The Income Statement is the next step in the Accounting Cycle after the Trial Balance is finalised. It is one of 3 financial statements that is prepared by an accountant. The other 2 are Balance Sheet and Cash Flow Statement.
It reports whether a business makes a profit or a loss, and is also called an Income and Expenditure Account, or a Profit and Loss Account.
The Income Statement must be handled carefully as one wrong figure throws off the profit or loss in the end.
If there is an error, you would only know when you complete the Balance Sheet and it does not balance. Here are 6 key factors to know when doing an Income Statement.
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6 key factors to remember with an Income Statement
1. Report income and expenses
- Discount received
- Purchases returns
- Bad debts recovered
- Rent revenue
- Carriage inwards and carriage outwards
- Sales returns
- Discount allowed
- Repairs and maintenance
- Bad debts
2. Items are direct and indirect
Income and expenses are divided into direct and indirect items. Direct items are directly related to the production of goods or carrying out of services.
- Sale of goods for resale
- Fees charged for services provided
- Salary of owner
- Purchases of goods for resale
- Carriages of goods for resale
- Cost of raw materials
- Wages and salaries of factory workers
- Rent of premises
- Fuel for machinery
Indirect items occur during the overall running of the business but are not directly related to the goods or services that earn an income.
- Sale of asset
- Sale of stationery
- Rent revenue for sublet
- Wages and salaries of supervisors and office clerks
- Advertising and marketing
- Bad debts
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3. Items are operating and non-operating
Income and expenses fall under operating and non-operating headings. Operating income is the money earned, unearned or contributed from activities that relate directly to the running of the organisation. Operating expenses cover all direct expenses and some indirect expenses. These costs make the business operate on a daily basis.
Sales – Cost of sales – Operating expenses
- Sold goods $50
- Cost of sales = Purchases $10 + Carriage inwards $2
- Operating expenses = Rent $15 + Salaries $5 + Utilities $4 + Advertising $2
- Formula: Sales $50 – Cost of sales $12 – Operating expenses $26
- Operating income = $12
- Repairs and maintenance
- Office supplies
Non-operating income is the money from activities that do not relate directly to the running of the business and are mainly unearned. Non-operating expenses are costs incurred but are not related to the production of goods, carrying out of services, or the running of the business.
- Rent revenue from tenant
- Interest income on investments
- Dividends received on shares
- Gains on foreign exchange
- Interest paid on debt
- Payments to settle lawsuits
- Restructuring costs
- Writing off inventory
4. Stock as asset is included
Additionally, opening and closing stock appear on the Income Statement. The asset stock is used to calculate the Cost of Sales in the beginning of the Income Statement.
The opening stock is added to the net purchases and then the closing stock is subtracted to find the Cost of Sales for the period. The closing stock figure also goes to the Balance Sheet under the Current Assets heading. If the question only provides closing stock, then subtract it from the net purchases as usual.
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5. Bad debts written off is included
Bad debts written off goes to the Income Statement to reduce profit. Provision of bad debts goes to the Balance Sheet to reduce debtors. A business writes off a debt to present a realistic profit. If the debtor decides to pay later on, the account is then called Bad debt recovered which is an income account.
6. Only depreciation for this year is reported
Provision for depreciation for this year is an expense that goes to the Income Statement. Provision for depreciation for last year is an asset with a credit balance. It must be added to the provision for depreciation for this year to reduce assets in the Balance Sheet.
These are 6 important factors to remember when doing an Income Statement. Simply practise the format of an Income Statement repeatedly and the items will fall into place when you are doing questions. No matter which items are presented or left out, you will be able to calculate Net Profit successfully.
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