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Spotting the difference between the income statement for a service company and a merchandising company is easier if you see both laid out in front of you. Figure 3-1 walks you through a service company income statement. It’s easy-peasy as you just need to report income and general and administrative operating expenses such as payroll, office supplies expense, and insurance expense.

FIGURE 3-1: Service business income statement.

Service business owner Maggie Cheap makes arrangements each year to open a pop-up tax return preparation service from January 31 to April 15. This year, she is operating out of an office-supply store that is not charging her a formal lease payment. She is making a token payment to cover utilities.

The reason behind the lease arrangement is two-fold. Maggie is doing the office-supply tax returns in barter type arrangement; the fair market value of which Maggie includes in her service revenue. Additionally, the office-supply store owner considers the traffic Maggie’s business attracts to his store as a favorable offset to rental income.

Figure 3-2 tackles the more complex merchandising income statement. Wondering if I completely forgot about manufacturing? I did not! A blown-out income statement for a manufacturing company is the centerpiece of Chapter 10.

Isabella Gabry operates a retail clothing store in downtown Winter Park, Florida. Rollins College is just around the corner from her shop with a built-in market of students looking for jeans and tees.

Chapter 10 walks you through most income and expenses shown on this income statement during the manufacturing company discussion. In this chapter, I want to give a quick-and-dirty explanation for a few that may not be intuitive.

 Sales discounts and sales returns and allowances: In this example, discounts include markdowns on clothing Izzie wants to move off the racks so that she can put out fresh inventory. The biggest returns and allowances are when a customer changes their mind and returns a purchase.

 Cost of goods sold — purchases: This is an important one, which differentiates between service, merchandising, and manufacturing. Izzie matches the cost of jeans and tees purchased from the manufacturer with the jeans and tees sold during the same time (see Chapter 12).

 Purchase discounts and purchase returns and allowances: Sometimes, the manufacturer gives Izzie a break on the price of the garments. There are many reasons why this might happen. In this example, Izzie is getting a $250 overstock discount. Purchase returns and allowances generally take place when the retail shop returns garments to the manufacturer that arrived damages, or maybe the wrong items were shipped.

FIGURE 3-2: Merchandising business income statement.

Comparing Figure 3-1 and Figure 3-2, the big difference is that the service business doesn’t have a cost of goods sold, because a service business normally doesn’t sell a tangible product. Makes sense, right?

You are probably a step ahead of me, but a fantastic example of a minor deviation from this would be a hair salon that sells product. While this type of business would have a cost of goods sold associated with the shampoo and conditioner sold to customers, it is still considered a service business because the product sale is subordinate to the income brought by the primary purpose of the salon — that of cutting, coloring, and styling customers’ hair.