How much is the

INCOME result of your

BLOOD,

STATEMENT SWEAT and

TEARS?
Balance Sheet:
Chapter 2 Review

■ Status report.
■ Financial position at point in time.
■ Assets = Liabilities + Shareholders’ equity.

3-2
Income Statement

■ Flow report.
■ Summarizes results of operations for a period of time.
■ Focuses on earnings activities (i.e., operating activities).
■ Reports on both what caused the activity (i.e., nature) and how large
the effect (i.e., magnitude).

3-3
Income Statement:
Basic Elements
■ Revenues:
• Inflows or creation of assets that result from sales of goods or
services.
• The core activity an entity is in.
■ Expenses:
• Outflows or consumption of resources to generate revenues.
• The “necessary evils” that are necessary to make revenues
happen.

3-4
Income Statement:
Basic Elements
■ Revenues:
• Inflows or creation of assets that result from sales of goods or
services.
• The core activity an entity is in.
■ Expenses:
• Outflows or consumption of resources to generate revenues.
• The “necessary evils” that are necessary to make revenues
happen.

3-5
Income Statement:
Basic Elements
■ Revenues - Expenses = Income.
■ Other names for income:
– Profit.
– Net income.
– Net earnings.
■ If expenses exceed revenues,
– Net loss.

3-6
Accounting Period

■ Measurement of activities for a specified arbitrary interval

of time.
■ A one-year timeframe is commonly used:
– Calendar or Fiscal year,
– Depending on the nature of the business

3-7
Relationship Between
Income and Owner’s Equity
– Owner’s Equity:
• Capital Investment + Net Income – Net Loss -
Drawings
– Stockholders’ Equity:
• Paid-in-capital + Retained earnings.
• Retained Earnings:
– Sum of all net income (loss) to date minus all dividends
paid out to date. 3-8
Relationship Between
Income and Owners’ Equity
• Retained Earnings:
– Sum of all net income (loss) to date minus all
dividends paid out to date.

Accounting Period
Retained Plus: Net Income Retained
Earnings Minus: Net Loss Earnings
Jan 1 Minus: Dividends Dec 31

3-9
Terminology Cautions
Income IS Revenue
NOT

IS
Net income NOT
Increase in Cash

IS
Retained Earnings NOT
Cash
Terminology Cautions
Income IS Revenue
NOT

IS
Net income NOT
Increase in Cash

IS
Retained Earnings NOT
Cash

3-11
Terminology Cautions
Income IS Revenue
NOT

IS
Net income NOT
Increase in Cash

IS
Retained Earnings NOT
Cash

3-12
Terminology Related to Expenses

Disbursement
Cost. Expenditure. Expense.
.
• amount of • a decrease in • an item of • a payment of
resources an asset or cost cash.
used for increase in a applicable to
some liability. the current
purpose. accounting
period.

3-13
Expenditures vs. Expenses

■ Expenditures:
– Made by paying cash or incurring a liability.
– Occur when acquiring goods or services.
– Can be assets and/or expenses.
– No necessary relationship between amounts of expenditures and
expenses (except over life of entity).

3-14
Dividends

■ Not an expense.
■ Distribution of earnings to owners.
■ Cash dividends reduce Cash and Retained earnings by same amount.

3-15
Gains and Losses

■ Not associated with routine operations.

■ Cash received (if any) less book value.
■ Gains increase Retained earnings.
– Similar to revenues.
■ Losses decrease Retained earnings.
– Similar to expenses.

3-16
Income Statement
■ Also called:
– Profit & Loss statement (i.e., P&L statement).
– Statement of earnings.
– Statement of operations.
■ Technically subordinate to Balance Sheet.
– Why? Shows detail of changes to Retained Earnings.
■ Many consider Income Statement more important than
Balance Sheet.
■ Variations in format. 3-17
 1. Heading:
• Name of entity.
• Name of statement.
2. Revenues.
• Time period covered.

