Income statement

(1) You can think of income statement as filling in the gaps between balance sheets. The balance sheets show the financial position of the company at discrete points in time, and the income statements explain the changes that have taken place between those points. Net income or net earnings is the famous bottom line in an income statement – the remainder after deducting all expenses from revenues.

(2) Most companies follow a similar operating cycle, during which the company uses cash to acquire goods and services, which in turn it sells to customers. The customers in turn pay for their purchases with cash, which brings us back to the beginning of the cycle. Let’s consider a retail company:

(3) The box for the amounts owed to the entity by customers is larger than the other two boxes because the company’s objective if to sell its goods at a price higher than it paid for them. The amount by which the selling price exceeds expenses is profit or income or earnings. The total amount of profit earned during a particular period depends on the difference between the selling price and costs and on how much merchandise the company sells during the fiscal year. The fiscal year is established for accounting purposes, which may differ from a calendar year, and does not necessarily end on December, 31. The fiscal year is usually the low point in annual business activity.

(4) Therefore, companies gain assets when they sell goods or services and record or recognize sales revenues, which increase the owner’s interest or equity in the business by the amount of assets received in exchange for the delivery of goods and services to customers. In contrast, companies give up assets when they recognize expenses, which decrease the owner’s interest or equity. Together revenues and expenses define the fundamental meaning of income or profit or earnings. For example, when Coca Cola sells a box of Coca bottles to a retailer, it gains revenue. But when it uses refined sugar, Coca concentrate and purified water to produce Coca Cola, or when it pays the costs of delivering Coca Cola to the retailer, it incurs expenses. The total cumulative owners’ equity generated by income or profits is called retained earnings or retained income.

►Question/Answer session:

1. What is an income statement and what is it used for?
2. When do companies gain and when do they give up assets? How do these revenues and expenses affect the balance sheet?

(5) Let’s now get back to Book Corner and suppose that it sold stationery and office supplies of $900 on open account to a large multinational company. Let’s also assume that the cost to Book Corner of the inventory sold was $200, which leaves us $700 of revenue. Selling on open account creates Account receivable or Trade receivable or simply Receivables. How should we recognize this transaction?

Дата добавления: 2015-11-16