Service companies

Service firms make up the largest business sector in the United States. Service companies are those that
do not sell a physical product but instead provide services to their customers. Service firms include
accounting firms, law firms, marketing firms, IT services firms, banks, dry cleaners, health care
organizations, educational institutions and many other businesses we interact with on a daily basis.

One major difference between service companies and the other two types is that service companies do
not have the cost of goods sold because there is no product being sold. Service firms also do not have
inventory, also because no physical product is being sold. There may be direct costs associated with
providing the service, but no physical product.

Merchandising companies

Merchandising companies are those which sell products but do not make products. Merchandising
companies are broken up into two different types: retailers and wholesalers.

Retailers sell products directly to the end user. Staples, Wal-Mart, Target, American Eagle, GAP, and
Home Depot are all retailers. They sell products that consumers and businesses use, rather than resell.

Wholesalers buy products from manufacturers and sell them to other merchandising companies, usually
retailers. For example, most small breweries will use a distributor to help get their beers into stores and
restaurants. These distributors have established relationships with local stores and restaurants, making
easier for small breweries to get their beers to the public. A distributor is a wholesaler. Wholesalers are
sometimes referred to as “middlemen” because they act as an intermediary between a manufacturer
and a retailer.

Merchandising companies purchase inventory (an asset) and sell that inventory. When inventory is sold,
the asset is considered used up, and the cost of that inventory is transferred from the balance sheet to
the income statement as an expense. This expense is called cost of goods sold. For merchandising
companies, the inventory account can also be referred to as merchandise inventory.

Manufacturing companies
Manufacturing companies are companies that make a product. Monster Beverages, Dell Computers,
Boeing, and General Motors are all companies that produce a product. These companies use labor and
machinery to turn materials into a product. Some manufacturing companies sell their products directly
to the end user, like Boeing. Some companies like Dell, sell their product directly to consumers and to
retailers. Monster Beverages and General Motors sell their products to retailers who sell the product to
the end user.

All manufacturing companies have three different inventory accounts to account for the steps in the
production process.

Raw materials inventory

Work-in-progress

Finished goods inventory

Raw materials inventory

Raw materials are the components that companies use to produce their products. Don’t let the word
“raw” lead you to think that this account is full of wood, plastic, metal or bolts of fabric. Many
companies purchase components already manufactured and use them in their finished products. For
example, Dell purchases processors from Intel to put in their computers. These processors are
considered raw materials until those processors actually go into a computer. Raw materials are any
materials that have not yet been used in the production process.

Work-in-progress

Companies are continuously making products, which means that at the end of each day or week or
month there are products that are not finished. These products have entered the manufacturing process
but are not completed. Work-in-progress is inventory that has gone into the production process but has
not yet been finished. Think of an aircraft at Boeing that does not have the seats or engines installed, but
the rest of the plane is built. We cannot call these raw materials, but we also cannot say that it is
finished. This plane would be considered part of work-in-process.

Finished goods inventory

When a product is finished it is transferred to finished goods inventory. Typically when we think of
inventory, we think of finished goods inventory, the stuff that is ready to be sold to our customers. Once
a product is classified as finished goods inventory, no additional costs can be added to the product. This
is a very important concept when we start talking about types of costs.

Hybrid companies

Many companies do not fit neatly into one of these categories. For example, restaurants make a product
(meals), sell products it does not make (wine and beer), and provides a service (serving the meal). These
companies are considered hybrid companies. When classifying companies, make sure to consider that a
company could fit into more than one of the categories above.

Final Thoughts

Considering the type of company you are working with can help you better identify the types of costs the
company will incur, how those costs should be allocated and the types of reports that would be useful in
the planning, decision making and controlling aspects of managerial accounting

The results of operations of a company is summarized in the income statement.

The income statement presents all revenues and all expenses. Revenues minus expenses is equal to net
income.

The net income is the primary measure of a company's financial performance for a particular period.

Here are examples of the income statement.

The amounts are assumed and contents are simplified for illustration purposes.
Example 1: Service Business

XYL Graphic Designs, Inc.

Income Statement

For the Year Ended December 31, 2017

Service Revenue $ 270,000

Less: Expenses

Salaries Expense 80,000

Rent Expense 30,000

Advertising Expense 16,000

Utilities Expense 10,000

Depreciation Expense 8,000

Supplies Expense 2,000 146,000

Income before Tax $ 124,000

Less: Income Tax Expense 48,360

Net Income $ 75,640

The income statement starts with a heading made up of three lines. The heading contains: (1) the name
of the company, (2) the title of the financial statement, and (3) the period covered by the report.

The income statement of a service type business is quite simple. Revenue accounts are presented first
followed by all of the company's expenses. The resulting amount is then subjected to income tax. Note:
Income tax treatment depends upon the tax laws of the state/country.

Some income statements of service businesses present "Cost of Service" in a separate line after
revenues. It shows the expenses that are directly associated with the services rendered.

Example 2: Merchandising Business, and for Manufacturing too..

GHI Market Associates Corporation

Income Statement

For the Year Ended December 31, 2017

Sales $ 960,000

Less: Cost of Sales 680,000

Gross Profit $ 280,000

Less: Operating Expenses

Selling Expenses

Sales Salaries Expense $ 40,000

Advertising Expense 15,000

Utilities Expense - Store 6,000

Depreciation Expense - Store 5,000

Store Supplies Expense 4,000 $ 70,000

Administrative Expenses

Office Salaries Expense $ 22,500

Utilities Expense - Office 6,500

Depreciation Expense - Office 5,000

Permits and Licences 4,000

Office Supplies Expense 2,500

Bad Debts Expense 1,500 42,000

Total Operating Expenses $ 112,000

Operating Income $ 168,000

Other Revenues and Expenses

Gain on Sale of Equipment $ 20,000

Interest Expense (12,000) 8,000

Income before Tax $ 176,000

Less: Income Tax Expense 68,640

Net Income $ 107,360

Example 2 shows how an income statement of merchandising and manufacturing businesses would look
like. In the above example, a separate line for "Cost of Sales" is presented. It shows the cost of items
sold, hence also known as "Cost of Goods Sold".

Selling expenses were shown separately from administrative expenses. Selling expenses pertain to
expenses directly related to the selling and marketing functions. Administrative expense pertain to those
associated with the activities of the administration such as billing and collection, hiring, board meetings,
etc.

The difference between all revenues and all expenses is then subjected to income tax to arrive at the
company's net income.

Conclusion

Though they may be presented differently, all income statements have the same goal and purpose. An
income statement presents a company's revenues and expenses over a particular period of time, to give
the users information about the operating performance of the company. When studying company
figures, it is good to compare income statements over different periods or with income statements of
other companies.