Parts of
Income 3. Cost of Sales. 4. Gross Margin.
Statement

5. Expenses. 6. Net Income.

3-18
 1. Heading:
• Name of entity.
• Name of statement.
2. Revenues.
• Time period covered.

Parts of
Income 3. Cost of Sales. 4. Gross Margin.
Statement

5. Expenses. 6. Net Income.

3-19
 1. Heading:
• Name of entity.
• Name of statement.
2. Revenues.
• Time period covered.

Parts of
Income 3. Cost of Sales. 4. Gross Margin.
Statement

5. Expenses. 6. Net Income.

3-20
 1. Heading:
• Name of entity.
• Name of statement.
2. Revenues.
• Time period covered.

Parts of
Income 3. Cost of Sales. 4. Gross Margin.
Statement

5. Expenses. 6. Net Income.

3-21
 1. Heading:
• Name of entity.
• Name of statement.
2. Revenues.
• Time period covered.

Parts of
Income 3. Cost of Sales. 4. Gross Margin.
Statement

5. Expenses. 6. Net Income.

3-22
 1. Heading:
• Name of entity.
• Name of statement.
2. Revenues.
• Time period covered.

Parts of
Income 3. Cost of Sales. 4. Gross Margin.
Statement

5. Expenses. 6. Net Income.

3-23
 Gross Sales
STEP 1: - Sales returns and allowances
Reporting
Revenues - Sales (cash) discounts

= Net Sales

3-24
Revenues in ■ Excluded from main revenue:
Income – Sales or excise taxes.
Statement – Postage, freight charge
billed to customers.
– Trade discounts are not
shown.
– Other revenues not relating
to main operations

3-25
 Illustration 5-14

Multiple-
Step

Key Items:
 Net sales

LO 5
 Net Sales

STEP 2: - Cost of Sales or Cost of

Deducting Goods Sold (COS or
Cost of Sales COGS)
= Gross Profit or Gross
Margin

3-27
 Illustration 5-14

Multiple-
Step

Key Items:
 Net sales
 Gross profit

Illustration 5-14

LO 5
 Gross Profit
STEP 3:
Deducting - Selling, General &
Operating Administrative Expenses
Expenses
= Operating Income

3-29
Expenses on
■ Selling , general, and
Income administrative expenses.
Statement
■ Separate disclosure of:
– Research & development
expenses.
– Interest expense.

3-30
 Illustration 5-14

Multiple-
Step

Key Items:
 Net sales
 Gross profit
 Operating
expenses

Illustration 5-14

LO 5
 Operating income
STEP 4: - Other revenues (expenses)
Completing
the = Income before taxes
Income
Statement - Income taxes

= Net income

3-32
 Multiple-
Step

Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Nonoperating
activities

Illustration 5-14

LO 5
 Multiple-
Step

Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Nonoperating
activities

Illustration 5-14

LO 5
 Multiple-
Step

Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Nonoperating
activities
 Net income

Illustration 5-14

LO 5
 Reconciles change in Retained earnings:
Retained + Net = Retained
-
earnings income earnings
Dividends
(beginning) (loss) (ending)
Statement of
Retained
Earnings
Articulates (connects) Balance Sheet and
Income Statement.
Other Concepts of Income

■ Accrual accounting.
– GAAP, focus of text.
■ Cash-basis accounting.
– Focuses strictly on cash inflows and outflows.
– Cash receipts (revenues) - cash payments (expenses).
■ Modified cash-basis accounting.
– E.g., cash basis except for inventory and long-lived assets.
 Similar but not identical
to accrual/GAAP.
Income Tax Objectives differ from
GAAP.
Accounting. Tax minimization (legal)
vs. tax avoidance
(illegal).

Other Difference in value at

end compare to value at

Concepts of Economic Income. beginning.

Considers cost of using
owners’ investment as

Income
an expense.

Alternative to GAAP.

Pro forma earnings. Excludes item(s)

management deems to
be nonrecurring.