Reading: Lesson 1 - Two income statements compared

To determine profitability or net income, a service company deducts total expenses incurred from revenues earned. A merchandising company is a more complex business and, therefore, has a more complex income statement. As shown in Exhibit 32, merchandising companies must deduct from revenues the cost of the goods they sell to customers to arrive at gross margin. Then, they deduct other expenses. The income statement of a merchandising company has three main divisions: (1) sales revenues, which result from the sale of goods by the company; (2) cost of goods sold, which is an expense that indicates how much the company paid for the goods sold; and (3) expenses, which are the company's other expenses in running the business.

In the next two sections we discuss the first two main divisions of the income statement of a merchandising company. The third division (expenses) is similar to expenses for a service company, which we illustrated in preceding chapters. As you study these sections, keep in mind how the divisions of the merchandising income statement are related to each other and produce the final figure—net income or net loss—which indicates the profitability of the company.