The conditions for revenue recognition are (a) an exchange transaction, and

(b) the earnings process being complete.

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The income statement is a financial statement that is used to help determine

the past financial performance of the enterprise, predict future performance,
and assess the capability of generating future cash flows . It is also known as
the profit and loss statement (P&L), statement of operations, or statement of
earnings.

A Sample Income Statement

Expenses are listed on a company's income statement.

The income statement consists of revenues (money received from the sale of
products and services, before expenses are taken out, also known as the "top
line") and expenses, along with the resulting net income or loss over a period
of time due to earning activities. Net income (the "bottom line") is the result
after all revenues and expenses have been accounted for. The income
statement reflects a company's performance over a period of time. This is in
contrast to the balance sheet, which represents a single moment in time.

Methods for Constructing the Income Statement

The income statement can be prepared in one of two methods: single or
multi-step.

The Single Step income statement totals revenues, then subtracts all
expenses to find the bottom line.

The more complex Multi-Step income statement (as the name implies) takes
several steps to find the bottom line. First, operating expenses are subtracted
from gross profit. This yields income from operations. Then other revenues
are added and other expenses are subtracted. This yields income before
taxes. The final step is to deduct taxes, which finally produces the net income
for the period measured.

Operating Revenues and Expenses

The operating section includes revenue and expenses. Revenue consists of
cash inflows or other enhancements of the assets of an entity. It is often
referred to as gross revenue or sales revenue. Expenses consist of cash
outflows or other using-up of assets or incurrence of liabilities.

Elements of expenses include:

Cost of Goods Sold (COGS): the direct costs attributable to goods produced
and sold by a business. It includes items such as material costs and direct
labor.
Selling, General and Administrative Expenses (SG&A): combined payroll
costs, except for what has been included as direct labor.
Depreciation and amortization: charges with respect to fixed assets
(depreciation) and intangible assets (amortization) that have been capitalized
on the balance sheet for a specific accounting period.
Research & Development (R&D): expenses included in research and
development of products.
Non-operating Revenues and Expenses
The non-operating section includes revenues and gains from non- primary
business activities (such as rent or patent income); expenses or losses not
related to primary business operations (such as foreign exchange losses);
gains that are either unusual or infrequent, but not both; finance costs (costs
of borrowing, such as interest expense); and income tax expense.

In essence, if an activity is not a part of making or selling the products or

services, but still affects the income of the business, it is a non-operating
revenue or expense.

Reading the Income Statement

Certain items must be disclosed separately in the notes if it is material
(significant). This could include items such as restructurings, discontinued

operations, and disposals of investments or of property, plant and equipment.

Irregular items are reported separately so that users can better predict future
cash flows.

The "bottom line" of an income statementoften, literally the last line of the
statementis the net income that is calculated after subtracting the
expenses from revenue. It is important to investors as it represents the profit
for the year attributable to the shareholders. For companies with
shareholders, earnings per share (EPS) are also an important metric and are
required to be disclosed on the income statement.
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The Balance Sheet

In financial accounting, a balance sheet is a snapshot of a company's (sole
proprietorship, a business partnership, a corporation, or other business
organization, such as an LLC or an LLP) financial situation. Assets, liabilities,
and ownership equity are listed as of a specific date, such as the end of the
company's financial year. Of the four basic financial statements, the balance
sheet is the only statement which applies to a single point in time of a
business' calendar year. A standard company balance sheet has three parts:
assets, liabilities, and ownership equity. The main categories of assets are
usually listed first, and typically in order of liquidity. Assets are followed by
the liabilities. The difference between the assets and the liabilities is known
as the equity (or the net assets, or the net worth, or capital) of the company,
and according to the accounting equation, net worth must equal assets minus
liabilities.

