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Case Study: Income Statement

Case Study: Income Statement

Author: Sophia Tutorial
Description:

Calculate the net profit or loss for a hypothetical business.

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Tutorial
what's covered
This lesson will cover the preparation of an income statement in the context of a case study, using a hypothetical business.

Our discussion breaks down as follows:

  1. Case Study: Legacy Realty
  2. Case Study: Income Statement


1. Case Study: Legacy Realty

The subject company for our case study is called Legacy Realty. Legacy Realty is a sole proprietorship, which is a type of company that is owned by one single individual, and where that individual and the business are legally treated as the same.

The purpose of Legacy Realty as a business is to own, lease, and manage its own rental properties. It purchases houses and condominiums and leases them out to tenants. They also perform their own management of their units, making repairs, performing maintenance, and collecting rent. Legacy Realty is located in Washington DC, and they have a small staff of five people.

Legacy Realty
Type of company Sole proprietorship
Business purpose Own, lease, and manage rental properties
Business location(s) Washington, D.C.
Staff of 5 people

Legacy Realty needs an income statement to provide information about a business's profitability, informing about the health or strength of the business, over one year or less of activity. This is important so that Legacy Realty can analyze the inflows and outflows within their business, which is critical information for potential investors and banks, as well as for the owners themselves.


2. Case Study: Income Statement

So, where do we start when we need to prepare an income statement? Well, we start with the trial balance worksheet, specifically the adjusted trial balance, shown below.

As you can see, we've prepared the trial balance, listing all of the general ledger accounts, as well as their corresponding debit and credit balances. We've also prepared the adjustments and adjustment explanations, making corrections to the accounts to match all revenues and expenses with the correct period. We've also corrected any errors or omissions may have been made.

Using this information, we have also prepared the adjusted trial balance, accounting for all of those adjustments that were made. Similar to the trial balance, the adjusted trial balance is a listing of all of the general ledger accounts, as well as the corresponding debit or credit balances within those accounts.

This adjusted trial balance is going to be the source for the financial statements, containing all the information needed to create those statements for Legacy Realty.

Now that we've got our adjusted trial balance, we can begin to prepare the income statement. The first part of the income statement is the heading, which includes the business's name, Legacy Realty Partners, "Income Statement," and that important phrase, "For the period ending December 31, 2012."

Now, referring back to the adjusted trial balance, do you think we need the information from all of these accounts to prepare the income statement? No, we don't need the permanent accounts--the assets, liabilities, and equity. All we need are the revenue and expense accounts, which are the temporary accounts.

We start with revenue, then input all of the operating expenses: salaries, repairs, advertising, rent, insurance, supplies, and depreciation. This provides the total operating expenses.

Next, we calculate a subtotal of what is called income from operations. This represents the operating income.

We add in other revenue or expense items, which in this case is the interest expense. We subtract the interest expense from the income from operations, to arrive at the total net income of $86,500.


summary
Today we introduced our case study company called Legacy Realty, that is in the business of owning and leasing their own rental properties. We walked through an example of preparing an income statement for Legacy Realty, starting with the adjusted trial balance and pulling information from the revenue and expense accounts to create the income statement.

Source: Adapted from Sophia instructor Evan McLaughlin.