Income Statement(Quick Test #2 with Coaching)

The statement of financial position is NOT another title for the income statement. The statement of financial position is another name for the balance sheet and it reports a company's assets, liabilities, and owner's (or stockholders') equity usually at the final moment of the accounting period.

The heading of the income statement shows the period of time covered (such as the year, quarter, month, 13 weeks, etc.), which is similar to the cash flow statement.

The heading of the balance sheet shows a point in time (such as the final moment on December 31, June 30, etc.).

The notes to the financial statements are an integral part of each of the annual external financial statements in order for the users to understand the amounts appearing on the face of the financial statements.

For example, accounting principles allow for different depreciation methods, inventory cost flow assumptions, and others which can cause different net incomes. Further, there may be some potential liabilities that are reasonably possible and could dramatically alter the reported amount of net income.

U.S. corporations with shares of stock that are publicly traded must present income statements that show three columns of amounts in order for readers to make comparisons. Hence, these financial statements are referred to as comparative income statements.

Generally, large corporations are required to use the accrual method of accounting in order to comply with the basic accounting principles (such as the revenue recognition principle and the matching principle) as well as more complex accounting standards.

Generally the sales of merchandise and the earning of fees from providing services are the main activities of a company. The revenues from the main activities are considered to be operating revenues.

The revenues from secondary activities are considered to be non-operating revenues.

Gross profit = net sales minus cost of goods sold.

[Operating income is the gross profit minus operating expenses often referred to as SG&A (for selling, general and administrative expenses).]

Profit margin is the result of dividing net income by net sales.

(Gross margin is gross profit divided by net sales.)

Net sales is defined as gross sales (or simply sales) minus sales discounts, sales returns, and sales allowances.

Bad debts expense is not part of the cost of goods sold. Rather, it is reported as part of a company's selling, general and administrative expenses (SG&A).

The matching principle and the accrual method of accounting require that the income statement report the sales occurring during the accounting period and then to match those sales with the cost of the goods that were sold.

This means that you cannot simply expense/match the cost of the goods purchased with the sales. The reason is that some of the goods purchased may have been added to inventory (and therefore not sold). It is also possible that the company sold more than the cost of its purchases by selling some of the merchandise from its inventory.

The interest incurred by a retailer is considered to be a non-operating expense. The reason is that investing is not considered a main operating activity of a retailer. (The main activities of a retailer are the purchasing and selling of merchandise.)

Non-operating expenses may be reported on the income statements under the heading of "other income" or "non-operating income".

Commissions (and other compensation) paid to sales personnel are selling expenses. Selling expenses are part of a retailer's operating expenses often referred to as SG&A or selling, general and administrative expenses.

A company's expenses fall into one of two categories: operating and non-operating. Since the car was used in the company's sales function, the depreciation will be one of the operating expenses. (The specific operating expense is selling expenses, which is part of the company's selling, general and administrative expenses often referred to as SG&A.)

The cost of goods sold is also an operating expense, but the selling expenses are not considered to be a cost of the goods.

The multiple-step income statement gets its name from the fact that there are multiple subtractions on the income statement in calculating the net income.

The first step is the subtraction of the cost of goods sold from the company's sales. The resulting amount is the gross profit.

Next, is a subtraction of the other operating expenses in order to determine the operating income.

Lastly, the non-operating items are added/subtracted to arrive at the net income.

The single-step statement subtracts the total of the operating and non-operating expenses from the total of the operating and non-operating revenues. The result after this one subtraction is the net income.

FOB shipping point indicates that the ownership of the merchandise will transfer from the supplier to the retailer when the merchandise is loaded onto a hauler's truck at the supplier's dock. Since the supplier is free of the goods when they were put on board the truck (FOB), the retailer now owns the merchandise and will be responsible for the merchandise and for paying for the hauler's trucking bill.

Adjusting entries, which are made at the end of the accounting period before the financial statements are prepared, are necessary in order to accrue revenues, expenses, and liabilities that have occurred during the accounting period but have not yet been processed in the general ledger accounts. Adjusting entries also defer revenues and expenses even though a transaction (cash was received or paid out) has been recorded in the general ledger. Adjusting entries also record depreciation and bad debts expense for the accounting period.

In order to comply with the matching principle of accounting, estimates may have to be made. For example, it is better to have an estimated amount for bad debts expense than to show $0. For the depreciation of an asset such as equipment, a company does not know with certainty whether the machine will be useful for 8, 10, 12, or 15 years. As a result, the company might arbitrarily select 10 years in computing the annual depreciation. The 10 years is clearly an estimate.

The cost of goods sold (COGS) is the amount that is subtracted from the sales revenues on the income statement.

For simplicity, assume that a company has only one product and during the year it sold 50,400 units at a selling price of $10 each. Also assume that the company’s cost for each unit has always been $7.

Now assume that during the year the company purchased 50,000 units at a cost of $350,000. This means that the company’s inventory was reduced by 400 units during the year, resulting in the inventory decreasing by $2,800 (400 units X $7).

To properly match the cost of the goods sold with the revenues from the goods sold, the cost of goods sold will be the $350,000 cost of the goods purchased + the $2,800 decrease in the costs in inventory. In short, a decrease in inventory is an addition to the cost of goods purchased.

Think of freight-out as a delivery expense, which is part of the operating expenses referred to as selling, general and administrative (SG&A). Hence freight-out is a cost that does not belong in inventory or in the cost of the goods that were sold.

(Freight-in is a cost of the goods. Recall that cost is defined as all costs necessary to get an asset in place and ready for use.)

The $18,000 is not reported as revenues on the December income statement because the retailer did not provide any goods or services in December. Instead, the $18,000 is to be reported as a liability on the December 31 balance sheet.

When a gift card is redeemed for goods or services, the liability will be reduced and the revenues will be reported on the income statement in the accounting period in which the revenues are earned.

Only the $1,500 selling price of the appliance is reported as sales revenues on the retailer's income statement.

The sales tax of $105 that was collected is a current liability that will appear on the retailer's balance sheet (until it is remitted usually to a state government).

The income statement accounts (revenues, expenses, gains, losses) are temporary accounts. This means these accounts are used during the year in order to generate detailed income statements. When the year is over, the balances will end up in the Retained Earnings account. Thus these temporary accounts will start the next year with $0 balances.

How a corporation recognizes revenues can be found in the corporation's Summary of Significant Accounting Policies, which is likely the first disclosure in the notes to the financial statements.

Only corporations with stock that is publicly traded are required to present the earnings per share on the face of the income statement.

Earnings per share (EPS) refers to the earnings per share of common stock.

Since the corporation's annual earnings occur throughout the year, it is logical that the earnings should be divided by the weighted-average number of shares of common stock that were outstanding during the year.

Unrealized gains/losses on postretirement benefit plans are not included in a corporation's net income. Rather this item is part of other comprehensive income.

The combination of other comprehensive income + net income is known as comprehensive income.

The annual report to the U.S. Securities and Exchange Commission (SEC) is known as the "10-K" or Form 10-K. In addition to the audited financial statements, it contains supplementary data, management's discussion and analysis of financial condition and results of operations, as well as other information on the business, business risks, and more.