Book Keeping and Accounting - Income Statement (types of expenses, retained earning, balance sheet, charts, table & examples)

Introduction

The income statement also called a profit and loss statement is a report made by company management that shows the revenue, expenses, and net income or loss for a period. The income statement is one of the main four financial statements that are issued by companies: balance sheet, income statement, statement of owner’s equity, and statement of cash flows.

The income statement shows income and expenses for a specific period of time. This could be monthly, quarterly, semi-annually, or annually. A January income statement for example would show all the income and expenses for the month. It would also show the net income or loss at the end of January. Income statements created for management are usually shorter in time frame. These weekly or monthly income statements help management evaluate the company’s performance. Quarterly and annual income statements are more commonly used by investors and creditors to track the overall performance of the company.

Income statements usually include a heading with the name of the company, the title of the statement, and the time period. Depending on the company’s size and complexity, the income statement can be large or small. A condensed income statement will have three main categories: revenues, expenses, and net income or loss. Revenues are listed and totalled first with expenses following. The expenses are usually sorted either alphabetically or by dollar amount. After the expenses are totaled, net income can be calculated by subtracting the total expenses from the total income.

The heading of the income statement must show:

the business enterprise to which it relates.
the name of the statement (income statement)
the time period covered (year ended 31st march of the relevant year)

The income statement is generally followed by various schedules that give detailed account of the items, listed on them. Information about these schedules are given against each item in the financial statements.

One important objective in reporting revenue on an income statement is to disclose the major source of revenue and to separate it from miscellaneous sources. For most companies the major source of revenue is the sale of goods and services.

Sales Revenue:

An income statement often reports several separate items in the sales revenue section, the net of which is the net sales figure. Gross sales is the total invoice price of the goods sold or services rendered during the period. It should not include sales taxes or excise duties that may be charged to the customers. Such taxes are not revenues but rather represent collections that the business makes on behalf of the government and are liabilities to the government until paid. Similarly, postage, freight or other items billed to the customers at cost are not revenues. These items do not appear in the sales figure but instead are an offset to the costs the company incurs for them. Sales returns and allowances represent the sales values of goods that were returned by customers or allowance made to customers because the goods were defective. The amount can be subtracted from the sales figure directly without showing it as a separate item on the income statement. But it is always better to show them separately.

Sometimes called as cash discounts, sales discounts are the amount of discounts allowed to customers for prompt payment. For e.g. If a business offers a 3% discount to customers who pay within 7 days from the date of the invoice and it sells rs.30,000 of goods to a customer who takes advantage of this discount, the business receives only rs.29,100 in cash and records the balance rs.900 as sales discount. There is another kind of discount called as trade discount which is given by the wholesaler or manufacturer to the retailers to enable them to sell at catalogue price and make a profit: e.g. List less 30 percent. Trade discount does not appear in the accounting records at all.

Miscellaneous Or Secondary Sources Of Revenues:

These are revenues earned from activities not associated with the sale of the enterprise’s goods and services. Interest or dividends earned on marketable securities, royalties, rents and gains on disposal of assets are examples of this type of revenues. For e.g. In the case of lia kbar ltd., its operating loss has been converted into net profit only because of other income, other than sales revenue. Schedule 13 gives details of other income earned by lia kbar ltd.

(rs.`000)

Income From Trade Investments

Interest On Bank Deposits & Others

Profit On Sale Of Investments

Profit On Sale Of Inventories

Miscellaneous Income

Factory Charges Recovered

Bottle Deposits Forfeited

825

1,042

456

813

2,394

9,081

25,336

39,947

Cost Of Goods Sold:

when income is increased by the sale value of goods or services sold, it is also decreased by the cost of these goods or services. The cost of goods or services sold is called the cost of sales. In manufacturing firms and retailing business it is often called the cost of goods sold. The complexity of calculation of cost of goods sold varies depending upon the nature of the business. In the case of a trading concern which deals in commodities it is very simple to calculate the most of goods sold and it is done as follows:

Opening stock xxx

Add: purchase xxx

Freight xxx

Goods available for sale xxx

Less: closing stock xxx

Cost of goods sold xxx

The calculation becomes a complicated process in the case of manufacturing concern, especially when a number of products are manufactured because it involves the calculation of the work in progress and valuation of inventory. The cost of goods sold in the case of ali akbar ltd., would have been calculated as given in illustration `e’.

