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In judging the success of a business it is important to know the extent to which the owners' equity has increased or decreased during a given period of time, and the specific factors responsible for the change.

An accounting report called the income statement provides this information. In order to understand how it is prepared, we must first examine the typical transactions of Comfortable Bedding Company.

On January 7, the company sold for $800 cash some comforter sets which had cost $500, owner's equity increased by $300.

An alternative view of this transaction is that it is composed of two events:

(1)the $800 sale, which brings in $800 of cash; and

(2)the delivery of merchandise, which had cost$500.

The effects of these two parts of the transaction - the $800 sale, and the delivery of goods costing $500 upon the owner's equity can be considered separately.

And, taken by itself, the fact that merchandise costing $500 is no longer owned by the business, results in a decrease of $500 in the owner's equity.

Taken by itself, the increase in owner's equity is called arevenue. For example, when Comfortable Bedding Company sold $800 of merchandise the transaction resulted in $800 of revenue.

And taken by itself, the associated decrease in owner's equity is called an expense. Thus when Comfortable Bedding Company has sold merchandise for$800 that had cost $500, the effects of the transaction on owner's equity can be separated into two parts: (1) a revenue of $800; and (2) an expense of $500.

Comfortable Bedding Company sells a dozen of down comforter sets for $1,000 that had cost it $700. In recording this transaction the proper accounting procedure would be to record a revenue of $1,000 and an expense of $700.

There are many categories of expenses which are also considered in computing for the net income aside from the cost of the product. Salaries and wages expense, interest expense, rental expense, and maintenance expense are a few.

We now focus our attention on an expense on an item calledcost of goods sold. As the name suggests, it refers to the cost of the merchandise sold to customers.

Another term for this item is cost of sales; that is, the phrasescost of goods sold and cost of sales are both acceptable designations for the expense item that shows the cost of the merchandise that is furnished customers.

Consider once again the transactions of Comfortable Bedding Company, and let us assume for simplicity, that the only items of revenue were the sales of merchandise and the only expenses were the cost of goods sold. The report of revenues and expenses of Comfortable Bedding Company would be: Total revenues - $1,000; total expenses - $1,200; and a net income of $800.

If total revenues exceed total expenses for a given period, the difference is termed the net income. If expenses exceed revenues, the difference is the net loss.

The term profit is synonymous with the term net income. That is, it is defined as the difference between revenues and expenses.

A statement of revenues and expenses for a given period is called an income statement.

A single balance sheet does not enable one to determine the net changes in owners' equity over a period of time.

The most convenient method for determining the net changes in owners' equity that have taken place during a given period of time and the factors responsible for these changes is to consult the income statement.

Evidently, the income statement reports changes over a period of time, whereas the balance sheet reports status as of a moment of time.

Revenue and expenses are defined as the increases and decreases in owners' equity, an item in the balance sheet.