Topic 4: The Income Statement

Net Income

The total earnings after all revenues, expenses, gains, losses, and tax impacts are considered

Net Income Formula

Net Income = Income from Continuing Operations ± Discontinued Operations ± Extraordinary Items

Gross Profit

The profit a company makes after deducting the cost of goods sold from revenue

Gross Profit Formula

Gross Profit = Sales Revenue - Cost of Goods Sold

Operating Income

The profit earned from core business operations, excluding interest and taxes

Operating Income Formula

Operating Income = Gross Profit - Operating Expenses

Income from Continuing Operations

Income derived from ongoing business activities, considered most sustainable for forecasting

Income from Continuing Operations Formula

Income from Continuing Operations = Operating Income - Interest Expense - Income Tax Expense ± Other Items

Comprehensive Income

Net income adjusted for changes in equity from non-owner sources like foreign exchange and investments

Comprehensive Income Formula

Comprehensive Income = Net Income ± Other Comprehensive Income

Revenues

Income generated from normal business operations such as sales or services

Revenue Example

Selling 1,000 units at $50 each results in $50,000 in revenue

Expenses

The costs incurred in earning revenues, including wages, rent, depreciation, and cost of goods sold (COGS)

Gains

Increases in equity from incidental or non-operating transactions

Gain Example

Selling equipment for $20,000 when its book value was $15,000 results in a $5,000 gain

Losses

Decreases in equity from peripheral or non-operating transactions

Loss Example

Disposing of an asset for $2,000 when its book value was $5,000 results in a $3,000 loss

Discontinued Operations

Results from parts of a business that have been sold or shut down, reported separately

Extraordinary Items

Rare and unusual gains or losses (no longer commonly used under updated GAAP standards)

Earnings Per Share (EPS)

The portion of a company’s net income allocated to each share of common stock

EPS Formula

EPS = Net Income / Weighted Average Shares Outstanding

Diluted EPS

EPS adjusted for the potential conversion of securities that could increase the number of shares

Diluted EPS Formula

Diluted EPS = (Net Income - Preferred Dividends) / (Weighted Avg. Shares + Convertible Shares)

Matching Principle

Expenses should be recognized in the same period as the revenues they help to generate

Revenue Recognition Principle

Revenue should be recognized when it is earned and collection is reasonably assured

Multiple-Step Income Statement

An income statement format that separates operating and non-operating sections, showing subtotals like gross profit and operating income

Single-Step Income Statement

An income statement format that groups all revenues and expenses together without subtotals

Forecasting Use

Analysts use income from continuing operations to estimate future profitability, as it excludes one-time items

Purpose of Income Statement

To report a company’s financial performance over a specific period, showing how revenues are transformed into net income

Gains vs. Revenues

Gains arise from peripheral activities (e.g., asset sales), while revenues result from the core business operation