Please Note: This article is part of a series of articles titled Accounting and Bookkeeping Principles for Contractors
Written by James R. Leichter
The period covered by a set of financial statements is called the accounting period. For most businesses, the official period is one year corresponding to the calendar year ending on December 31st. Most managers, however, do not wait for the annual statements to find out how the business is performing. Aptora’s Total Office Manager software and other accounting programs provide users with interim financial statements such as the Monthly Income Statement.
The Meaning of Income
Income, also called profit or earnings, is the difference between revenue and expenses, or the change in equity, for an accounting period. A positive difference means there was more revenue than expenses and the business was profitable; a negative difference means there were more expenses than revenue and the business lost money; and no difference means that the business broke even.
Income and the Balance Sheet
An Income Statement reports financial information for a specific period of time, whereas a Balance Sheet reports financial information for a single moment. The amounts recorded in revenue and expense accounts are used to prepare the Income Statement for an accounting period. An account in the Equities section of the Balance Sheet, often called Retained Earnings, shows the accumulated amount of such income for all periods to date.
Retained Earnings is a claim against cash and other assets that is credited for the amount of income, or earnings, and debited for amounts paid to the owners as dividends or another type of withdrawal. The balance of the Retained Earnings account is the amount of earnings that have been retained in the business. The income earned for the current fiscal year is added to a separate account in the Equities section called Current Earnings or Profit/Loss. At the end of the fiscal year, Current Earnings is added to the Retained Earnings account.
The Income Statement
Income is reported in an Income Statement, also called a Profit and Loss Statement or Operating Statement that summarizes the revenue and expenses for a period of time. Since revenues and expenses are increases and decreases in equity, the Income Statement actually explains changes in Retained Earnings on the Balance Sheet.
An Income Statement is formatted according to the needs of the business. Most accounting software programs, such as Aptora’s Total Office Manager, provide a default format that can be modified as needed. In this format, the various items of revenue are shown first, the total revenue is calculated, and the expenses are subtracted. The difference between revenues and expenses is income or net profit, referred to as the bottom line because of its location at the bottom of the statement.
The Balance Sheet and the Income Statement: An Example
The following example uses data to illustrate the relationship between the Balance Sheet and the Income Statement for an accounting period. Balance Sheet data for the beginning of February is taken from the Pro-USA Services example transactions for the end of January on page 5. The February Income Statement is presented below the Balance Sheets. Note that the change in Retained Earnings during the month of February is the result of the income incurred for the period ($14, 800) and the dividend paid during the period ($1500). Also note that, although income for February was $14,800, Cash decreased by $2,700 ($13,000-$10,300), illustrating that there is not necessarily a connection between the income of a period and the change in Cash during the same period. Furthermore, pay attention to the change in assets and equities between the Balance Sheets and the revenue and expenses in the Income Statement.
Note that, although income for February was $14,800, cash decreased by $2,700 ($13,000-$10,300).
Please read The Accrual Principle next.