Income Statement (Word Scrambles with Coaching)

Revenues are amounts earned through a company’s main business activities. Under the accrual basis of accounting, revenues are reported on the income statement in the period when they are earned, which often occurs before the cash is received from customers.

Example: A company provides $5,000 of services to a client in December and allows the client to pay 30 days later. The company will report the $5,000 as revenue on its December income statement even though the cash is received in the following year.

Sales are a retailer’s revenues earned from selling merchandise, which is the retailer’s main business activity. Sales are reported on the income statement when the merchandise is delivered to customers, which is often before the cash is received.

Example: A retailer sells $10,000 of merchandise to customers in March, but allows them to pay in April. The retailer will report sales revenues of $10,000 on its income statement for the month of March.

Expenses are costs used up in order to earn revenues. Under the accrual basis, expenses are reported on the income statement in the period when they are incurred (match up with revenues, are used up, have no future value that can be measured, etc.) not necessarily when the cash payment occurs.

Example: A company pays $12,000 in December for a 12-month insurance policy that will begin on January 1. The company will report insurance expense of $1,000 on each monthly income statement from January through December of the following year.

The accrual basis of accounting reports revenues when they are earned and expenses when they are incurred, regardless of when cash is received or paid. This provides a better matching of revenues and expenses and more accurately measures profitability in a given period (as opposed to the cash basis).

Example: A company incurs $2,000 of commission expenses in June but doesn’t pay the commissions until July. Under accrual accounting, the $2,000 of commission expense is reported on the June income statement when the sales occured.

Interest is the expense associated with loans payable. Interest expense is reported on the income statement in the period when it is incurred.

Example: A company borrows $100,000 at a 6% annual interest rate on September 1, with interest payable on the first of each month. The company will report interest expense of $500 ($100,000 x 6% x 1/12) on its income statement for the month of September.

At the end of the accounting year, the balances in the temporary accounts, which are the income statement accounts (revenues, expenses, gains, losses), are transferred to a permanent account, usually retained earnings (for a corporation) or the owner’s capital account (for a sole proprietorship). This “closing” process returns the balances of the temporary accounts to zero for the start of the next year.

Example: A corporation has $800,000 of revenues, $600,000 of expenses, and $50,000 of gains for the year, resulting in net income of $250,000. At the end of the year, closing entries are made which transfer the balances of the revenue, expense, and gain accounts into retained earnings. This brings the balances in the temporary accounts to zero for the start of the next year.

Gross profit is calculated as net sales minus the cost of goods sold. For a retailer, this represents the profit earned after accounting for the costs of the merchandise that was sold. (However, selling, general and administrative expenses must be subtracted from the gross profit to determine the retailer’s net income).

Example: A retailer has sales of $200,000 and the cost of goods sold is $140,000. The gross profit is $60,000 ($200,000 sales - $140,000 cost of goods sold). From this $60,000 of gross profit, the retailer must substract its operating expenses, interest, and income taxes.

On a multiple-step income statement, selling, general and administrative (SG&A) expenses are typically grouped together and described as operating expenses. They relate to operating the business and generating sales.

Example: Operating expenses for a retailer include salaries for salespeople, rent and utilities for the store, advertising costs, and depreciation on store equipment. These are reported in the SG&A section of the income statement.

The income statement heading discloses the specific period of time covered by the statement, such as “For the Year Ended December 31, 20XX” or “For the Three Months Ended March 31, 20XX.”

Example: The header on a corporation’s annual income statement reads “For the Year Ended December 31, 20XX.” This tells the reader that the amounts reported on the income statement are for the 12-month period that began on January 1 and ended on December 31.

A fiscal year is an accounting year of any 12 consecutive months ending on a date other than December 31. Many companies use fiscal years that align with their natural business cycle.

Example: A school district is likely to have an accounting year beginning on July 1 and ending on June 30 of the following year. This 12-month period is referred to as a fiscal year.

