Income Statement:

Contents:

1. 2. 3. 4. 5.

Definition and Explanation Format of Income Statement Different Items of Income Statement Income Statement of Manufacturing Companies 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 Less: Sales discount Sales returns and allowances Net sales Less Cost of Goods Sold: Merchandise inventory opening Purchases Less: Purchase discounts Purchase returns and allowances Net purchases Plus carriage inwards Delivered cost of net purchases Cost of goods available for sale Less merchandise inventory Cost of goods sold Gross profit Less Operating Expenses: salaries Advertising Depreciation Total Operating expenses Net operating income Plus Other revenues: Commission received 5,000 3,000

$ 6500 8500

$ 525000 15000

510,000 35,000 320,000 8,000 312,000 1,2500 324,500 359,500 37,500 322000 188,000 91,600 7000 8500 107100 80,900 2500 83,400

Less other expenses: Interest expenses Net income

900 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. 2.

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

Materials available for use Less materials inventory, December 31, 2005

9950400 1270600

Direct materials consumed Direct labor Factory overhead: Indirect labor Salaries Payroll taxes Power Heat Light Factory supplies Depreciation - factory building Depreciation - machinery Repairs and maintenance Patent amortization Tools and dies used Insurance on building and machinery 1329300 972000 489000 112000 69200 44300 50000 68300 403000 145800 33200 178600 21200

8679800 7346400

3915900

Total manufacturing cost Add work in process inventory, January 1 2005.

19942100 2338000

Total cost to be accounted for Less work in process inventory, December 31 2005.

22280100 1303200

Cost of goods manufactured Add finished goods inventory, January 1, 2005

20976900 966100

Cost of goods available for sale Less finished goods inventory, December 31, 2005.

21943000 658000

Cost of goods sold

21285000

Gross profit Less commercial expenses: Marketing expenses Administrative expenses 580000 533750

3465000

1113750

Income from operation Other income and expenses: Royalties and dividends Gain from sales of plant 167000 12000

2351250

179000 Interest and debt expenses 129500

Net addition

49500

Income before income tax Less income tax

2400750 1064250

1336500

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.