12. Income statement and net income

By: Andrea Terzi

Monetary incomes
Information contained in the double-entry ledger book is the source for a second key document: the income statement. Its conceptual basis stems from the notion that economic units, in any given time period, earn monetary incomes when providing productive services, i.e., by selling labor services, leasing property, lending money, and selling newly produced output. Because it is a selection of entries from the ledger, debits and credits need not match. For example, while the selling of a service on the ledger comprises both a debit entry (the payment received) and a credit entry (the service provided), only the latter shows on the income statement.

Two kinds of economic units are considered here, consistent with a longstanding taxonomy in economics: business firms and households. Households earn by selling productive services and spend on goods and services for their current consumption. Business firms convert acquired productive services and intermediate products into output for sale.

Net income is the difference between revenue (i.e., the proceeds received from sales, from selling labor services, from renting property, and from lending money) and current expenditure (i.e., the payments made for acquisitions of output consumed in the accounting period, for using labor services, for using property, and for borrowing money). Yet, depending on the type of economic entity being considered (households or business), different terms are used for revenue and expenses.

Income statements of business firms
Business firms’ net income is called profit. This is the difference between output sales (on the credit side) and operating expenses (on the debit side). The latter includes the expenses of output and productive services consumed in the period for running the business operation, typically labor, rental, and interest costs; the expenses for intermediate products used in the production of new output; and the expenses for maintaining and replacing capital goods (i.e., business plant and equipment). Operating expenses do not include expenditures for new capital goods whose lifespan is expected to extend beyond the accounting period. Figure 3 illustrates the key entries of a typical profit (or loss) statement for business.

Figure 3. Profit (or loss) statement for business

Revenue (proceeds) Output sales (OS)
Current expenditure (payments) Operating expenses (OE)
Net income generated Profit

Income statements of households
Households’ net income is called saving. This is the difference between earned incomes from productive services (on the credit side) and consumption expenses (on the debit side). The latter include the expenses of output consumed during the period and do not include household expenses of assets whose lifespan extends beyond the period of reference, typically real estate. Figure 4 illustrates the key entries of a typical personal income statement for households.

Figure 4. Personal income statement for households

Revenue (proceeds) Incomes from productive services (IPS)
Current expenditure (payments) Consumption expenses (CE)
Net income generated Saving

Consolidated sector income statements
A consolidated income statement combines the accounts of all units in a given sector in one single document. With only two sectors here assumed to be operative, this defines the (net) saving of the household sector and the (net) profit of the business sector. Considering consolidated statements, household incomes from productive services (IPS) must be equal to business operating expenses (OE). Conversely, household consumption expenses (CE) only make one component of business output sales (OS) —the other component being sales of capital goods that buyers account as capital expenses.

This means that consolidated household saving and consolidated business profit do not cancel out. Because any payment to acquire capital goods is accounted as part of business revenue and yet it is not accounted as an operating expense, the economy’s aggregate revenue exceeds aggregate current expenditure by the value of all (business plus household) capital expenses; or, the sum of business profit and household saving equals the acquisition of capital goods.

Next module: Flow of funds accounts and the net financial position
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