2.2 The Income Statement

What does the income statement measure?

Performance over a period of time (quarter or year).

What is the income statement equation?

Revenues − Expenses = Income

How is the income statement different from the balance sheet?

Balance sheet = snapshot; income statement = video showing changes over time.

What was U.S. Corporation’s net income for 2024?

$493 million.

How much was paid in dividends?

$123 million.

How much was added to retained earnings?

$370 million (493 − 123 = 370).

What does “addition to retained earnings” mean?

Profit kept in the company instead of paid out as dividends.

Formula for EPS?

Net income ÷ Total shares outstanding.

EPS for U.S. Corporation?

$493 ÷ 200 = $2.46 per share.

Formula for dividends per share?

Total dividends ÷ Total shares outstanding.

Dividends per share for U.S. Corporation?

$123 ÷ 200 = $0.615 per share.

When does GAAP recognize revenue?

When it’s earned — not when cash is received.

What is the recognition principle?

Record revenue when the earnings process is complete and value is known.

Record revenue when the sale is complete and value is known.

You sell a laptop today for $1,000, but the customer will pay next month.

• You record $1,000 revenue today (because the sale happened).

• You don’t wait until the cash arrives.

What is the matching principle?

Match expenses to the same period as the related revenue.

So if you sell that laptop today, you also record the cost of making it today — even if you paid for the parts last month.

You sell the laptop today for $1,000.
It cost you $600 to make.

• You record $1,000 revenue today.

• You record $600 expense today.

• Profit = $400.

Why might income statement numbers differ from cash flow?

Because revenue and expenses are recorded when earned, not when cash moves.

What’s the main noncash item on the income statement?

Depreciation.

Why is depreciation noncash?

It’s an accounting expense — no cash leaves the company each year.

Example: $5,000 asset depreciated over 5 years → annual expense?

$1,000 per year.

Why do accountants use depreciation?

To match the cost of an asset with the revenue it helps generate over time.
Real cash outflow happened when you bought the equipment

Why do financial managers care about noncash items?

Because accounting income ≠ actual cash flow.

What’s the difference between short run and long run?

Short run = some costs fixed; long run = all costs variable.

Examples of fixed costs?

Property taxes, rent, insurance.

Examples of variable costs?

Wages, materials, supplier payments.

How do accountants classify costs?

As product costs (materials, labor, overhead) or period costs (selling, admin).

Why isn’t the income statement a good guide to fixed vs. variable costs?

Because accountants group costs by type, not by behavior.

Who sets U.S. accounting standards?

FASB (Financial Accounting Standards Board).

Who sets international standards?

IASB (International Accounting Standards Board).

What’s the relationship between GAAP and IFRS?

They’ve become similar but haven’t fully merged.