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Income Statement:


  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      
Less other expenses:
Interest expenses 900
Net income       82500

Different Items of Income Statement:


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


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


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

 Sales       24750000
Direct Materials:        
Materials inventory, January 1, 2005   1572400    
Purchases 8420000      
Less purchases returns and allowances 42,000 8378000    

Materials available for use   9950400    
 Less materials inventory, December 31, 2005   1270600    
Direct materials consumed     8679800  
Direct labor     7346400  
Factory overhead:
     Indirect labor 1329300
     Salaries   972000    
     Payroll taxes   489000    
     Power   112000    
     Heat   69200    
     Light   44300    
     Factory supplies   50000    
     Depreciation - factory building   68300    
     Depreciation - machinery   403000    
     Repairs and maintenance   145800    
     Patent amortization   33200    
     Tools and dies used   178600    
     Insurance on building and machinery   21200    
Total manufacturing cost     19942100  
Add work in process inventory, January 1 2005.     2338000  
Total cost to be accounted for     22280100  
Less work in process inventory, December 31 2005.     1303200  
Cost of goods manufactured     20976900  
Add finished goods inventory, January 1, 2005     966100  
Cost of goods available for sale     21943000  
Less finished goods inventory, December 31, 2005.     658000  
Cost of goods sold       21285000
Gross profit       3465000
Less commercial expenses:        
     Marketing expenses   580000    
     Administrative expenses   533750    
Income from operation       2351250
Other income and expenses:        
     Royalties and dividends   167000    
     Gain from sales of plant   12000    
     Interest and debt expenses   129500    
Net addition       49500
Income before income tax       2400750
Less income tax       1064250

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.

Relevant Articles:

Income statement
Cost of Goods Sold Statement
Cost of Goods Manufactured Statement
Balance Sheet - Report Form
Difference between Income Statement and Trading and Profit and Loss Account
Adjustments and their Effect on Financial Statements
Evaluation of Financial Statements




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