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Using Income Statements in Accounting

The income statement, also known as a profit and loss statement, summarizes a firm's revenues and expenses for a particular period of time. Revenues represent amounts that a business earns by providing goods and services to its customers. Expenses represent amounts that a firm spends providing those goods and services. If a business can provide goods or services to customers for revenues that exceed its expenses, the firm earns a profit. If expenses exceed revenues, obviously, the firm suffers a loss.

The first table summarizes the sales that an imaginary business enjoys. The second table summarizes the expenses that the same business incurs for the same period of time. These two tables provide all the information necessary to construct an income statement.

A Sales Journal
Joe $1,000
Bob 500
Frank 1,000
Abdul 2,000
Yoshio 2,750
Marie 2,250
Jeremy 1,000
Chang 2,500
Total sales $13,000
An Expenses Journal
Purchases of dogs and buns $3,000
Rent 1,000
Wages 4,000
Supplies 1,000
Total supplies $9,000

Using the information from these tables, you can construct a simple income statement. Understanding the details of an income statement is key to your understanding of how accounting works and what accounting tries to do.

Simple Income Statement
Sales revenue $13,000
Less: Cost of goods sold 3,000
Gross margin $10,000
Operating expenses
Rent $1,000
Wages 4,000
Supplies 1,000
Total operating expenses 6,000
Operating profit $4,000

The first thing to note about the income statement shown in the third table is the sales revenue figure of $13,000. This figure shows the sales generated for a particular period of time. The $13,000 figure shown here comes directly from the Sales Journal shown in the first table.

One important thing to recognize about accounting for sales revenue is that revenue gets counted when goods or services are provided and not when a customer pays for the goods or services. The timing of the payment for goods or services doesn't matter. Information about when customers pay for those goods or services, if you want that information, can come from lists of customer payments.

Cost of goods sold and gross margins are two other values that you commonly see on income statements. In this case, the actual items that you sell — hot dogs and buns — are shown separately on the income statement as cost of goods sold. By separately showing the cost of the goods sold, the income statement can show what is called a gross margin. The gross margin is the amount of revenue left over after paying for the cost of goods. In the third table, the cost of goods sold equals $3,000 for purchases of dogs and buns. The difference between the $13,000 of sales revenue and the $3,000 of cost of goods sold equals $10,000, which is the gross margin.

Knowing how to calculate gross margin allows you to estimate firm break-even points and also to perform profit, volume, and cost analyses. All these techniques are extremely useful for thinking about the financial affairs of your business.

The operating expenses portion of the simple income statement repeats the other information listed in the Expenses Journal. The $1,000 of rent, the $4,000 of wages, and the $1,000 of supplies get totaled. These operating expenses are then subtracted from the gross revenue.

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