When a corporation’s stock is publicly traded on a stock exchange, the corporation must report its earnings per share (EPS) on the face of its income statement. EPS shows the corporation’s net income or loss per share of outstanding common stock.

Example: A corporation reports net income of $5,000,000 for the year and has 1,000,000 shares of common stock outstanding for the entire year. The income statement will report earnings per share of $5.00 ($5,000,000 net income ÷ 1,000,000 shares).

A gain is an increase in net assets from a peripheral or incidental transaction, such as selling a piece of equipment that was used in the business for more than its book value. Gains are reported on the income statement seperate from revenues.

Example: A company sells a piece of its old machinery for $10,000 cash when the machinery had a book value of $7,000 on the company’s balance sheet. The company will record a gain of $3,000 ($10,000 cash received - $7,000 book value) on its income statement.

On a multiple-step income statement, interest expense is reported as a nonoperating expense because the financing activities of the company are not part of its primary revenue-generating operations. Nonoperating items are typically reported after the income from operations.

Example: A retailer borrows money to fund an expansion. The interest expense on this debt is considered a nonoperating expense and is reported after the retailer’s operating income on it’s income statement.

If a corporation eliminates an entire subsidiary, division, or major product line, it will report the results of that business segment separately on the income statement as income or loss from discontinued operations. The amount will appear after income from continuing operations. This allows readers to evaluate the ongoing profitability of the company without the amounts pertaining to the discontinued operations.

Example: A manufacturer sells its entire home appliance division. On the income statement for the year of the sale, the company will report the sales and expenses of the home appliance division separately as “Income (loss) from discontinued operations.”

If a corporation sells a plant asset like a building or machine for less than the asset’s carrying value or book value (cost minus accumulated depreciation), it reports a loss on the sale equal to the difference between the proceeds received and the asset’s carrying value. This loss is reported on the income statement, usually in the nonoperating section.

Example: A company sells one of its machines for $80,000. The machine’s original cost was $250,000 and its accumulated depreciation was $150,000, resulting in a carrying value of $100,000. The company reports a loss of $20,000 ($80,000 proceeds - $100,000 carrying value) on its income statement.

The income statement is also known as the statement of operations. It summarizes the company’s operating performance over a period of time by showing revenues generated and expenses incurred from the company’s operations.

Example: The heading on Apple Inc.’s income statements reads “Consolidated Statements of Operations.”

For a retailer, cost of goods sold is usually the largest expense reported on its income statement. Cost of goods sold represents the cost of the merchandise that was sold to customers during the period.

Example: A shoe store purchases shoes from a supplier for $30 per pair and sells them for $50. When it sells 100 pairs, it reports sales of $5,000 and cost of goods sold of $3,000 on its income statement.

The matching or expense recognition principle of accrual accounting requires that expenses be reported on the income statement in the same period as the revenues they helped generate, regardless of when the expense was paid. This provides a more accurate picture of a company’s profitability during the period of the sale.

Example: An insurance company pays commissions to its sales staff in January for policies sold in December. On the December income statement, the company reports the commission expense along with the revenue from the related policies sold, even though the commissions weren’t paid until January.

Under U.S. GAAP, changes in accounting estimates are not considered errors that need to be corrected. Instead, companies should update estimates prospectively as new information becomes available. Common estimated amounts include uncollectible accounts receivable, warranty expenses, and various accrued expenses.

Example: Based on past experience, a company estimated that 2% of its credit sales will be uncollectible and recorded the amount as an expense for bad debts. In the following year, the company determines that 3% is a more accurate estimate. The company does not restate the prior year’s financial statements, but instead uses the 3% rate going forward.

Certain gains and losses bypass the income statement and are instead reported as other comprehensive income (OCI). These items are excluded from net income but still affect overall company performance and are reported on the statement of comprehensive income.

Example: A company has a subsidiary in France. When preparing consolidated financial statements, the company must translate the French subsidiary’s euros into U.S. dollars. Changes in exchange rates create translation adjustments that are reported as other comprehensive income on the statement of comprehensive income.