The Income Statement
This lesson focuses on the elements and limitations of the income statement and the effects of GAAP on the income statement. It will also discuss noncash items.
The income statement, or profit and loss statement (P&L), reports a company's revenue, expenses, and net income over a period of time.
Differentiate between operating and non-operating revenues and expenses
Construct an income statement
- The income statement consists of revenues and expenses along with the resulting net income or loss over a period of time due to earning activities. The income statement shows investors and management if the firm made money during the period reported.
- The operating section of an income statement includes revenue and expenses. Revenue consists of cash inflows or other enhancements of assets of an entity, and expenses consist of cash outflows or other using-up of assets or incurring of liabilities.
- The non-operating section includes revenues and gains from non-primary business activities, items that are either unusual or infrequent, finance costs like interest expense, and income tax expense.
- The "bottom line" of an income statement is the net income that is calculated after subtracting the expenses from revenue. It is important to investors - also on a per share basis (as earnings per share, EPS) - as it represents the profit for the accounting period attributable to the shareholders.
- income bond
a debt instrument where coupon payments are only made if the issuer can afford it
- statement of cash flows
a financial document that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities
- income statement
a calculation which shows the profit or loss of an accounting unit during a specific period of time, providing a summary of how the profit or loss is calculated from gross revenue and expenses
- gross profit
The difference between net sales and the cost of goods sold.
- net income
Gross profit minus operating expenses and taxes.
Elements of the Income Statement
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 statement – often, literally the last line of the statement – is 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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