The income statement summarizes the revenues, expenses, gains, and losses of a company during a period of time, generally a month, quarter, or year. It is the statement given the most attention by financial analysts and the financial press. A net income that fails to meet analyst forecasts by even a small amount can send a stock's price plummeting. A string of net losses is likely to signal a company in financial distress. Since net income is followed closely by investors and financial analysts, management pays close attention to this number as well.

Two major principles governing the income statement are the revenue recognition principle and the matching principle. The revenue recognition principle requires that revenues be recorded when they have been earned. The matching principle requires that the expenses incurred to earn revenues be included in the same income statement as those revenues. Although revenue recognition rules for many transactions are well-established, they may be misunderstood by those who focus on cash flows. Similarly, the matching principle, although generally accepted by the business community, has implications which may be forgotten by non-accountants.

A company can recognize revenue before, during, or after payment from a customer. The accrual basis of measuring income is generally accepted as being superior to the cash flow method because cash flows can be lumpy. That is, cash may be paid before, during, or after completion of a multi-period project. A company can work on several projects, collecting expenses without getting paid for its products or services, all the while earning value for its efforts. Looking only at the cash flow might give a distorted version of the company's net worth.

The timing of all transactions is very important. By recognizing revenue when it is earned, financial accounting shows the dollar value of the goods or services provided during the income statement period, rather than focusing on when the cash is received. Revenue should be recognized when the company has done everything that it should to be entitled to payment, whether or not cash has been received.

Similarly, a company may recognize an expense before, during, or after it is paid. The accrual method of accounting shows a company's liabilities during a specific period of time by matching those expenses with the value earned, rather than dollars paid.

Recognizing revenues and expenses before or after cash is received or paid out also affects other balance sheet accounts. For example, if revenue is recognized before cash is collected, the balance sheet category Accounts Receivable must be increased. If an expense such as wages is recognized before cash is paid out, a balance sheet liability account such as Wages Payable must be increased.

 
 
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