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　　Section II Income statement
　　The income statement, also called the statement of earnings, represents revenues, expenses, net income, and earnings per share for an accounting period, generally a year or a quarter. Closely related to the income statement is the statement of retained earnings. This statement documents the changes in the balance sheet retained earning account from one accounting period to the next. Usually, this reconciliation consists of the beginning retained earnings balance plus or minus an profit or loss for the period and less the deduction for any dividends. Annual reports include three years’ income statements and statements of retained earnings.
　　Regardless of the perspective of the financial statement user – investors, creditor, employee, competitor, supplier, regulator – it is essential to understand and analyze the earning statement. But it is also important that the analyst realize that a company’s report of earnings and other information presented on the income statement are not complete and sufficient barometers of financial performance. The income statement is one of many pieces of a financial statement package, and like the other pieces, the income statements is partially the product of a wide range of accounting choices, estimates, and judgments that affect reported results, just as business policies, economic conditions, and many other variables affect results.

　　Total sales revenue for each year of the three-year period is shown net of returns and allowances. A sales return is cancellation of sale, and a sales allowance is a deduction from the original sales invoice price. Since sales are the major revenue source for most companies, the trend of this figure is a key element in performance measurement.
　　The first expense deduction from sales is the cost to the seller of products or services sold to customers. This expense is called cost of goods sold or cost of sales. The amount of cost of goods sold for any accounting period will be affected by the cost flow assumption used to value inventory.
　　The difference between net sales and cost of goods sold is called gross profit or gross margin. Gross profit is the first step of profit measurement on the multiple-step income statement and is a key analytical tool in assessing a firm’s operation performance. The gross profit figure indicates how much profit the firm is generating after deducting the cost of products sold. Gross profit, expressed as percentage of net sales, is the gross profit margin.

　　The most common categories of operating expense are selling and administrative, advertising, lease payments, depreciation and amortization, and repairs and maintenance. These are all areas over which management exercises discretion and which have considerable impact on the firm’s current and future profitability. Thus, it is important to track these accounts carefully in terms of trends, absolute amounts, relationship to sales, and relationship to industry competitors.
　　Selling and administrative expense are expenses relating to sales of products or services and to the management of the business. They include salaries, rent, insurance, utilities, supplies and sometimes depreciation and advertising expense. Advertising costs are or should be a major expense in the budgets of companies for which marketing is an important element of success. Lease payments include the costs associated with operating rentals of leased facilities for retail outlets.

　　The cost of assets other than land that will benefit a business enterprise for more than a year is allocated over the asset’s service life rather than expensed in the year of purchase. The cost allocation procedure is determined by the nature of the long-lived asset. Depreciation is used to allocate the cost of tangible fixed assets such as buildings, machinery, equipment, furniture and fixture, and motor vehicles. Amortization is the process applied to the cost expiration of intangible assets such as patents, copyright, trademarks, licenses, franchises, and goodwill. The cost of acquiring and developing natural resources – oil and gas, other minerals, and standing timber – is allocated through depletion. The amount of expense recognized in any accounting period will depend on the level of investment in the relevant asset, estimates with regard to the asset’s service life and residual value, and on the method of depreciation used.
　　Repairs and maintenance are the annual costs of repairing and maintaining the firm’s property, plant, and equipment. Expenditures in this area should correspond to the level of investment in capital equipment and to the age and condition of the company’s fixed assets. Similar to research and development and advertising and marketing expenses, inadequate allowance for repair and maintenance can impair the ongoing success of an organization.