Income Statements - Ch. 3
The income statement is a major statement that every business prepares. It
summarizes the items of revenue and expenses and determines the net
income or net loss for an accounting period or fiscal year. This may be a
week, month, quarter, year, bi-annually etc. The accounting period depends
on when your accounting is carried out and so in not necessarily Jan – Dec
which is the calendar year. So it could be from June – July.
Revenue – money coming into the business, which has been earned through
the goods sold or the services provided.
Expenses – this is what it costs the business to operate and so this is the
money spent to run the business e.g. salaries, supplies, advertising, utility
bills, delivery charges etc.
Equation: Revenue – Expenses = Net Income or Net Loss
People opened their business because they want to earn money, have pride
of ownership, gain the satisfaction of building a successful business, and to
use their own talents and skills to the fullest.
Time-Period Principle requires that the same accounting time period can be
used for comparison. Time consistency is important, with each business
having to show their accounting period it becomes easy for companies to use
the same time period when analyzing or comparing data or profits of a
similar time period. This will produce accurate and consistent financial
Matching Principle states that expenses should be recorded and matched
with the revenue they help to generate during the same accounting period.
This accurately reflects the business activities since all the income or loss for
that accounting period is consider. This is the accrual basis of accounting.
If transactions are placed in different accounting periods then the monthly
statements will give a wrong reflection of the period. It may state that it was
a profitable period when in fact a loss was made.Accrual Basis of Accounting – This is a system where revenue earned is
matched against expenses incurred for the accounting period. This produces
an accurate picture of the financial affairs. The Accrual Basis uses the
matching principle, where revenue is recorded as it’s earned and is recorded
whether cash or A/R is used.
When revenue is earned it increases owner’s equity and a loss would
decrease owner’s equity.
Cash Basis of Accounting – This method of accounting recognizes the
revenue and expenses on a cash basis only. Expenses is recorded only when
cash is use to pay for it, and revenue is recorded only when cash is received
The cash basis does not compare all revenue earned for that accounting
period with all the expenses of the same period. It does not abide by the
matching principle and this is why it’s not used by Accountants in their
Do: Pages 73-75
Income Statement Accounts
To prepare an income statement we need to have in the general ledger:
1. Assets, liability and owner’s equity accounts for the Balance Sheet
2. Revenue and expense accounts for preparing the Income Statement
This is the proceeds from the sales of goods and services to customers.
Revenue could be membership fees, commission from sales, sales revenue
from goods sold or services rendered e.g. a Lawyer or Dentist.
Separate revenue accounts are set up for the different types of revenue that a
firm will earn. This allows for better accuracy in collecting and summarizing
the revenue e.g. a spa may do facials, tanning, etc.Expense Accounts