TABLE 1-2 An Expenses Journal
| Purchases of hot dogs and buns | $3,000 |
| Rent | 1,000 |
| Wages | 4,000 |
| Supplies | 1,000 |
| Total expenses | $9,000 |
Using the information from Tables 1-1 and 1-2, you can construct the simple income statement shown in Table 1-3. Understanding the details of an income statement is key to understanding of how accounting works and what accounting tries to do. Therefore, I want to go into some detail in discussing this income statement.
TABLE 1-3 Simple Income Statement
| Sales revenue | $13,000 |
| Less: Cost of goods sold | 3,000 |
| Gross margin | $10,000 |
| Operating expenses | |
| Rent | $1,000 |
| Wages | 4,000 |
| Supplies | 1,000 |
| Total operating expenses | 6,000 |
| Operating profit | $4,000 |
The first thing to note about the income statement shown in Table 1-3 is the sales revenue figure of $13,000. This figure shows the sales generated for a particular period. The $13,000 figure shown in Table 1-3 comes directly from the sales journal shown in Table 1-1.
One important thing to recognize about accounting for sales revenue is that revenue gets counted when goods or services are provided, not when a customer pays for the goods or services. If you look at the list of sales shown in Table 1-1, for example, Joe (the first customer listed) may have paid $1,000 in cash, but Bob, Frank, and Abdul (the second, third, and fourth customers) may have paid for their purchases with a credit card. Yoshio, Marie, Jeremy, and Chang (the fifth through eighth customers listed) may not have even paid for their purchases at the time the goods or services were provided. These customers may simply have promised to pay for the purchases at some later date. The timing of payment for goods or services doesn’t matter, however. Accountants have figured out that you count revenue when goods or services are provided. Information about when customers pay for those goods or services, if you want that information, can come from lists of customer payments.
Cost of goods sold and gross margins are two other values that you commonly see in income statements. Before I discuss cost of goods sold and gross margins, however, let me add a little more detail to this example. Suppose that the financial information in Tables 1-1, 1-2, and 1-3 shows the financial results from your business: the hot dog stand that you operate for one day at the major sporting event in the city where you live. Table 1-1 describes sales to hungry customers. Table 1-2 summarizes the one-day expenses of operating your super-duper hot dog stand.
In this case, the actual items that you sell — hot dogs and buns — are shown separately in the income statement as cost of goods sold. By separately showing the cost of the goods sold, the income statement can show what is called a gross margin. The gross margin is the amount of revenue left over after paying for the cost of goods. In Table 1-3, the cost of goods sold equals $3,000 for purchases of dogs and buns. The difference between the $13,000 of sales revenue and the $3,000 of cost of goods sold equals $10,000, which is the gross margin.
The operating expenses portion of the simple income statement shown in Table 1-3 repeats the other information listed in the expenses journal. The $1,000 of rent, the $4,000 of wages, and the $1,000 of supplies get totaled. Then these operating expenses are subtracted from the gross.
Do you see, then, what an income statement does? An income statement reports on the revenue that a firm has generated. It shows the cost of goods sold and calculates the gross margin. It identifies and shows operating expenses, and finally shows the profits of the business.
One other important point: Income statements summarize revenue, expenses, and profits for a particular period. Some managers and entrepreneurs, for example, may want to prepare income statements on a daily basis. Public companies are required to prepare income statements on a quarterly and annual basis. And taxing authorities, such as the Internal Revenue Service (IRS), require tax return preparation both quarterly and annually.
Balance sheet
The second-most-important financial statement that an accounting system produces is a balance sheet. A balance sheet reports on a business’s assets, liabilities, and owner contributions of capital at a particular point in time:
The assets shown in a balance sheet are those items that are owned by the business, which have value and for which money was paid.
The liabilities shown in a balance sheet are those amounts that a business owes to other people, businesses, and government agencies.
The owner contributions of capital are the amounts that owners, partners, or shareholders have paid into the business in the form of investment or have reinvested in the business by leaving profits inside the company.
As long as you understand