Merchandising Income Statement vs. Service Income Statement
A nationwide chain that sells hats from around the world is very different from a business that writes customized computer systems. Nevertheless, both must conform to generally accepted accounting principles and periodically publish financial reports, including an income statement. The accounting profession acknowledges the dissimilarities between merchandising and service companies by permitting differently formatted income statements.
Along with the balance sheet and the statement of cash flows, the income statement is one of the “big three” financial reports. Its purpose is to disclose business results for a specified period. The top of the statement is devoted to income and gains. Expenses and losses follow next, including separate lines for interest and tax expenses and ending with the net income for the period. Some companies must also report “other comprehensive income” after net income -- the after-tax unrealized income or loss resulting from items outside of management’s control, such as currency translations or pension costs.
A merchandising company purchases inventory wholesale and sells it retail. The income statement of a merchandiser begins with gross profit, which is the difference between sales revenues and cost of goods sold. Gross profit is also known as gross margin from sales. The company may choose to split out sales discounts, refunds and returns from total sales to derive net sales revenues. COGS is equal to beginning inventory plus inventory purchases during the period minus ending inventory. The income statement lists and subtracts operating expenses to arrive at operating income. In a multi-step income statement -- normally only used by a merchandiser -- the company lists different expense categories such as advertising, depreciation, rent and wages. These categories are lumped together as general and administrative expenses in a single-step income statement.
A service company performs some tasks on your behalf and charges you for them, usually as a fixed amount or on a time and materials basis. The income statement of a service company is simpler than that of a merchandiser because it doesn’t deal with COGS. Instead, the revenues from services head up the statement, followed once again by the costs of doing business. Service companies may incidentally provide materials to customers, such as instruction manuals. The company can factor the costs of these materials into service revenue or list them separately. Other common expenses a service company incurs include travel costs, equipment and facility rentals and other service delivery costs.
The income statement lists results from operations first and then separately discloses any gains or losses that are outside the scope of operations. Both kinds of companies can experience gains and losses from non-operational sources, but typically these sources differ between the two business types. For example, a merchandiser might decide to redecorate a retail store and sell off fixtures for a profit. A service company might have a one-time gain from the sale of a patent. Either type of business might have a non-operational loss stemming from a lawsuit judgment. The merchandiser is more likely to be involved in a suit over defective goods, whereas the service provider might be sued for breach of contract.
Some companies manufacture the goods they merchandise. In this case, the company expands the COGS calculation to include the cost of raw materials, labor and overhead associated with the manufacturing process. The company has the option to list these costs as separate components of COGS or simply lump them together.
A merchandiser faces inventory-related expenses that reduce net income, expenses with no counterpart in a service company. Examples include losses due to inventory damage, spoilage, obsolescence and theft. The merchandiser can include these costs in COGS or explicitly list them on the income statement.