Income Statement:

Contents:

1. Definition and Explanation

2. Format of Income Statement

3. Different Items of Income Statement

4. Income Statement of Manufacturing Companies

5. Service Enterprises

Definition and Explanation:

An income statement shows the results of operating for a period of time. It is sometimes called operating statement or statement of operations. It shows how well an organization performed during the period covered.

The term revenue, expense and profit should be somewhat familiar to you already. Revenue is the inflow of assets in return for services performed or products delivered during a period; an expense is a sacrifice, or cost incurred to generate (produce) revenue; net profit is simply the amount by which the revenues for a particular period of time exceed the expenses incurred to generate them.

Revenue generally considered earned when services are performed or goods are sold, regardless of when money is actually received. In other words, revenues are identified with the period in which they are earned. For example, a retail trader earns revenue when a sale is made on credit. A right to receive money is recognized as account receivable. An account receivable (debtor a/c) is an asset that will eventually be converted to cash.

Expenses are also recognized in the period that is benefited, regardless of when payment is made in cash. For example, salaries earned by employees are considered  an expense of the period in which employees work, even though they may not be paid in cash until the following period. Thus the amount by which the revenues for a particular period of time exceed the expenses incurred to generate them is called net income or net profit.

For example suppose during the month of January, a trader has a total revenue (sales) of $55,000 and has incurred total expenses of $46,000, his net income will be $9,000 (55,000 - 46,000) for the month of January.

Thus an income statement is a statement in which revenues for a period of time are matched with expenses for the same period of time. If revenues exceed the expenses, the result is net income, and if expenses exceed the revenues, the result is net loss. The format of income statement varies with the needs of users, preferences of accountants and other circumstances.

Format of Income Statement:

The format of a common income statement is given below:

Name of Business
Income Statement
For the year ended......
 

	$	$	$	$
Sales			525000
Less: Sales discount		6500
Sales returns and allowances		8500	15000
Net sales				510,000
Less Cost of Goods Sold:
Merchandise inventory opening			35,000
Purchases		320,000
Less: Purchase discounts	5,000
Purchase returns and allowances	3,000	8,000
Net purchases		312,000
Plus carriage inwards		1,2500
Delivered cost of net purchases			324,500
Cost of goods available for sale			359,500
Less merchandise inventory			37,500
Cost of goods sold				322000
Gross profit				188,000
Less Operating Expenses:
salaries			91,600
Advertising			7000
Depreciation			8500
Total Operating expenses				107100
Net operating income				80,900
Plus Other revenues:				2500
Commission received
				83,400
Less other expenses:
Interest expenses				900
Net income				82500

Different Items of Income Statement:

Sales:

It is the gross amount of goods sold or services rendered during an accounting period.

Net Sales:

When sales discount, sales returns and allowances to customers are deducted or subtracted from gross sales the result is net sales.

Cost of Goods Sold:

It represents the sum of the costs of all goods which have been sold during the accounting period. It is ascertained by adding the value of unsold goods at the beginning of the year (opening inventory or stock) to the purchases made during the year and the deducting the values of unsold goods at the end of the year (closing inventory of stock) from the purchases. Theses are expired costs, and thus are actual expenses for the year.

Gross Profit:

Goods are normally sold at a price that is more than the cost price. Gross profit or gross margin is what remains after cost of goods sold is deducted from net sales. This is the margin that is available to cove the other expenses for a period and to yield net income, if there is any.

Gross Profit = Net sales - Cost of goods sold

Operating Expenses:

Merchandising or trading concerns incur operating expenses in addition to cost of goods sold. So, the expenses which are incurred for the generation of revenues from the sales of goods are called operating expenses. Operating expenses may be divided into two:

1. Selling Expenses: All expenses regarding sale of goods and sending them to the buyer belong to this class e.g. Carriage outwards, advertisements, salesmen's salaries, sales commission, traveling expenses, bad debts, packaging expenses etc.
2. Administrative Expenses: All expenses connected with the office and its conduct are called administrative expenses. Examples of administrative expenses include office salaries, office rent, electric charges, postage and telegrams, telephones, printing and stationary etc.

Net Operating Income:

Operating expenses are deducted from gross profit to arrive at net operating income. Net operating income is what is left after both cost of goods sold and operating expenses for a period have been deducted from net sales. For a merchandising concern, it is what has been earned from the normal operations of buying and selling merchandises.

Net operating income = Gross profit - operating expenses

OR

Net operating income = Net sales - Cost of goods sold - Operating expenses

Other Revenues and Expenses:

Non-sales revenues (which have not been earned by selling merchandise) and non-operating expenses are reported towards the bottom of an income statement under the heading, other revenues and expenses. Included in the revenues are revenue from rentals (rent received), interest income, gain on loss of assets other than merchandise and other miscellaneous revenue items. Under other expenses are interest on borrowed money, loss on sales of assets other than merchandise, and other non-operating expenses and losses.

Net Income:

Other revenues are added to an other expenses are deducted from net operating income to arrive at net income. Net income is what is left after the other revenues have been added to net operating income and other expenses have been deducted from it.

Net income = Net operating income - Other revenues - Other expenses

Or

Net operating income = Net sales - Cost of goods sold - Operating expenses + Other revenues - Other expenses

Income Statement of Manufacturing Companies:

There is a small difference between the income statement prepared by manufacturing companies and income statement prepared by merchandising companies. Manufacturing companies also calculate cost of goods manufactured in their income statement. This calculation is not required by merchandising companies.

Following is an example of the income statement of a manufacturing company:

Income Statement
For the year ended 31st December, 2005

Income Statement for Service Enterprises:

Service enterprises are the business concerns which are engaged to perform or provide services only. They do not deal with the purchase and sale of merchandise (goods). Their major source of revenue is fees, commission, rent or interest etc. which they receive from their customers or clients against the services provided to them. For example doctors, lawyers, chartered firms, workshops etc.

The income statement for a service enterprise is prepared in the same way as we prepare for merchandising concerns except that the nature of revenues and expenses is different.

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