Gross profit, operating income, other items, tax — and what the notes must say

Why steps

Northlake's income statement so far has been a single step: revenues, less expenses, net income. A merchandiser — a company that buys goods and sells them — reports in steps, because its reader wants to know three separate things: what the goods earned over their cost, what the business earned from running itself, and what it earned after the things that are not operations at all.

Worked example — Bramble Lane Outfitters Ltd.

Year-end figures: net sales 412,000; cost of goods sold 247,200; salaries 68,000; rent 30,000; amortization 9,400; utilities 6,100; interest expense 4,300; a gain on the disposal of a delivery van 1,200; income tax at 20 %.

Bramble Lane Outfitters Ltd.
Income Statement
For the year ended 31 December

Net sales                                     412,000
Cost of goods sold                            247,200
Gross profit                                  164,800
Operating expenses
  Salaries expense                  68,000
  Rent expense                      30,000
  Amortization expense               9,400
  Utilities expense                  6,100
  Total operating expenses                    113,500
Income from operations                         51,300
Other income and expense
  Interest expense                  (4,300)
  Gain on disposal of equipment      1,200     (3,100)
Income before income tax                       48,200
Income tax expense                              9,640
Net income                                     38,560

Step 1 — gross profit. $412,000-247,200=164,800$: what the goods sold for over what they cost. Hermanson calls it gross margin; Dauderis & Annand gross profit; the paper accepts either. A service company has no cost of goods sold and no gross-profit line — Northlake would start at operating expenses.

Step 2 — income from operations. Gross profit less the expenses of running the store: $164,800-113,500=51,300$. This is the number that says whether the business works.

Step 3 — other income and expense. Interest expense is the cost of how the company is financed, not of running a store, so it sits below operating income; a gain on selling a van is a one-off, not what Bramble Lane is in business to do, so it sits there too. Net other items $-4,300+1,200=-3,100$; income before tax $51,300-3,100=48,200$.

Step 4 — tax. $48,200\times 20\%=9,640$; net income $38,560$.

Gross margin percentage

$$\text{Gross margin \%}=\frac{\text{Gross profit}}{\text{Net sales}}=\frac{164,800}{412,000}=40.0\%$$

Forty cents of every sales dollar is left after the goods are paid for, to cover operating expenses and profit. It is the one ratio a merchandiser's lender reads first, and Module 8 shows how the inventory cost formula moves it.

The work sheet

Some bookkeepers build the statements on a work sheet — a grid with the adjusted trial balance in the first pair of columns and each balance carried right into an income-statement pair or a balance-sheet pair. It is an optional tool, not a statement: nothing on the paper asks for it, and no reader receives it.

The notes

A private company's statements come with notes, and the first note is the accounting policies. ASPE gives choices — a cost formula for inventory, an amortization method, a revenue policy — and a lender comparing Bramble Lane with another outfitter needs to know which were taken. Three policies every case can be expected to disclose: