (500) (1. Income Statement For the Five Months Ended May 31.000) 7.000 3.000 75.000 Note that the two unique items are shown near the bottom of the income statement.500 2. This is where the items should appear on both single-step and multiple-step statements.000 3. 2012 Sales Cost of Goods Sold Gross Profit Operating Expenses Selling Expenses Advertising Expense Commissions Expense Administrative Expenses Office Supplies Expense Office Equipment Expense Total Operating Expenses Operating Income Non-Operating or Other Interest Revenues Gain on Sale of Investments Interest Expense Loss from Lawsuit Total Non-Operating Income before Disc Op and Extraordinary Item Discontinued Operations Extraordinary Item Net Income $100.000 $ 21.000 5.000 (4.500) 6.000 25.000 18.

Income Statement in Contribution Margin Format For the Five Months Ended May 31. 2012 Product Line 1 $70. might prefer other formats when the profit and loss statement remains inside the company.000 50.000 15. It is common for the notes to the financial statements of large companies to be 10-20 pages in length.000 5.000 80.000 11.000 Product Line 2 $30.000 Total Sales Variable Expenses Cost of Goods Sold Commissions Expense Total Variable Expenses Contribution Margin Fixed Expenses . commitments made by the company.000 14. however. The company's management.If the business is a corporation with common stock that is publicly traded. Such a format may provide insight on how the company's profits change as sales change. Look at the notes near the end of the annual report.000 5. it is required that the net income. This type of internal income statement is shown below (and columns have been added to show the amounts by product line). The notes contain information that is critical to properly understanding and analyzing a company's financial statements. discontinued operations. This format also shows the total amount offixed expenses (those expenses that will not change as sales change).000 75. and extraordinary items be shown on the income statement on an aftertax. and potential liabilities and potential losses.000 6.000 2.000 .000 20.000 5.000 0 25. Line Subtotal $100. per-share basis. Example Products Co.000 25. The notes inform the readers about such things as significant accounting policies. For example. Go to the website for a company whose stock is publicly traded and locate its annual report. a company might want to prepare an income statement—for inside the company only—that focuses on the contribution margin instead of the gross profit or gross margin.000 55. Notes To Financial Statements The notes (or footnotes) to the income statement and to the other financial statements are considered to be part of the financial statements.000 3. Other Income Statement Formats The single-step and multiple-step income statement formats are the required formats when the statement is distributed to people and places outside of the company.Prod.000 4.

In other words they cannot be traced directly to Product Line 1 or Product Line 2. the expenses are not arbitrarily divided up between the product lines.000 of fixed expenses are common to both product lines.000 As you can see above. It is shown here to let you know that income statement formats other than the single-step and multiple-step are permissible when they stay within a company.Fixed Expenses . Remember that this format is not acceptable for distribution outside of the company—its accessibility should be limited to the members of the company's management. $2. not financial accounting. this type of income statement is usually covered as part of managerial accounting. Rather than mislead someone.Common Operating Income 2. .000 $12. In fact. and may prove very useful to a company's managers.