4 Revenue and Expenses

Now that we know what assets and liabilities are, and how to record transactions, let’s take a closer look at the retained earnings account. In the last chapter, sales and expenses directly changed the balance in retained earnings. Sales made retained earnings bigger with a credit, and expenses made it smaller with a debit. This was a simplification because you only know one financial statement, the Statement of Financial Position, so all we had to work with were assets, liabilities, and equity.

In this chapter we will learn another financial statement, the Income Statement. The income statement holds all the sales and expenses that we saw in retained earnings. Basically, revenue and expenses are so important that they get their own financial statement before being recorded in retained earnings.

Let’s take a moment to talk about what we mean by revenueRevenue:
Profit-increasing items arising from the business model, like sales or service revenue. See also: income. and income. Both terms indicate that the account has a credit balance, and therefore make profit higher. Revenue is used for profit-increasing items arising from the business model, like sales revenueSales Revenue:
Value generated by selling inventory to customers. Sales revenue appears at the beginning of the Income Statement in the calculation of gross profit., whereas income is commonly used for peripheral itemsPeripheral Income Statement Items:
Income and expenses, and gains and losses, from transactions that are outside of the company’s operating incomes, as described in their business model. Examples include gains and losses from sales of property, interest income from investments, and interest expenses from loans. such as interest income. Regardless of the term used, both revenue and income accounts increase profit!

Profit is often called earnings or income and all three of these words can mean the same thing: what’s leftover. Please note that income is sometimes used in place of revenue, so let’s be more specific: operating incomeOperating Income:
Net profit generated by operating a company’s business model. Calculated as gross profit less operating expenses. and net incomeNet Income:
Profit generated by a company over a period of time, after deducting all expenses. Calculated as operating income less peripheral items (other income and expense; gains and losses) and income tax expense. Also called net profit. are profit measures.

In this chapter we will study three profit measures: gross profitGross Profit:
Defined as sales revenue less cost of goods sold. Also referred to as mark-up on inventory., operating income (also called operating profit), and net income (net profit). Each profit measure gives us a clue about how efficiently a company is running, and where operating improvements can be made.

The term net is used often in accounting. Net just means that something has been subtracted. For example, net income or net profit is revenue with expenses subtracted.