How does income measurement differ between a merchandising and a service company

The income statement of a service company is different from that of a merchandising company because a service company does not sell goods to make money, but instead provides an intangible product or service. A service company’s income statement will list revenues, cost of services, sales and marketing and reorganization costs. Other factors impacting the income statement include: interest expense, fee income and income taxes (Kimmel, Kieso, & Weygandt, 2011).

In contrast to a service company, merchandising companies engaging in selling tangible products. These products have a variety of income factors such as sales revenue, product rebates, cost of goods sold, storage, shipping and insurance. A merchandising company lists on its income statement the account “cost of goods sold,” while service companies do not list this account (Kimmel, Kieso, & Weygandt, 2011).

Service based companies do not carry inventory and therefore don’t use this “cost of goods sold” account. Merchandising companies must account for the cost of purchasing the inventory and shipping it to the appropriate locations for selling to customers (Kimmel, Kieso, & Weygandt, 2011). Service companies do not maintain this account.

References

Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2011). Financial accounting: Tools for business decision making (6th ed.). Hoboken, NJ: John Wiley & Sons

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Vincent Triola. Fri, Feb 05, 2021. How Income Statements Differ Between Merchandising & Service Companies Retrieved from https://vincenttriola.com/blogs/ten-years-of-academic-writing/how-income-statements-differ-between-merchandising-service-companies

Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.

The income statement is the first financial statement that any small businesses should prepare. It shows how much money a business made as well as how much it spent. This, in turn, provides an indicator of cash flow and profitability. An income statement’s format depends on the type of operations the business uses to generate revenue. Some businesses, such as retailers and manufacturers, sell inventory, while others offer their clients services. The difference in treatment between the cost of services and the cost of selling inventory gives rise to these two formats.

Income Statement for Merchandising

Merchandising income statements separate income from operating activities from incidental revenue, such as interest revenue from a loan made to a customer. The 'top line' reports total sales less allowances and returns from operating activities, setting non-operating revenues aside to be added back in later. This is different to service companies who will report total revenue, since these businesses do not experience product discounts, faults and returns.

Cost of Goods Sold

Inventory costs money even before putting it on the shelves or onto the production line. Income statement items for merchandising companies therefore include the cost of goods sold underneath net sales, reports Accounting Focus. Segregating the cost of goods from the remaining operating costs, analysts can assess the health of the merchandising company's operations. Gross margin, the ratio of net income after subtracting cost of goods sold, is a common indicator that analysts review. Service income statements do not include this component.

Operating Expenses

Running a business costs money. Payroll, rent, property taxes and advertising are just some of the usual line items that show up under operating expenses, suggests Accounting Tools. While service income statements arrive at net income before taxes and after subtracting expenses, merchandising statements must account for nonoperational cash flows. Any revenue, such as interest from a loan provided to a client, is added back in, and any expenses – such as interest payments on corporate debt – are subtracted back out. This new total is the merchandising company’s net income before tax. For both types of income statements, tax expenses are reported separately near the very end of the income statement.

Even though merchandising companies and service companies conform to generally accepted accounting principles (GAAP), there are differences in the ways each prepares its financial statements, especially income statements, where most differences center around the existence of inventory.

Key Takeaways

• A merchandising company engages in the purchase and resale of tangible goods.
• Service companies primarily sell services rather than tangible goods.
• Income statements for each type of firm vary in several ways, such as the types of gains and losses experienced, cost of goods sold, and net revenue.

Merchandising Company

A merchandising company buys tangible goods and resells them to consumers. These businesses incur costs, such as labor and materials, to present and sell products. Retail and wholesale companies are the two types of merchandising companies. Retail companies sell products directly to consumers, and wholesale companies sell products directly to retailers or other wholesalers. The operating cycle of a merchandising company is the time between the purchase of the product and the sale of that product.

Service Company

Service companies do not sell tangible goods to produce income; rather, they provide services to customers or clients according to a specific expertise or specialty. Service companies sell their services, often charging base fees and hourly rates. Examples of service companies include consultants, accountants, financial planners, and insurance providers.

Key Differences in the Income Statements

The income statement shows financial performance from operations first and then separately discloses gains and losses that fall outside the regular scope of operations.

The differences in income statements can be further understood by examining the balance sheets of both types of companies. For instance, inventory is a large percentage of the assets category for a merchandising company. As such, they tend to have less cash on hand than service businesses since their capital is tied up in illiquid assets. By contrast, service businesses' assets tend to be weighted toward accounts receivable. For a service business, the absence of inventory means receivables are a greater proportion of total assets.

Both service and merchandising companies may experience gains or losses from non-operational sources. However, sources of the gains or losses differ between the two business types. For instance, a merchandiser might decide to redecorate a retail store and sell off fixtures for a profit. A service company might have a one-time gain from the sale of a patent. Lawsuits may also be a factor for both types of businesses. For merchandisers, lawsuits are often related to defective goods. Meanwhile, a service provider might be more likely sued for breach of contract.

Both merchandising companies and service companies prepare income statements to help investors, analysts, and regulators understand their internal financial operations. Merchandising companies hold and account for product inventory, which makes their income statements inherently more complicated. Much of the inventory calculation is manifested through the line-item cost of goods sold, which is an expense account describing the cost of purchasing inventory and delivering it to customers. If you look at an income statement for a service company, you will not see a line item for the cost of goods sold.

The nature of increases or decreases in net revenue for each type of company is also different. Service companies do not typically have enormous expense accounts, meaning that fluctuations in net revenue are almost entirely a function of generating sales. Manufacturing companies are less certain since a decrease in net revenue could be an increase in expenses or a decrease in revenues.

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