The income statement is one of the five types of financial statements that report and present an entity’s financial transactions including revenues, expenses, net profit, or loss for a specific period of time.
This is also known as the statement of financial performance because it tells whether the entity making losses or profits for the period.
And It is also known as a profit or loss statement.
All of these names referring to the same statement. However, the income statement is different from the balance sheet since it is showing only financial transactions while the balance sheet showing the balance of accounts at the end of the periods. The important financial transactions occurring every day are report and present in the income statement.
The income statement is generally prepared at the same time along with other financial statements by complying with financial reporting frameworks such as GAAP and IFRS.
To ensure that users could analyst the current financial performance, this statement is required to present the current period financial information with its comparative period which is usually the previous period.
Changing the name of the statement:
An income statement generally and officially called Statement of Comprehensive Income.
This name had been changed by IASB from Statement of Comprehensive Income to statement of profit or loss and other comprehensive income.
We can interpret the new name of this statement in a simple way as it is provided.
For example, this statement contains Statement of Profit and Loss Plus Other Comprehensive Income.
Statement of Profit and Loss report the entity’s main revenues and expenses It is the choices of entity to consider present them by nature or function.
Other revenues and expenses like revaluation gain or loss, exchange difference, and so on are recorded in the Other.
The entity could choices to prepare and present its revenues and expenses in two different formats either:
- In a single statement of profit or loss and other comprehensive income; or
- In two statements: a separate statement of profit or loss and a statement of other comprehensive income.
1) A single statement of profit or loss and other comprehensive income:
The entity could decide to present its income statement in the single statement of profit and loss and other comprehensive income as it is allowed by IASB.
This statement reports the Other comprehensive income in a single statement with the statement of profit and loss.
As you could see in the example below, the entity reports its statement of profit and loss for the year 2017 at the top of the statement. And Another comprehensive income section is reporting after profit or loss.
Operating incomes and expenses are recording in the profits and loss section which non-operating incomes and expenses are recording in the Other Comprehensive Income section in only one statement.
The following is the example of a single step statement of profit or loss and other comprehensive income:
2) Multi statement of profit and loss and other comprehensive income:
Multi statement of profit and loss and other comprehensive income reports and present the statement of profit and loss in the difference statement from the statement of Other comprehensive income.
All of the operating income and expenses that occur during the period are recording in the statement of profit and loss.
This statement will show the profit for the year and this profit will be forward to another statement called Others comprehensive statement which is reported and presented non-operating income and expenses during the period.
The following is the example of a multi-step statement of profit or loss and other comprehensive income:
Income Statement is one of the important statement that reports and present the financial transactions of entity for the specific period.
Revenues’ items are generally present at the time of the statement and follow by expenses items.
Net income is shown in the bottom line. The following are the importance of financial information that you could find in the income statement:
1) Sales Revenues:
This is the total amount of revenues that the entity generates in the reporting period. This information is shown on the top of the statement.
For example, if the entity operating in the selling of clothes, this line will show the total amount of clothes that entity sales in monetary during the months, quarters or annually.
Standard requires revenues that an entity earns during the period shown on the face of the income statement. Total revenues here are both revenues from cash sales and revenues from credit sales.
Lines of incomes or revenues are sometimes shown in the face of the income statement and sometimes; normally when there are many different lines of income; are shown in the notes to financial statements.
You can see the Note’s reference number and review what are the sources of income that entity earning and what are the major sources of income.
You probably could see the current year’s performance comparing to the previous year’s performance.
Increasing revenues prove that the entity’s sales performance performing well. And if the revenues decline, it is proved that sales’ performance is not performing competitively.
The cost of goods sold is a direct cost related to the sold products. These costs are the variable cost that attributes to the goods sold during the period.
These costs are not including the fixed cost and administrative expenses for the period and they have to be recognized consistently with revenues that we recognize.
Cost of goods sold equal to the beginning of inventories plus purchase during the period less ending inventories.
Costs of goods should be increasing or decreasing consistently with the revenues fluctuation. If the trend goes in a different direction, then either costs or revenues are not correctly recording or reporting.
This is the gross operating profits that the entity generates for the period. This amount is equal to revenues less cost of goods sold.
Gross profits are reporting below the costs of goods sold and it is important information for users of financial information for assessing how the profitability of the entity is comparing to the same kind of entities in the market.
If the gross profit margin is low compared to other companies, then we can assume that the entity’s production costs are higher than the competitors. In other words, the entity does not manage its production costs effectively.
