 Hello and welcome to the session in which you would look at the elements and format of the income statement. I thought I was going to cover the elements separately than the income statement, but I have decided to combine both topics. And the reason is because we already covered the element in depth when we looked at the conceptual framework. Understanding the format of the income statement is critical, whether you are taking intermediate accounting. And this is typically covered in chapter three or four in your intermediate accounting textbook, or you are studying for FAR. The FAR CPA exam, I consider those series as a bootcamp for your income statement. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. My resources are a useful addition to your CPA review course, useful complement. Simply put, you keep your course, you use me as alternative backup. 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So in this session, I'm going to be focusing on elements briefly because we already covered those. Then more importantly, the format of the income statement, because the format of the income statement will feed into the next session when we look at the various income items presented on the income statement. So the four elements that goes on the income statement, I list them right in front of you, revenues, expenses, gains, and losses. So that's what goes on the income statement. So assets don't go on the income statement. Liabilities don't go on the income statement. Dividend don't go on the income statement. So the first thing you need to know is which elements goes on the income statement, that we need to understand what each element means and how do they all fit together. So revenues, what are revenues? Well, revenues, they result in increases in assets or a reduction in liabilities. Simply put, revenues are something that's going to increase your asset, usually cash, or you can reduce your liabilities. If someone owe you something, you can provide them a service or you can give them goods or services. So simply put, as a result of delivering goods or producing services from the company's ongoing central operation or major operation, each company exists for a purpose. For example, your university exists to serve you. Therefore, they have something called tuition revenue. You pay them and that's their central major operation. For example, if you're taking a CPA review course, you pay for that CPA review course. That's revenue for the CPA review course. That's sales revenue. You, if you work somewhere, you have a source of revenue and that's your work. But companies will have all sorts of revenues, such as sales revenue, consulting revenue, tuition revenue, depending on what business you are in. I'm going to illustrate this concept by talking about McDonald's. What do McDonald's do? McDonald's sell food, sell burgers. So if I ask you, what's the revenues for McDonald's? You would say food, usually burger, but they sell all sorts of food, but mainly burgers and fries, right? So this is the sales revenue of burger. Now keep that in mind because we're going to be talking about something else similar to revenues, but it's not really revenues. So this is what revenues are. What the company does on a day-to-day basis to increase their assets, to generate more cash, and that's their revenues. Expenses, what are expenses? They are decreases in asset or increases in liabilities. Sometimes you don't pay for the expenses, but they're going to increase your obligation to pay for them on the future. In a sense, they're opposite of expenses. Why? Well, you need expenses to run the business. Like McDonald's, they need to buy the buns. They need to buy the bread. They need to buy the fries. They need to hire employees. They need to pay for insurance. They need to pay for taxes. They need to pay for rent. They need to pay for maintenance. They need to pay for all sorts of different expenses to run the business on a day-to-day basis. This is what expenses are. Expenses are basically a cost to run the business. And expenses usually are matched with revenues. So if we incur an expense, if it's generating revenue, it gets matched with that revenue. Now let's talk about the third element of the income statement and that's gain. And what is gain? Increases an asset or a reduction in liabilities. Hold on a second. This sounds like what? This sounds like exactly like revenues. However, as a result from peripheral or incidental transaction of the entity, what does that mean? Simply put, you're going to increase your assets or you're going to have less liabilities because you satisfied your obligation as a result of some event. What could be that event? Examples of gains. For example, a sale of property, plant, and equipment. And the best example I can give you is McDonald's. Okay? I'm sure you're aware and I'm pretty sure you see those trucks on the road every once in a while. McDonald's truck delivering fries or delivering burgers to their stores. Now guess what? Every once in a while, McDonald's will sell these vehicles. They don't keep them forever. They sell them. And sometimes they might sell them at a gain. Usually they don't, but let's assume they could sell them at a gain. What is a gain? Well, a gain is more than their book. If they sell it more than the book value, they will have a gain. Sometimes they sell them at a gain. So if you want to go to McDonald's and you tell them, look, I'm interested in buying one of your delivery truck. They would say, sorry, we don't, you know, they, you know, usually they call the cops because, you know, they think you're nuts. And you know, at McDonald's, there's a lot of wild incidents. So you cannot buy a delivery truck or a delivery truck from McDonald's. That's not what they sell, but they do sell them. But that's part of their peripheral activities. They