Deciphering a company's finances can be confusing because of all the different financial statements: balance sheets, income statements, cash flow statements and statements of shareholders' equity. However, understanding how debits and credits are used to record income and expenses can go a long way toward making it all comprehensible.
Income Statement Purpose
The purpose of the income statement is to calculate the net profit or loss for the corporation for the time period that the income statement covers. Every publicly held company must produce an income statement as part of its reporting requirements. If you run your own business, you might not be required to publish an income statement, but it will show you whether you're making money or losing money.
All of the company's debits from other accounts are reported as expenses on the income statement. These other accounts may include employee salaries, costs of goods sold, utilities and rent. When these amounts are moved to the balance sheet, however, they must be matched with entries in the individual accounts. For example, when you report a $5,000 rent expense on the income statement, you have to report a $5,000 credit to match and ensure the rent expense doesn't get double-counted.
Credits from your other accounts are reported as revenue on the income statement. Revenues include professional fees, inventory sales and rental income. As with expenses, you must make a matching entry to the individual account. For example, if your inventory sales account has a $10,000 balance that you transfer to the income statement as a credit, you must enter a $10,000 debit on the sales account to make sure the same income isn't counted twice.
Income Statement Formatting
On the income statement, revenues are reported first, then expenses, and finally net income. Often, these different revenues and expenses are reported by category in one column and then combined and reported as total expenses in another column. For example, you might use the left-hand column to report the expenses of each category and then the right-hand column as your totals column. The net income is calculated by subtracting total expenses from total revenues.
- U.S. Securities and Exchange Commission: Beginners' Guide to Financial Statements
- Austin Community College: Rules of Debits and Credits
- Cengage Learning: T Accounts, Debits and Credits, Trial Balance, and Financial Statements
- McGraw-Hill Higher Education: College Accounting, Chapter 3: Debits and Credits
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