The Bottom Line on Income Statements

There are operating expenses associated with running the business, like sales and marketing costs, research and development, and general and administrative costs.

Things get hairy when a company decides to classify an expense cost as a long-term investment. So, instead of taking a one-time charge, the company elects to spread the charge out over a longer period of time. The bean counters call this "capitalizing the cost."

There are accounting rules that explain which expenses should be a one-time hit (like certain start-up costs) and which expenses can be capitalized over a longer period of time.

But, remember, taking an expense as a one-time hit can really bring net income way down. So, some companies attempt to capitalize certain expenses, or spread them out over a longer period of time to help to ease the pain. But it's cheating.

That's what AOL (now a part of Time Warner (TWX Quote - Cramer on TWX - Stock Picks)) tried to do back in the late '90s, reminds Ketz. AOL claimed that various marketing charges and other indirect costs associated with new subscribers should be capitalized over a five-year period because that's how long the average subscriber stays on as a member.

But those subscription costs should have been expensed as a one-time charge up front. So, AOL changed its policy. But like a guy with a speeding ticket who's still doing 90 miles per hour, it tried to get away with it again back in 2003. And no surprise, got caught.

Research and development has always been an expense associated with much debate. Should it be expensed in the year incurred, or capitalized over a few years because it can be a big asset to the company? The accounting higher-ups have said it needs to be expensed, and companies need to stay consistent. Again, read the MD&A for policies and procedures.

Operating Income vs. Net Income

Once you subtract operating expenses from gross profit, you have your company's operating income. This number is strictly based on the operations of the business. And many will argue that this provides the clearest look at a company's health.

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