do it every once, once a year or twice a year. They replenish their truck inventory. So that's not really a gain. And sometimes they might sell the truck and incur a loss. A gain is when you sell it more than the book value, a loss when you sell it less than the book value. Also McDonald's could have investments. They can invest in Apple. They can invest in, in Amazon. They can invest in other companies as a result. They make an investment. They sell it. They have a game. They sell it more than what they pay for it. They have right off of assets. Those are all gains. Also they incur, they could incur losses. Losses are the opposite of gains. Decreases in assets or increases in liabilities from peripheral or incidental. If we go back to this truck here, they might sell it at a loss. And usually they sell them at a loss because who's going to buy a truck that's already been used and the seller will have a gain. Usually it's at a loss, but it doesn't really matter. Okay. So losses are the opposite of gains. Also McDonald's could buy Apple's stock, then sell it at a, sell it and incur a loss. That's a sale of an investment. So those are the four elements that goes on the financial statements. So notice here, we don't have assets. Again, we don't have liabilities. We don't have dividend. Those go somewhere else, right? So we have to know what goes on each financial statement and eventually we'd look at the balance sheet in details as well. But today we're going to be focusing on the income statement. Again, the income statement will have the name of the company, the name of the statement and four year ended or four period ended. And the reason I said again, because in the prior chapter, we briefly covered the income statement. Now we're going to dig deeper into the income statement. So the first thing we're going to understand about the income statement, usually the income statement is separated into operating section and non-operating section. Then we're going to have a section for tax. So this is the simple income statement, which is it's simple for us now, but it wasn't simple earlier. In other words, earlier, I'm sorry, earlier was even simpler because earlier we just took revenues minus expenses. Now we're going to break the income statement into three components, into three components, the operating section, non-operating section and taxes. And those are not the only three components you're going to see in the next session. We're going to be adding more components to the income statement. But generally speaking, any company will have those three sections. They will surely have the operating section and they will surely have to pay taxes. Now companies may or may not have a non-operating section, but the point is we have to understand the various components of the income statement. Now also the income statement, we could have a multiple step or a single step income statement. First, I'm going to show you the multiple step income statement. The multiple step income statement basically break the income statement into various intermediate sections to help you make a better decision about the company. And we're going to look at the multiple step as well as the single step and compare the two. Now why do companies provide multiple step? Multiple step highlight certain figures that are relevant to investors, relevant to creditors. The company wants to show like gross profit. What is gross profit? Gross profit is sales minus cost of goods sold. For example, this company here, they have sales of 120,000, cost of goods sold of 75,300, their gross profit is 44,700. So if the company wants to show you, wants to highlight this figure, they will prepare a multiple step income statement to show you their gross profit. That's what they want to highlight. It's highlighted in multiple step. And this is an important number for investors because when you want to invest in a company, you want to see how much they're selling their product for versus their cost. And you can compare, for example, McDonald's to Burger King, McDonald's to Wendy's, McDonald's to some other burger place. So that's very important. Then the company will have would list their operating expenses. They need expenses. Remember, we need expenses to run the business. So we kind of took care of revenues. Now also sales revenues could become, you know, we could get the net sales, which is sales minus returns and allowances, but we don't have to worry about this much today. Operating expenses, we could have selling expenses and we could have administrative expenses. So under operating expenses, we can break this category into two components and we're still working within the operating section. What are selling expenses? Selling expenses are cost incurred to help you sell your product or your services, like sales commission, depreciation on sales equipment, like delivery vehicles, delivery expense. So any cost that's going to help you directly sell your product is called the selling expense. And notice we add them up and selling expenses happens to be 17,150. Then we have administrative expenses. What are administrative expenses? Administrative expenses are cost incurred to run the business but they're not related to sales. They're related to the whole company, support of the whole company. They could be like officer's salary, notice depreciation, but office furniture and equipment, office, office, not sales. So notice depreciation in both end, okay? We could have other expenses such as rent, rental for renting something for our operation, usually employee salaries like human resources, payroll, those are administrative expenses, versus sales commission. So sales commission are form of payroll, but since those employees are being paid to generate sales, it's considered selling expenses. So you could see the same expense in this