The Income Statement

The business entity's Income Statement, like the Balance Sheet and Statement of Changes in Financial Position, is an end result of the accounting procedures. It may be defined as a summary of the revenues, expenses and net income of a business entity for a specific period of time, and is sometimes called the Earnings Statement, Operating Statement or Statement of Profit and Loss.

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Accounting Principles and Policies

In preparing a firm's the financial statements, the accountant must consider the accounting policies established by its management. Such policies can significantly affect the amount of net income, and must be disclosed, according to APB Opinion No. 22, as an integral part of all audited financial reports. Policies of special interest to the analyst, such as inventory, depreciation, pensions and other specified matters fall into this category, as do unusual applications of GAAP, industry peculiarities which conflict with GAAP and those which differ from existing acceptable alternatives. Another requirement, established by APB Opinion No. 15, is that the published income statement must disclose net earnings or loss per share.

Format of the Income Statement

The income statement may be presented in a multiple-step or single-step format. Unlike the balance sheet, Which is a position statement at a fixed point in time, the income statement reports activities over a period of time. That is, it summarizes net income for the current fiscal period.

Multiple-Step Statement

First look as below picture that is an example of Multiple-Step statement

The multiple-step income statement presents figures significant in the determination of net income. Its various classifications define the on-going operations of the business entity, providing a perspective as to its flow of revenues and expenses. The usual multiple-step classifications are:

(1)Revenue From Sales: In this section, usually called Gross Sales, revenue (income) earned from normal operations is summarized. It is offset by the contra income accounts, Sales Returns and Allowances and Sales Discounts.

(2)Cost of Goods Sold: This section includes the cost of goods applicable to the revenue obtained for the period. Its presentation is slightly different for a mercantile than a manufacturing company since the former does not have inventories of raw materials, goods in process, direct labor or manufacturing overhead. It has only furnished goods, called merchandise inventory.

Once the manufacturing schedule is completed, its bottom line (cost of goods manufactured) is incorporated in the cost of goods sold section of the income statement.

(3) Gross Profit on Sales. This figure is the difference between net sales and cost of goods sold. It is frequently divided by net sales to determine the average percentage of margin for the fiscal period. The same ratio is developed for cost of goods sold and it can easily be seen that they are complementary.

(4) Operating Expenses. These are often classified according to the major functions of the business (i.e., selling, general and administrative). Terminology may differ as appropriate; however, taxes on income, extraordinary items and prior period adjustments must be segregated at the bottom of the statement.

Selling expenses typically include sales salaries, commissions, related payroll costs, advertising, store display costs, store supplies used, etc.

General and administrative expenses include officer and office salaries and related payroll taxes, telephone and communication costs, heat, light and power costs, postage and office supplies, legal and accounting costs, etc.

(5) Other Income and Expense include all other miscellaneous recurring items. Other income includes interest, dividends, rents and royalties: other expense includes interest and miscellaneous expenses.

(6) Income Taxes. Total income taxes due is presented as a single figure on the income statement and is applied against the subtotal, Net Income before Income Taxes. Income from normal operations is often supplemented by a gain or loss from extraordinary items. The amount directly applicable to income from normal operations is taxed at normal rates. Extraordinary items are often taxed at lower capital gains rates. The applicable tax for each extraordinary item should be deducted and the net amount shown on the income statement.

Note: Property, payroll and excise taxes are properly allocated to the various business functions as normal operating expenses.

(7) Net Income. The excess of revenues over expenses. In the multiple-step format, separate captions are generally shown for Income Before Taxes, Income Before Extraordinary Items, and Net Income.

(8) Extraordinary Items. Those events and transactions which are material in amount and which are significantly different from the regular activities of the business (APB Opinion No.9). Extra ordinary or nonrecurring earnings, when included in the income statement, are shown below (separately from) regular earnings.

Single-Step Statement

First look at below picture:

A simple, condensed statement devoid of all classification except the general groupings: (1) revenues, and (2) cost and expenses has been developed for stockholders' reports and other special uses. Section labeling is at a minimum. The single-step format does not recognize intermediate stages such as gross profit from operations or income before extraordinary items. All income, including rents, interest, dividends, etc., is included in the first section. All costs and expenses are shown in the next, including Federal and state taxes on income. This form tends to be compact and relatively uncluttered at the sacrifice of information. Generally the costs and expenses are classified on the object basis rather than the functional basis.

When the object basis is used, the nature of each cost and expense rather than whether it serves manufacturing, selling, general and administrative, or some other function is the controlling factor. Examples of this classification are such broad captions as materials, supplies and services purchased salaries and wages, and depreciation. The functional basis, on the other hand, expands the income statement so that it includes major classifications such as cost of goods sold, sales revenues and operating expenses as major headings, with applicable sub functions in each category.

It should be noted that the required separation of ordinary and extraordinary items resulting from application of APB Opinion No. 9 also applies to the condensed single-step form.