BUS103: Introduction to Financial Accounting

The purpose of the income statement is to show managers and investors whether the company was profitable during the period being reported.

Learning Objective

Explain how interested parties use the income statement to assess a company's profitability

Key Points

• An income statement reflects the revenues and expenses of a company for a specific period of time.
• Businesses use these reports to understand the financial position of their business and where to make changes for future years.
• Income statement information provides the basis for a variety of decisions.
  

Terms

• net income
  Net income also referred to as the bottom line, net profit, or net earnings is an entity's income minus expenses for an accounting period.
  
  
• FIFO
  First in, first out (accounting).
  
  
• LIFO
  Last-in, first-out (accounting).
  

Income statements, balance sheets, statements of retained earnings, and statements of cash flows are generally accepted financial statements. The income statement, sometimes referred to as a profit & loss statement, reflects the revenues and expenses for a specific period of time. Revenues minus expenses equals the net income or (loss) for that particular period.

Income statement
Example income statement

The primary purpose of the income statement is to show managers and investors whether the company was profitable during the period being reported. Income statements help investors and creditors determine the past financial performance of the enterprise, predict future performance, and assess the capability of generating future revenue streams through the reporting of income and expenses. In addition to tracking revenue, the income statement can compare expenses from year to year, indicating a firm's success in controlling costs. The income statement also reflects the periodic decline in the value of fixed and intangible assets when depreciation and amortization expenses are reported. The intangible asset goodwill is not subject to amortization but must be tested for impairment once a year; any reductions in value are reported as an impairment loss on the income statement.

Income statement information provides the basis for a variety of decisions. Companies use these reports to understand the financial position of their business and where to make changes for future years. Investors use these reports to make decisions about whether they want to invest the business, because earnings underlie a firm's ability to generate cash flows for dividends and growth. Accountants use these reports to prepare tax returns for both individuals and businesses. Lenders use the income statement to decide whether to provide the company with a loan, because a firm's ability to repay a loan in a timely manner ultimately depends on its profitability.

The income statement also has several limitations:

• Items that might be relevant but cannot be reliably measured are not reported (e.g., brand recognition and loyalty)
• Some numbers depend on accounting methods used (e.g., using FIFO or LIFO accounting to measure inventory level)
• Some numbers depend on judgments and estimates (e.g., depreciation expense depends on estimated useful life and salvage value)