Financial performance or results of operations is primarily measured by computing the net income. Net income is equal to all revenues earned minus all expenses incurred.
Revenues come from several sources; and expenses are incurred for different purposes. The following summarizes and explains the items found in an income statement.
Revenue Accounts in the Income Statement
- 1. Sale of inventory - This is the primary income-generating activity of merchandising and manufacturing businesses. The most common account titles used are: Sales, Sales Revenue, or Revenue from Sales.
- Sales Discounts, and Sales Returns & Allowances are deducted from Sales to come up with the company's Net Sales.
- 2. Rendering of services - The primary income-generating activity of service type firms. The general account title used is Service Revenue. Specific account titles that depend upon the industry of the business include: Professional Fees for professional firms, Tuition Fees for schools, Admission Fees or Entrance Fees for performances, Commissions for agencies, etc.
- 3. Other revenues - Rent Income, Interest Income, Dividend Income, Royalty Income, and other revenues that are earned through other activities aside from the normal operations of the business.
- Sale of assets other than inventory - Sales made not in the ordinary course of business are not included in the Sales account. The gain on the sale is recorded under a different account title. Examples include: Gain on Sale of Equipment, Gain on Sale of Land, Gain on Sale of Investment, etc.
Expense Accounts in the Income Statement
Expenses can be grouped into the following categories:
- 1. Cost of Sales or Cost of Goods Sold - In a merchandising business, it is equal to the purchases price and freight-in costs of the items sold. In manufacturing business, it is equal to the cost of producing the products sold.
- 2. Selling or Distribution Expenses - includes Salaries Expense of Sales Personnel, Sales Commission Expenses, Marketing and Advertising Expense, Delivery Expense or Freight-Out, Depreciation of Delivery Equipment, Depreciation of Store Equipment, and other expenses directly related to the selling function.
- 3. Administrative or General Expenses - Salaries Expense of Administrative Personnel, Office Supplies Expense, Bad Debts Expense, Depreciation of Office Equipment, and other expenses related to the administrative function.
- Take note that some expenses (for example: Rent Expense and Utilities Expense of the entire company) can be related partly to sales and partly to administration. In a functional multi-step income statement, it is important to determine how much of the expense is related to sales and how much is related to administration.
- 4. Other Expenses - includes losses such as Loss on Sale of Equipment, Loss on Sale of Investment, Fire Loss, Typhoon Loss, etc., and finance costs (cost of borrowing money). The most common finance cost account is Interest Expense.
- 5. Income Tax Expense - current income tax computed by multiplying the applicable tax rate by the earnings before taxes.