Cost Of Goods Sold

(rs.`000)

Opening Stock

Raw Materials Consumed

Packing Materials Consumed

Excise Duty

Less: Closing Stock

4,436

22,151

48,536

7,805

82,928

4,242

Cost Of Goods Sold

78,686

Gross Profit:

The excess of sales revenue over cost of goods sold is gross margin or gross profit. In the case of multiple-step income statement it is shown as a separate item. Significant managerial decisions can be taken by calculating the percentage of gross profit on sale. This percentage indicates the average mark up obtained on products sold. The percentage varies widely among industries, but healthy companies in the same industry tend to have similar gross profit percentages.

Operating Expenses:

Expenses which are incurred for running the business and which are not directly related to the company’s production or trading are collectively called as operating expenses. Usually operating expenses include administration expenses, finance expenses, depreciation and selling and distribution expenses. Administration expenses generally include personnel expenses also. However sometimes personnel expenses may be shown separately under the heading establishment expenses.

Until recently most companies included expenses on research and development as part of general and administrative expenses. But now-a-days the financial accounting standards board (fasb) requires that this amount should be shown separately. This is so because the expenditure on research and development could provide an important clue as to how cautious the company is in keeping its products and services up to date.

Operating Profit: operating profit is obtained when operating expenses are deducted from gross profit.

Non-Operating Expenses:

These are expenses which are not related to the activities of the business e.g. Loss on sale of asset, discount on shares written off etc. These expenses are deducted from the income obtained after adding other incomes to the operating profit. Other incomes or miscellaneous receipts have already been explained. The resultant profit is called as profit (or) earning before interest and tax (ebit).

Interest Expenses:

Interest expense arises when part of the expenses are met from borrowed funds. The fasb requires separate disclosure of interest expense. This item of expense is deducted from income or earnings before interest and tax. The resultant figure is profit (or) earnings before tax (ebt).

Income Tax: the provision for tax is estimated based on the quantum of profit before tax. As per the corporate tax laws, the amount of tax payable is determined not on the basis of reported net profit but the net profit arrived at has to be recomputed and adjusted for determining the tax liability. That is why the liability is always shown as a provision.

Net Profit:

This is the amount of profit finally available to the enterprise for appropriation. Net profits is reported not only in total but also per share of stock. This per share amount is obtained by dividing the total amount of net profit by the number of shares outstanding. The net profit is usually referred to as profit or earnings after tax. This profit could either be distributed as dividends to shareholders or retained in the business. Just like gross profit percentage, net profit percentage on sales can also be calculated which will be of great use for managerial analysis.

Statement Of Retained Earnings

The term retained earnings means the accumulated excess of earnings over losses and dividends. The statement of retained earnings is generally included with almost any set of financial statements although it is not considered to be one of the major financial statements. A typical statement of retained earnings starts with the opening balance of retained earnings, the net income for the period as an addition, the dividends as a deduction, and ends with the closing balance of retained earnings. The statement may be prepared and shown on a separate sheet or included at the bottom of the income statement. The balance shown by the income statement is transferred to the balance sheet through the statement of retained earnings after making necessary appropriations. This statement thus links the income statement to the retained earning item on the balance sheet. This statement can be prepared in `t’ shape also when it is called as profit and loss appropriation account. Illustration `f’ gives the statement of retained earning of ali akbar ltd.

Illustration – F Ali Akbar Ltd.

For The Year Ended 31st March 2020

(Rs.`000)

Retained Earnings At The beginning Of The Year

Add: Net Income

Less: Dividends

General Reserve

5,600

625

700

5,625

6,325

6,225

Retained Earnings At The End Of The Year

100

Balance Sheet

The balance sheet is basically a historical report showing the cumulative effect of past transactions. It is often described as a detailed expression of the following fundamental accounting equation:

Assets = Liabilities + Owners’ Equity (Capital)

Assets are costs which represent expected future economic benefits to the business enterprise. However, the rights to assets have been acquired by the Enterprise as a result of past transactions.

