Which of the following best describes how Net Sales is calculated on the income statement?

• A. Net Sales = Gross Sales + Sales Returns and Allowances
• B. Net Sales = Gross Sales - Sales Returns and Allowances - Sales Discounts
• C. Net Sales = Gross Sales - Operating Expenses
• D. Net Sales = Gross Sales + Cost of Goods Sold

Answer: (B)

Verified step by step guidance

1. Understand the concept of Net Sales: Net Sales represent the actual revenue a company earns from its sales after accounting for deductions such as sales returns, allowances, and discounts.
2. Identify the components of the formula: Gross Sales, Sales Returns and Allowances, and Sales Discounts. Gross Sales refer to the total revenue from sales before any deductions. Sales Returns and Allowances are reductions in revenue due to returned goods or price adjustments. Sales Discounts are reductions offered to customers for early payment or other reasons.
3. Recall the correct formula for Net Sales: Net Sales = Gross Sales - Sales Returns and Allowances - Sales Discounts.
4. Analyze the incorrect options: For example, 'Net Sales = Gross Sales + Sales Returns and Allowances' is incorrect because returns and allowances reduce revenue, not increase it. Similarly, 'Net Sales = Gross Sales - Operating Expenses' is incorrect because operating expenses are not part of the Net Sales calculation. Lastly, 'Net Sales = Gross Sales + Cost of Goods Sold' is incorrect because Cost of Goods Sold is subtracted later in the income statement to calculate Gross Profit, not Net Sales.
5. Apply the correct formula to calculate Net Sales in practice: Subtract Sales Returns and Allowances and Sales Discounts from Gross Sales to determine the Net Sales figure for the income statement.