Chapter 5 Accounting for Merchandise Operations 217Because of its wide use, we will use the perpetual inventory method throughout the
remainder of this chapter.
Exhibit 3 shows that Online Solutions reported gross profit of $182,950 in 2010.
Operating income, sometimes called income from operations, is determined by sub-
tracting operating expenses from gross profit. Most merchandising businesses classify
operating expenses as either selling expenses or administrative expenses. Expenses
that are incurred directly in the selling of merchandise are selling expenses. They in-
clude such expenses as salespersons’ salaries, store supplies used, depreciation of store
equipment, and advertising. Expenses incurred in the administration or general oper-
ations of the business are administrative expensesorgeneral expenses. Examples of
these expenses are office salaries, depreciation of office equipment, and office supplies
used. Credit card expense is also normally classified as an administrative expense.
Although selling and administrative expenses may be reported separately, as shown
in Exhibit 3, many companies report operating expenses as a single item.
As we will illustrate later in this chapter, operating income is often used in finan-
cial analysis to judge the efficiency and profitability of operations. For example, oper-
ating income divided by total assets or net sales is often used in comparing merchandise
businesses.
Online Solutions’ income statement in Exhibit 3 also reports other income and ex-
pense. Revenue from sources other than the primary operating activity of a business
is classified as other income. In a merchandising business, these items include income
from interest, rent, and gains resulting from the sale of fixed assets.
Expenses that cannot be traced directly to operations are identified as other ex-
pense. Interest expense that results from financing activities and losses incurred in the
disposal of fixed assets are examples of these items.
Other income and other expense are offset against each other on the income state-
ment, as shown in Exhibit 3. If the total of other income exceeds the total of other ex-
pense, the difference is added to income from operations. If the reverse is true, the
difference is subtracted from income from operations.
Deducting income taxes from income before taxes yields the net income. As we il-
lustrated in Chapter 4, net income or loss is closed to Retained Earnings at the end of
the period.Single-Step Income Statement
An alternate form of income statement is the single-step income statement. As shown
in Exhibit 5, the income statement for Online Solutions deducts the total of all expenses
in one stepfrom the total of all revenues.Exhibit 5
Single-Step Income
StatementOnline Solutions
Income Statement
For the Year Ended December 31, 2010Revenue:
Net sales $708,255
Expenses:
Cost of merchandise sold $525,305
Operating expenses 105,710
Income taxes 15,000
Other income and expense (net) 1,840 647,855
Net income $ 60,400International Perspective
To promote international
consistency in financial
reporting, the International
Accounting Standards
Board and the U.S.
Financial Accounting
Standards Board have
joined forces on an ac-
counting convergence
project. The goal of the
project is to improve con-
sistency in how transac-
tions are accounted for
under U.S. GAAP and
IAS.