Overview:
Income statement presents the results of the company’s operations for a specified accounting period. Accounting periods may be quarterly or yearly as required by laws and regulations.
Income statement examines the income and expenses in a particular accounting period and finally arriving at net profit.
The financial performance of the business in terms of income and expenses involves the summary prepared by using the data from both operating and non-operative activities.
Income statement must reflect all the items of profit and loss recognized during the accounting period except items that need prior period adjustments and those that should be disclosed directly in the balance sheet.
This statement is normally used by the management team, owner, shareholders, and many other stakeholders.
Income statement provide much useful information to these stakeholders; however, it also has many limitations.
The following are the limitation (Disadvantages) of the income statement:
- Provides Confirmatory Value: The fist limitation of Income statement is that it is prepared after auditing all the financial data recorded by the business. Hence, there is room for data manipulation or management by individuals with ill intentions. In such instances, the establishment of internal control is necessary and also the financial statement which contains income statement needs to be audited by the external and reputed auditors.
- Provides Predictive Value: The second limitation of Income Statement is it is prepared using various accounting policies and methods. These are subject to bias from the management or the business owners. The forecasts are also judgmental in nature. If the accounting methods are regularly changed or accounting policies are implemented differently as per different cases, the income statement is bound to give predictive value and deviate a lot from the true values. Hence, accounting policies that are adopted by the business forecast the future in predictive style based on bias and changing policies.
- Profit is an Opinion: Despite income statement being called as the gospel to test the business health, it is widely called in investors’ community as mere opinion. Investors therefore also place emphasis on cash flow statements and in some cases, they rely more on cash flow rather than the auditors’ opinion on profit. Hence, Profit is an opinion, while cash is always real. Cash also needs to be certified in physical by the auditors which provide more credibility than the profit and loss statement.
- Ignores non-revenue factors: Income statement is all about the data that impacts the revenue and wages. Qualitative factors such as how the wages are determined, how the company earns from its customers and its sales policy are not accounted for in the income statements as they are not in monetary terms.
- Does not provide actual cost: Imagine buying an asset. Although the asset is shown in the balance sheet and depreciation forms part of the income statement, the life of the asset must be estimated well in advance. The asset may last longer than estimated. However, the costs are already debited to the income statement as depreciated. This shows that the costs are actually concentrated in a few accounting periods rather it should have been distributed over the actual use. Hence, the application of the income statement does not provide actual costs of the asset, rather it provides a fair estimation of expenses. Hence, it is said that the auditors express the opinion of financial statements and emphasizes that it reflects true and fair view.