There are three basic financial statements: the income statement that measures the revenues and expenses of the firm, the balance sheet that reports on the assets and liabilities of the firm, and the statement of cash flows that examines the sources and the uses of cash.
An income statement provides information about a firm’s operating activities over a specific time period. The net income of a company is equal to the revenues minus expenses, where revenues arise from selling goods or services, and expenses measure the costs associated with generating these revenues.
Classification—A Typical Income Statement
Since income can be generated from a number of different sources, generally accepted accounting principles (GAAP) require that income statements be classified into four sections—income from continuing operations, income from discontinued operations, extraordinary gains or losses, and adjustments for changes in accounting principles. A typical income statement starts with revenues, and adjusts for the cost of the goods sold, depreciation on assets used to produce the revenues, and any selling or administrative expenses, to arrive at an operating profit. The operating profit, when reduced by interest expenses, yields the taxable income, which when reduced by taxes yields net income.
Accrual versus Cash Basis—Income Statements
Firms often expend resources to acquire materials or manufacture goods in one period, but do not ...