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The income statement

The company uses its assets to produce goods and services. Its success depends on whether it is wise or lucky in the assets it chooses to hold and in the ways it uses these assets to produce goods and services.

The company's success is measured by the amount of profit it earns—that is, the growth or decline in its stock of assets from all sources other than contributions or withdrawals of funds by owners and creditors. Net income is the accountant's term for the amount of profit that is reported for a particular time period.

The company's income statement for a period of time shows how the net income for that period was derived. For example, the first line in Table 2 shows the company's net sales revenues for the period: the assets obtained from customers in exchange for the goods and services that constitute the company's stock-in-trade. The second line summarizes the company's revenues from other sources.

The income statement next shows the expenses of the period: the assets that were consumed while the revenues were being created. The expenses are usually broken down into several categories indicating what the assets were used for. In Table 2, six expense items are distinguished, starting with the cost of the merchandise that was sold during the period and continuing down through the provision for income taxes.

The bottom portion of the income statement reports the effects of events that are outside the usual flow of activities. In this case it shows the result of the company's sale of some of its long-term investments for more than their original purchase price. Because this was not part of the company's normal operations, the sale price, costs, and taxes on the sale were kept separate from the operating revenue and expense totals; the income statement shows only a single number, the net gain on the sale.

Net income summarizes all the gains and losses recognized during the period, including both the results of the company's normal, day-to-day activities and any other events. If net income is negative, it is referred to as a net loss.

The income statement is usually accompanied by a statement that shows how the company's retained earnings have changed during the year. Net income increases retained earnings; net operating loss or the distribution of cash dividends reduces them. Any Company, Inc., started the year with retained earnings of $213 and added $52 in net income during the year (Table 2). Dividends amounting to $35 were distributed to shareholders during the year, leaving a year-end balance of $230. This is the amount on the year-end balance sheet (Table 1).