Liabilities also result from past transactions. They represent obligations which require settlement in the future either by conveying assets or by performing services. Implicit in these concepts of the nature of assets and liabilities is the meaning of owners’ equity as the residual interest in the assets of the enterprise.

Form And Presentation Of A Balance Sheet

Two objectives are dominant in presenting information in a balance sheet. One is clarity and readability; the other is disclosure of significant facts within the framework of the basic assumptions of accounting. Balance sheet classification, terminology and the general form of presentation should be studied with these objectives in mind.

It is proposed to explain the various aspects of the balance sheet with the help of the following typical summarised balance sheet of an imaginary

Partnership firm:

Sundaram & Sons

Balance Sheet As At 31st December 2020

Liabilities & Capital	Rs		Rs	Assets	Rs		Rs
Current Liabilities Bills Payable Creditors Outstanding Expenses Income Received In Advance Provision For Income Tax Total Current Liabilities Long Term Liabilities Mortgage Loan Owners’ Equity S’s Capital A’s Capital U’s Capital General Reserve	7,000 7,000 7,000 1,000 10,000		32,000 20,000 10,000 15,000 20,000 10,000	Current Assets Cash Bank Marketable Securities Bills Receivables Debtors Less Provision For Doubtful Debts Inventory Prepaid Expenses Total Current Assets Investments: Long Term Securities AtCosts Fixed Assets: Furniture & Fixtures Less: Accumulated Dep. Plant & Machinery Less: Accumulated Dep. Land Buildings Intangible Assets Patents Trade Marks Goodwill	10,000 1,000 1,000 100 10,000 2,000		1.000 2,000 3,000 3,000 9,000 12,000 3,000 33,000 3,000 900 8,000 20,000 2,100 11,000 9,000
Total Assets		1,07,000		Total Liabilities & Owners’ Equity		1,07.000

Conventions Of Preparing The Balance Sheet:

There are two conventions of preparing the balance sheet, the american and the English. According to the american convention, assets are shown on the left hand side and the liabilities and the owners’ equity on the right hand side. Under the English convention just the opposite is followed i.e. Assets are shown on the right hand side and the liabilities and owners’ equity are shown on the left hand side. In the illustration `a’, the american convention has been followed.

Forms Of Presenting The Balance Sheet:

There are two forms of presenting the balance sheet – account form and report form. When the assets are listed on the left hand side and liabilities and owners’ equity on the right hand side, we get the account form of balance sheet. It is so called because it is similar to an account. An alternative practice is the report form of balance sheet where the assets are listed at the top of the page and the liabilities and owners’ equity are listed beneath them. In illustration `a’ we have followed the account form of balance sheet. Now-a-days joint stock companies present balance sheet in the form of a statement in the annual reports. To illustrate, the balance sheet of ali akbar ltd. Pondicherry as on 31-3-2012 is given below:

Listing Of Items On The Balance Sheet

Assets in balance sheet are generally listed in two ways – i) in the order of liquidity or according to time i.e. In the order of the degree of ease with which they can be converted into cash or ii) in the order of permanence or according to purpose i.e., in the order of the desire to keep them in use. Some assets cannot be easily classified. For e.g. Investments can be easily sold but the desire may be to keep them. Investments may therefore be both liquid and semi-permanent that is why they are shown as a separate item in the balance sheet. Liabilities can also be grouped in two ways; either in the order of urgency of payment or in the reverse order. The various assets and liabilities grouped in the two orders will appear as follows:

Order Of Liquidity

Liabilities

Assets

Bank Overdraft

Bills Payable

Creditors

Outstanding Expenses

Income Received In Advance

Provision For Income-Tax

Mortgage Loan

Debentures

Owners’ Equity

Cash

Bank

Marketable Securities

Debtors

Inventory

Bills Receivable

Prepaid Expenses

Investments

Furniture And Fixtures

Plant And Machinery

Land And Buildings

Patents

Trade Marks

Goodwill

Preliminary Expenses

Order Of Permanence