Another way to look at the same equation is that assets equals liabilities plus
owner's equity. Looking at the equation in this way shows how assets were
financed: either by borrowing money (liability) or by using the owner's money
(owner's equity). Balance sheets are usually presented with assets in one
section and liabilities and net worth in the other section with the two sections
"balancing. "

A business operating entirely in cash can measure its profits by withdrawing

the entire bank balance at the end of the period, plus any cash in hand.
However, many businesses are not paid immediately; they build up

inventories of goods and they acquire buildings and equipment. In other

words: businesses have assets and so they cannot, even if they want to,
immediately turn these into cash at the end of each period. Often, these
businesses owe money to suppliers and to tax authorities, and the proprietors
do not withdraw all their original capital and profits at the end of each period.
In other words, businesses also have liabilities.
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All balance sheets follow the same format: when two columns are used,
assets are on the left, liabilities are on the right, and net worth is beneath
liabilities. When one column is used, assets are listed first, followed by
liabilities and net worth. Balance sheets are usually prepared at the close of
an accounting period.

Current Assets
To start, focus on the current assets most commonly used by small
businesses: cash, accounts receivable, inventory and prepaid expenses. Cash
includes cash on hand, in the bank, and in petty cash. Accounts receivable is
what you are owed by customers. To make this number more realistic, an
amount should be deducted from accounts receivable as an allowance for
bad debts.

Inventory may be the largest current asset. On a balance sheet, the value of
inventory is the cost required to replace it if the inventory were destroyed,
lost, or damaged. Inventory includes goods ready for sale, as well as raw
material and partially completed products that will be for sale when they are
completed.

Prepaid expenses are listed as a current asset because they represent an

item or service that has been paid for but has not been used or consumed.
An example of a prepaid expense is the last month of rent on a lease that
may have been prepaid as a security deposit. The prepaid expense will be
carried as an asset until it is used. Prepaid insurance premiums are another
example of prepaid expenses. Sometimes, prepaid expenses are also referred
to as unexpired expenses. On a balance sheet, current assets are totaled and
this total is shown as the line item called "total current assets. "

Fixed Assets
Fixed assets are the assets that produce revenues. They are distinguished
from current assets by their longevity. They are not for resale. Many small
businesses may not own a large amount of fixed assets, because most small
businesses are started with a minimum of capital. Of course, fixed assets will
vary considerably and depend on the business type (such as service or
manufacturing), size, and market.

Fixed assets include furniture and fixtures, motor vehicles, buildings, land,
building improvements (or leasehold improvements), production machinery,
equipment and any other items with an expected business life that can be
measured in years. All fixed assets (except land) are shown on the balance
sheet at original (or historic) cost, minus any depreciation. Subtracting
depreciation is a conservative accounting practice to reduce the possibility of
over valuation. Depreciation subtracts a specified amount from the original
purchase price for the wear and tear on the asset.

It is important to remember that original cost may be more than the asset's
invoice price. It can include shipping, installation, and any associated
expenses necessary for readying the asset for service. Assets are arranged in
order of how quickly they can be turned into cash. Like the other fixed assets
on the balance sheet, machineryand equipment will be valued at the original
cost minus depreciation. "Other assets" is a category of fixed assets. Other
assets are generally intangible assets such as patents, royalty arrangements,
and copyrights.

Liabilities
Liabilities are claims of creditors against the assets of the business. These are
debts owed by the business.There are two types of liabilities: current
liabilities and long-term liabilities. Liabilities are arranged on the balance
sheet in order of how soon they must be repaid. For example, accounts
payable will appear first as they are generally paid within 30 days. Notes
payable are generally due within 90 days and are the second liability to
appear on the balance sheet.

Current liabilities include the following:

Accounts payable
Notes payable to banks (or others)
Accrued expenses (such as wages and salaries)
Taxes payable
The current amount due within a one year portion of long-term debt
Any other obligations to creditors due within one year of the date of the
balance sheet
The current liabilities of most small businesses include accounts payable,
notes payable to banks, and accrued payroll taxes. Accounts payable is the
amount you may owe any suppliers or other creditors for services or goods
that you have received but not yet paid for. Notes payable refers to any
money due on a loan during the next 12 months. Accrued payroll taxes would
be any compensation to employees who have worked, but have not been
paid at the time the balance sheet is created.

Liabilities are arranged on the balance sheet in order of how soon they must
be repaid.

Long-term liabilities are any debts that must be repaid by your business more
than one year from the date of the balance sheet. This may include start up
financing from relatives, banks, finance companies, or others.
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