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Referencing this week’s readings and lecture, address the following:

  • What are the two causes of an increasing or decreasing sales number?
  • Discuss all the reasons that might explain an increase or decrease in gross profit.


Week Three Lecture

The Income Statement

The income statement, also termed a statement of income or statement of earnings, is used by managers to determine how much profit their company has made over a specified period. Income statements can be prepared monthly, quarterly, or annually, and help disclose the performance status of a company (Biery, 2013). An income statement is made up of four key sections:

  1. Sales/revenues: how much a company receives after selling merchandise.
  2. Cost of goods sold: the total expenditure incurred by a company in acquiring products/services to be sold.
  3. Expenses: include expenses incurred in order to keep the company operational.
  4. Net profit/loss: referred to as the “bottom-line” and helps to tell whether a company made profit or loss.

Unlike the balance sheet, an income statement shows business performance over a long period of time. Instead of “as of” in a balance sheet, an income statement date appears as “the period ended at.”

An income statement can be formatted in either single-step or multi-step presentation, which offer the same information, but may differ on basis of summary totals found when multi-step format is used. The single-step format puts all data into two broad categories, namely revenues and expenses. The multi-step format, on the other hand, divides data into several categories, each with crucial subtotals to aid information analysis. Multi-step format may, in addition to revenues and expenses categories, include gross profit, operating profit, profit before income tax expense and net profit. Many companies may also incorporate such items as earnings before tax, taxes, depreciation, and amortization abbreviated as EBITDA (Biery, 2013).

In order for the income statement to be accurate, revenues have to be recognized appropriately in accordance with accounting principles (although public companies which have to file their financial statements with the SEC use accrual accounting to recognize and record revenue). Usually, revenue is recognized when a product/service is sold, although some additional issues such as price negotiation, distribution issues, service/installation/training issues and buyback agreement may come into consideration when determining revenue recognition. In addition to revenue recognition, sales adjustments are used when computing net sales.

Cost of services or goods sold is cost incurred for what will be sold and includes purchase of raw materials, labor costs, and storage costs. Gross profit is used in determining how much a company has achieved before deducting operating expenses (Biery, 2013). In obtaining net sales/loss, operating expenses which include selling, general, and administrative expenses, research and development, depreciation and amortization are deducted from gross profit.

Statement of income contains elements of a statement of shareholders’ equity at the bottom, which shows how shareholders were affected by significant changes and it is made of various accounts, such as common stock and additional paid-in capital, retained earnings, treasury stock, accumulated other comprehensive income/loss, and non-controlling interest. A common-sized income statement can be used to analyze major line items that resulted in profit or loss from a varying perspective.

Forbes School of Business Faculty


Biery, M. E. (2013). What are your financial statements telling you? Forbes. Retrieved from http://www.forbes.com/sites/sageworks/2013/12/22/understanding-financial-statements/


***DISCUSSION 2*****

Income statements are presented in the table below for the Elf Corporation for the years ending December 31, 2010, 2009, and 2008. Write a one-paragraph analysis of Elf Corporation’s profit performance for the period. Create a common-sized income statement for the three years. What conclusions can you draw from the different parts of the statement? What are the causes and effects of Elf’s performance for those three years?

Elf Corporation Income Statements for the Years Ending December 31

(in millions) 2010 2009 2008
Sales $700 $650 $550
Cost of goods sold   350   325   275
Gross profit   350   325   275
Operating Expenses:      
Administrative   100   100   100
Advertising and marketing     50     75     75
Operating profit $200 $150 $100
Interest expense     70     50     30
Earnings before tax $130 $100 $  70
Tax expense (50%)     65     50     35
Net income $  65 $  50 $  35



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