3. income statement

Net income = revenues - expenses

• revenues: inflows of assets (from selling goods and providing services)

• expenses: outflows of assets (from generating revenues)

= between beginning and ending balance sheet

• sales revenue

• Cost of goods sold

• SG&A = selling, general and administrative expense

• R&D = research and development expense

• Interest Expense

• Interest Income

• Income Tax Expense

1. Top line: Sales Revenues

2. It then subtracts expenses of business operations to arrive at Operating Income, including:

– Cost of Goods Sold

– Sales, General, Administrative Expenses (SG&A)

– Researchand Development (R&D)

3. The next line items display other sources of income (such as Interest Income) and other expenses (such as Interest Expense) to arrive at Income Before Income Taxes

4. Income Tax Expense is then subtracted to arrive at Net Income (A.K.A the “bottom line”)

At the end of the reporting period, we make adjustments and

record revenues / expenses (if they don’t coincide with thecorresponding cash transfer). Adjustment necessary when:

1. Unearned Revenues become earned (e.g. advances to customers)

2. Accrued Revenues are earned (e.g. Receivables)

3. Prepaid Expenses become expenses (e.g., prepaid rent)

4. Accrued Expenses are incurred (e.g, interest expense)

• Cash was received in advance and recorded as a liability

• During the period, unearned revenues become earned

Adjusting entry is made to record the revenue for sales and services performed during the period and to show the liability that remains.

Decrease (a debit) to a liability account. Increase (a credit) to a revenue account.

• When goods and services are delivered during the period and the cash collection has not happen

• When goods and services are delivered during the period and the cash collection has not happen

Increases (debits) an asset account.

Increases (credits) a revenue account

Certain expenses are paid before they are used

– At the time of payment, they are recorded as an asset

– Prepaid Rent, Prepaid Insurance, Equipment, etc.

Adjusting entries for prepaid expenses

– At the end of each period:

Increases (debits) an expense account and

Decreases (credits) an asset account.

• Certain expenses are paid after they are used

– At the end of each period, they are accrued into a liability

– Accrued interest expense, etc.

• Certain expenses are paid after they are used

– At the end of each period, they are accrued into a liability

– Accrued interest expense, etc.

Increases (debits) an expense account.

Increases (credits) a liability account.

1. By function of expense (cost of sales method)

   • COGS

   • Selling expenses

   • Administrative expenses

2. By Nature of Expense (total cost method)

   • Depreciation expense

   • Transportation cost

   • Rent expense

   • Wage expense

   • …