Earnings Statement

Preparing the Income Statement in the Accounting Cycle

The financial statements are the final product in the accounting cycle.

This income statement example goes over preparing the earnings statement in the accounting cycle. The income statement is also called the profit and loss statement, or the earnings statement.

The end result of the accounting cycle was summarized in the adjusted trial balance. From the adjusted trial balance, we now have all of the account balances necessary to complete the earnings statement, the balance sheet, and the statement of cash flows for January.

We now use the sales and expense accounts on the adjusted trial balance, highlighted below, to prepare the earnings statement. Earnings statement accounts are called nominal or temporary accounts because they are closed after the reporting period to start a new balance in each account. For example, if we report income for the year 2010, we want a new balance of zero to start the new year.

Balance sheet accounts, on the other hand, are called real or permanent accounts because they continue to accumulate for the life the asset, liability, or equity account.

Sunny Sunglasses Shop
Adjusted Trial Balance
January 31, 2010

Sunny prepared the January earnings statement from the adjusted trial balance accounts highlighted above as follows:

Sunny Sunglasses Shop
Earnings Statement
January 31, 2010

He used two revenue accounts, the net sales account (net of returns) of $11,680, and the repair revenue of $20 under “other income” on the adjusted trial balance, to fill in revenue for January on the income statement.

The Income Statement Format

The earnings statement separates revenue from the main operations of the business, called operating income, from revenue incidental to the business. Similarly, the earnings statement separates operating expenses from those expenses that do not directly contribute to the generation of revenue.

Since Sunny Sunglasses Shop sells Sunglasses, the main operating revenue is from sales. Repairing sunglasses is incidental to the business and categorized outside of operating income. Similarly, accountants do not consider interest and taxes as an operating expense, and separate it from the main operating expenses of the business.

Sunny then used each expense account to arrive at the net income of $248 (total revenue less total expenses). The business made a small profit during the first month of operations.

The business has completed the production of the monthly income statement from the accounting cycle.

Income Statement Example: Preparing the Earnings Statement in the Accounting Cycle

Financial statements are produced from the account balances in the adjusted trial balance. The earnings statement is created from the nominal or temporary accounts highlighted above. The balance sheet is created from the real or permanent accounts. Real accounts are the assets, liabilities, and owner’s equity discussed in the next section.

From the Income Statement Example to the Next Step in the Accounting Cycle: Preparing the Balance Sheet

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