These expenses are different from the cost of goods sold. Operating Expenses are the general administrative expenses that occurred during the period to support the entity’s operating activities.
Those expenses include the salary of administrative staff including sales, admin, account, financial audit and other staff which is not directly related to productions.
Other expenses that also include in this line include electricity, repair and maintenance, utilities, gasoline, the bank charged, and other operating expenses.
Noted: There is a debate among different publishers that operating costs include both the cost of goods sold and administrative expenses.
5) Operating Profits:
They are the profits after eliminating the operating expenses out of the gross profits. In the example above, operating profits are equal to Profits before tax.
These profits are quite important for users of financial information. Mostly, people use these profits to figure out what is the remaining amount that the company could possibly make before paying tax and financial cost.
Especially, banks normally assess how the company could pay back their debt by assessing this number. Operating profits are not including non-operating income and non-operating expenses.
6) Finance Costs:
Finance costs are mostly related to interest expenses. These expenses are the difference from bank charges and they should report separately.
Yet, sometimes we report them in one line in the Income Statement just because one of them is immaterial. Finance Costs could also be charged from intercompany borrowing.
Finance Costs increasing mean that the entity’s debts are increasing and these kinds of expenses will not make the shareholders happy.
The high finance costs might mean the entity’s financial strategy favorite on debts rather than equity. The entity needs to leverages between financial strategy between debt-equity.
7) Income Taxes:
It is the corporate tax expenses for the accounting period. These expenses are for the hold period and they are the difference from tax payable and tax payments.
Taxes payable are the remaining amounts that the company going to pay next time. Taxes payable are recording in the balance sheet while the income taxes are recording in the income statement.
Income Taxes normally stay after the interest expenses in the income statement. But, they are reporting before net income.
Rate of corporate tax is the difference from one country to another and it might also differ from one industry to another in the same country.
8) Net Income:
This sometimes called net income or Net Profit. This profit is what the company deliver to its shareholder or keep for reinvesting.
Because of these reasons, net income becomes the most interesting figure for most stakeholders including shareholders, investors, bankers, creditors, suppliers, customers, and employees as well.
The positive net income means the entity generates profit and the negative net income means the entity operating loss.
Limitation of Income Statement
Besides providing the entity’s useful financial information to users, income statement also has its limitation and the users should be aware of. Here is the limitation:
- It provides the past data of the entity. As you know, that information is the past data and it might not help users much on their decision. Most decisions need current and further data and information to make sure that the decision is not being made in the wrong direction.
- It contains only figure. As you can see, all of this information contains only financial data and figures. It does not contain the non-financial information that might be important to the users for their decision making.
- Financial information could influence by accounting policies. This is probably the most important point. For example, the net income of the entity for the period might be significantly changed if there is a change in accounting policy for depreciation of fixed assets.
- The income statement also highly influenced by the demand of top executives whose performance is based on some figure in income statements like sales revenues, gross profits, or net profits. For example, management might try to manipulate the amounts of sales revenues for the period while the actual sales are not made to the goods or services. They might also try to influence accounting policies like LIFO and FIFO to make sure the cost of goods sold amounts are increased or decreased as they want.
Disclosure to income statement:
Disclosure to the income statement is part of disclosure to financial statements which is the requirement of IAS 1 Presentation of Financial Statements.
As per requirement, the entity requires to disclosure all necessary information in the financial statements that mater to the users of financial statements.
Those include major accounting policies, significant accounting treatment, the major change in the business, as well as a major change in the key management team.
All of these things really could help the users of financial statements especially investors and shareholders to gain a better understanding of financial statements.
For the income statement, there are certain things that should disclose to make sure that the users get the best benefit, and complying with IAS 1. Here are those things:
- Accounting Policies: Accounting policies that relevant to those significant items in the income statement like revenues, cost of goods sold, and other major expenses like depreciation.
- Accounting Classification and Measurement of the significant items in the income statement.
- Component of significant items in the income statement. For example, in the income statement, we have only one line of revenues like ” Sales Revenues.” Sales Revenues is the combination of many sublines of sales revenues. For example, revenues from hotels, restaurants, gaming, etc. These concepts should also apply to other significant items in the income statement—for example, the cost of goods sold and administrative expenses.
- Intercompany transactions related to the income statement. This is very important to make sure that users could understand how many business transactions that the entity has with its related parties. Those related parties could be the parent company, subsidiary, shareholders, the board of directors, management team, and employee.