An income statement measures a firm’s profitability (or lack thereof) for a period of time known as the accounting period, which can be monthly, quarterly, yearly, or any other length of time. If the accounting period coincides with the calendar year, the firm’s INCOME is reported on a calendar-year basis. If the accounting period is a 12-month period of time other than the calendar year (say July 1– June 30), the income is reported on a FISCAL YEAR basis. Because the income statement is one of the FINANCIAL STATEMENTS used to convey information about the firm to entities outside the firm, it must be constructed using the ACCRUAL BASIS and in accordance with GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP). An income statement consists of three major sections: revenues, expenses, and net income. Revenues are RESOURCES accruing to the firm as a result of the sale of goods and/or SERVICES, both for cash and on credit. Expenses are resources flowing out of the firm as a result of the revenue-earning process. Included in expenses are those that have been paid in cash and those that have not yet been paid but nonetheless were incurred during the accounting period being reported. At the bottom of an income statement is the section stating net income. The difference between revenues and expenses is always called net income, both when there is a PROFIT and when there is a loss for the period. In corporate income statements, it is customary for the net income to be reported in total and per share. Earnings per share (EPS) is determined by dividing net income by the number of common shares outstanding. Income statements are generally organized as multiplestep statements, as follows:



The difference between revenues and COST OF GOODS SOLD is the gross margin—the excess (or mark-up) of a firm’s prices for goods and services over their cost to the firm. A firm’s gross margin is closely monitored and given a prominent place on the income statement. The gross margin must be sufficient to cover the firm’s remaining expenses and to ultimately contribute to net income. If the gross margin is insufficient, the firm must raise prices (if possible), reduce expenses (including cost of goods sold), or implement some combination of these two. Gross margin is routinely expressed not only in dollars but as a percentage of sales. Firms in extremely competitive markets find it most useful to compare gross-margin ratios to monitor their profitability. Cost of goods sold is a crucial element in the determination of a firm’s gross margin. It is the most important and closely watched of all the expenses within a firm. While a firm has little, if any, control over its revenues (a customer cannot be forced to buy), it does have control over its expenses. For this reason, cost of goods sold is separated from the other expenses and subtracted from revenues before the other expenses to determine the firm’s gross margin. Income statements, like all financial statements, are excellent tools of comparison among firms. Because revenues and expenses are reported on the accrual basis and statements must adhere to GAAP, the practice of accounting is standardized and interfirm and interindustry comparisons are possible.
See also FINANCIAL ACCOUNTING.