week 8 final project

Part 2 Income Statement

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Income Statement The Income Statement is always the first statement you should complete. Why? You will take information directly from the Income Statement to prepare the other two financial statements. As stated before, the Income Statement communicates revenues and costs for a period of time. It is sometimes referred to as the “Profit and Loss Statement” because the statement’s bottom line is a profit or loss figure for that period of time.

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Income Statement There are four major components of the Income Statement:

 Revenue  Cost of Goods Sold  Operating Expenses  Net Income

We’ll look at Revenues First.

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Income Statement Revenue Gross Sales indicates the amount of revenue received from customers. In an accrual basis, this also includes money that you can reasonably expect to receive from customers due to transactions conducted during the period. In a business plan, revenues can be estimated by calculating an average price and multiplying it by the number of expected customers. Gross Sales also includes any sales tax collected from customers that purchased tangible products, which will be deducted in a different section of the statement. Sales Returns and Allowances are discounts or refunds given to customers for services or products. Generally, this figure is a small percentage of gross sales. Subtracting this number from Gross Sales gives you Net Sales.

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Income Statement Revenue Cost of Goods Sold is the cost to acquire or manufacture products that are sold to customers. Note that service-based companies do not have a cost of goods sold. You will learn more about cost of goods sold on the next screen.

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Income Statement Cost of Goods Sold is the cost* to acquire or manufacture products that are sold to the customer. What qualifies as a Cost of Goods Sold? The types of expenditures reflected in the Cost of Goods Sold depend on how the company acquires inventory.

 Service-based businesses do not carry an inventory and therefore do not have a Cost of Goods Sold.

 Retailers base inventory figures on their cost to acquire goods from a supplier.

 Manufacturers calculate Cost of Goods Sold by totaling the cost of raw materials and any production line (direct) labor required to assemble the product. Manufacturers are the only businesses that can include labor in the Cost of Goods Sold.

*Although valuing inventory can be much more complicated than stated here, this introductory module will focus on valuation based on cost.

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Income Statement Example: Cost of Goods Sold Question: Are office supplies, like paper and pencils, a Cost of Goods Sold?

Answer: It depends on what your business sells.

 A computer manufacturers considers office supplies an expense because it is in the computer business.

 An office supply store considers office supplies a Cost of Goods Sold because it sells office supplies.  Note, however, that the office supply store still has an office supplies expense

that reflects the cost of office supplies used by their own employees in daily operations.

Answer: It depends on what your business sells?

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Income Statement Revenue Cost of Goods Sold Calculation Finding the amount of inventory sold during a period requires you to know three things:

The calculation looks like this: Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold

The beginning inventory figure is taken directly from last year’s Income Statement. In most cases, a new company starts with a beginning inventory of zero in the first year. See your instructor for exceptions. You will have to derive the purchases and ending inventory from the company’s accounting records.

1. How much inventory did you start with? (In their first year, companies don’t have a starting inventory)

2. How much inventory was left over at the end of the period?

3. How much inventory did you purchase between the beginning and end of the period?

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Revenue

Example: CGS Calculation Calculate the Cost of Goods Sold for the 2008 fiscal year, beginning 1/1/08 and ending 12/31/08.

Income Statement

1/1/08 2/1/08 5/12/08 10/1/08 12/31/08

Answer:

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Income Statement Revenue Other Revenues may include returns on investments or interest income. These revenues are also recorded in the Revenues section of the Income Statement, if applicable. Complete the Revenue section by calculating Gross Profit, as shown at left. The Gross Profit is ideally a positive number because there are further expenditures to deduct in the Operating Expenses section.

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Income Statement Operating Expenses All expenditures that are not directly related to the acquisition or production of products sold to the customer are listed in the Operating Expenses. In other words, all expenses but those included in Cost of Goods Sold are operating expenses. They are separated into two distinct areas:

 Selling Expenses

 General and Administrative Expenses

Slide # 11

Income Statement Operating Expenses Selling Expenses are costs incurred directly in the sale of products or services. Items normally included are advertising, commissions or salaries for salesmen, delivery expenses when shipping directly to the customer, sales tax collected and owed to the government for the sale of tangible products, entertainment expenses incurred while pursuing customers, and any other miscellaneous expenses linked to sales. If you want to know more about estimating sales tax for a business plan, click here.

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Income Statement Sales Tax Calculation When you see the figure called Net Sales, it includes sales tax that you collected at the point of sale. That sales tax must be deducted in the Selling Expenses so that you can remit tax payments to the government. If you know the sales tax rate in your area and Net Sales, you can calculate this figure. In our examples, we assumed a sales tax rate of 6.25%. The calculation is a two step process that looks like this: Calculate the amount of Retail Sales:

Net Sales / (1 + Tax rate) = Retail Sales Subtract Retail Sales from Net Sales to find the amount of tax collected:

Net Sales – Retail Sales = Tax Remitted to Government

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Income Statement Operating Expenses General and Administrative Expenses are costs connected with the day-to-day operations of the business. A major component is the salary for office staff that support the sales force. Other expenditures include utilities, permits or licenses, maintenance, insurance, and depreciation. In other words, any expense not included in Cost of Goods Sold or Selling Expenses belongs here.

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Income Statement Operating Expenses List the expenses under the appropriate category and sum these figures to find Total Operating Expenses. Income Statements vary radically in the naming and grouping of expenses. This module uses expense categories that are blatantly descriptive, to help you learn the concepts. When you create your own Income Statements, categories should be named to give a clear picture of what goes on in the company and should be consistent from year-to-year.

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Income Statement Income Before Taxes Subtotal Gross Profit minus Total Operating Expenses to calculate Income Before Taxes.

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Income Statement Income Taxes Paid For small businesses, Income Before Taxes is usually the last entry on the Income Statement because the owners pay taxes of out of their own pockets. However, this module includes taxes on the Income Statement to make it explicitly clear that taxes have to be paid at some level. If you want more details about how to treat small business owner expenses and income, see Schedule C of IRS Form 1040. In our examples, we’ll use a tax rate of 25%. Tax rates

change over time and are based on how the business is classified (corporate vs. sole proprietorship) and tax brackets. Consult your instructor or www.irs.gov for information on current tax rates.

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Income Statement Net Income After Taxes Finally, you arrive at the bottom line of the Income Statement with Net Income after Taxes, by completing the above calculation. The Income Statement is now complete. However, you still need to keep it handy as we move on to the Cash Flow Statement. Before moving on, try the three Income Statement activities provided.

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Income Statement You have completed the Income Statement portion of this learning module. Close this browser window to return to the launch page, where you can try activities or watch other parts of the tutorial. Feel free to revisit the information provided here at any time.

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