category and in this category, depending what it's being done. For example, advertising expense would always be a selling expense. Of course, sales commission would always be a selling expense. Okay, renting your sales offices will always be a selling expense. I want to make you aware of this. So now we add the operating expenses. They are up to $26,000, $10. We'll take gross profit minus the operating expenses will give us income from operation. And usually this is another important number. This number tells us how well the company generating gross profit, sales minus their cost. For example, McDonnell, they have to make sales, but they have to pay for their burgers, the buns, the tomatoes, the onions, all their supplies, which is cost of goods sold. Then after that, after their gross profit, they have to pay their employees. They have to pay the delivery people. They have to pay the insurance on the place where they operate. They have to depreciate the equipment. They are listed here. And after that, we know whether the company is making a profit or not making a profit. So gross profit minus operating expenses, this is the operating section of the income statement, operating section, because we have an operating section and we have an unoperating section. And a company cannot exist without an operating section because you exist to do something. And that something is the operating section. Now, a company could have a non-operating section as well, like what? Other revenues and gains. For example, McDonnell sold one of their warehouse and as a result, they had a gain of $10,000. McDonnell also rented some equipment to someone and they had $17,230. What does that mean? It means they generated, they increased their assets, they had a gain, but it has nothing to do with what they do. For example, McDonnell, they're not here, they're not selling burgers. They sold their warehouse. They rented some equipment. That's not revenue. Well, that's good. That's going to increase their assets. Therefore, we're going to take $18,000 plus the $10,000 plus the $17,000. Now we're up to $45,920. Also, this is basically we're starting the non-operating section. Those are non-operating. Also, they might have other expenses and losses with the non-operating, like a loss from a sale of an investment. They sold an investment, they incurred a loss of $5,000. Also, interest expense. Interest expense is the cost to borrow money. When you borrow money, it's how you finance yourself. It has nothing to do with selling burgers, how you finance yourself. Therefore, it's listed under other expenses and losses. And interest expense is important that we have a separate line on the income statement is how much are we paying a cost of bringing money to the business? Interest expense, the cost of borrowing. So this is non-operating. Then obviously we're going to subtract those and we're going to come up with income before income taxes, which happens to be $39,060. Then this is the third section, which is tax. So it's important to know that the way you pay taxes on operating expenses will be different than the way you pay your taxes for other items that we're going to see later. Items that we call below the line. Below the line, which you will see in the next session. So these items operating and non-operating, we compute them, then we compute the tax. And I'm assuming here it's 21% tax rate, which is the current US tax rate. Our taxes are $8,203. Our net income is $30,875. And we'll talk about earnings per share later. But those are the three section, operating, non-operating, and tax. Now, are these the only three section on the income statement in the answer? Absolutely not. You would wish. For most companies, you could have those three sections. But you're going to see in the next session, we're going to be dealing with various items, such as discontinued operation, non-controlling interests. So there are other components that we have to be aware of that are called basically below the line. And we'll look at those later on in the next session. Now, this is a multiple step income statement. This is a multiple step income statement. Breaking down the information, this is what we just saw on the previous slide, breaking down the information in a way that makes sense to the investors. Now, is this the only format that the company can utilize to provide income statement? The answer is no, but most companies would use the multiple step income statement. The company could also use the single step income statement. What would the single step income statement? Easy. They will bunch all the revenues and gains together, okay, which is notice, sales revenue, gains and rent. They bunch them all together and they end up to 147, 230. They will bunch all their expenses together. Then they will take their expenses, revenues minus expenses. They will come up with income before income taxes. Notice we are still reporting tax on a separate line. That's 8,230. And notice net income is the same, whether you are using the multiple step or the single step income statement. And that's the point. The point they are both, they give you the same figure, except they are presented differently. They are presented differently. Most companies use the multiple step income statement. Now, at the end of this recording, I'm going to remind you, again, I don't replace your CPA review course because I don't. I'm a useful addition to your CPA review course. In the next session, we would look at other topics on the income statement. And specifically, I'm going to be looking at unusual and unfrequent gains and losses and non-controlling interests. Invest in yourself. Your CPA is a lifetime investment. Once you have it, it's forever. Invest, take care of it, put it behind you so you could focus on your career. Good luck, study hard, and of course, stay safe.