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Income Statement

The income statement is the report that measures the success of company operation for a given
period if this also often called the statement of income or statement of earning.

- Usefulness : the income statement helps users of financial statement predict future cash
flows in a number of ways.

Evaluate past performance of the company . examining revenues and expenses indicates how the
company performed and allows comparison of its performance to its competitors.

Provide a basis for Predicting future performance. Information about past performance helps to
determine important trends that, if continued, provide information about future performance.

Help assess the risk or uncertainty of achieving future cash formation on the various
components of income-revenues, expenses, gains, and loses-highlights the relationships among
them. It also helps to assess the risk of not achieving a particular level of cash flows in the future.

- Limitations: because net income is and reflects a number of assumptions, income statement
users need to be aware of certain limitations with its information.

Companies omit items that cannot be measured reliably. Current pactice prohibits recognition of
certain items from the determination of income even though the effects of these items can arguably
affect the company’s performance.

Income is affected by the accounting methods employed. One company may deprecition Its plant
assets on an accelerated basis; another choose straight-line depreciation.

Income measurement involves judgment. Similarly, some companies may make optimistic estimates
of future warranty costs and bad debt write-offs, which results in lower expense and higher income.

- Quality of Earnings

Companies have incentives to manage income to meet or beat market expectations, so that

market price of stock increases and

value of management’s compensation increase.

Quality of earnings is reduced if earnings management results in information that is less useful for
predicting future earnings and cash flows.

Format of the Income Statement

 Elements of the Income Statement.

Income The statement can further classify income by customer, product line, or function or by
operating and non-operation, and continuing and discontinued. The two major elements of the
income statement are as follow
Income – Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other than those
relating to contributions from shareholders.

The definition of income includes both revenues and gain. Revenues arise from ordinary activities of
a company and take many forms, such as sales fees, interest, dividends, and rents. Gains represent
other items that meet the definition of income and may or may not arise from ordinary activities.

Expenses includes both expenses and losses. Expenses generally arise from the ordinary activities of
a company and take many forms, such as cost of goods sold, depreciation, rent, salaries, and wages,
and taxes.Losses represent other items that meet the definition of expenses and may or may not
arise from ordinary activities.

Expenses – Decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result in decreases in equity, other than those
relating to distributions to shareholders.

 Minimum disclosures

As indicated above, disclosing components in an income statement helps users to understand the
financial performance for the current year and provides a basis for predicting future results.

 Intermediate Components

Common for companies to present some or all of these sections and totals within the income

 Illustration

Includes all of the major items in the list above, except for discontinued operations.

 Condensed income statements

In some cases, an income statement cannot possibly present all the desired expense detail. To solve
this problem, a company includes onlty the totals of components in the statement of income. It then
also prepares supplementary schedules to support the totals. This format may thus reduce the
income statement itself to a few lines on a single sheet. For this reason, readers who wish to study
all the reported data on opertions must give their attention to the supporting schedules.

Reporting Within the Income Statement

Gross Profit

Computed by deducting cost of goods sold from net sales revenue.

Disclosure of net sales revenue is useful.

Unusual or incidental revenue is disclosed in other income and expense.

Analysts can more easily understand and assess trends in revenue from continuing operations.
Income from Operations

Determined by deducting selling and administrative expenses as well as other income and expense
from gross profit.

Highlights items that affect regular business activities.

Used to predict the amount, timing, and uncertainty of future cash flows.

Expense classification

An advantage of the nature of expense method is that it is simple to apply because allocations of
expense to different functions are not necessary. The function of expense method, however, is often
viewed as more relevant because this method identifies the major cost drivers of the company and
therefore helps users assess whether these amounts are appropriate for the revenue generated

Income before Income Tax

Under IFRS, companies must report their financing costs on the income statement. The reason for
this requirement is to differentiate between a company’s business activies (how it uses capital
create value) and its financing activities(how it obtain capital)

As indicated, some companies offset interest expense, and identify it as either finance costs or
interest expense revenue, net.

Net Income

Represents the income after all revenues and expenses for the period are considered. It is viewed
by many as the most important measure of a company’s success or failure for a given period of time.

Allocation to Non-Controlling Interest

If a company prepares a consolidated income statement that includes a partially own subsidiary.
IFRS requires that net income of the subsidiary be allocated to the controlling and non-controlling
interest. This allocation is reported at the bottom of the income statement after net income.

Earnings Per Share

Net income - Preference dividends

Weighted average of ordinary shares outstanding

Important business indicator.

Measures the dollars earned by each ordinary share.
Must be disclosed on the income statement.

Discontinued Operations

A component of an entity that either has been disposed of, or is classified as held-for-sale, and:

1. Represents a major line of business or geographical area of operations, or

2. Is part of a single, co-coordinated plan to dispose of a major line of business or
geographical area of operations, or

3. Is a subsidiary acquired exclusively with a view to resell.

Companies report as discontinued operations

1. (in a separate income statement category) the gain or loss from disposal of a component of
a business.

2. The results of operations of a component that has been or will be disposed of separately
from continuing operations.

3. The effects of discontinued operations net of tax, as a separate category after continuing

A company that reports a discontinued operation must report per share amounts for the line item
either on the face of the income statement or in the notes to the financial statements.

Intraperiod Tax Allocation

Companies report discontinued operations on the income statement net of tax. The allocation of tax
to this item is called intraperiod tax allocation, that is, allocation within a period.

Relates the income tax expense to the specific items that give rise to the amount of the tax expense.

On the income statement, income tax is allocated to:

(1) Income from continuing operations before tax

(2) Discontinued operations

Other reporting issues

Accounting Changes and Errors

Changes in Accounting Principle

Company adopts a different accounting principle.

Retrospective adjustment.

Cumulative effect adjustment to beginning retained earnings.

Approach preserves comparability.

Examples include:

 Change from FIFO to average cost.

 Change from the percentage-of-completion to the completed-contract

Changes in Estimate

Accounted for in the period of change and future periods.

Not handled retrospectively.

Not considered errors.

Examples include:

 Useful lives and residual values of depreciable assets.

 Allowance for uncollectible receivables.

 Inventory obsolescence.

Corrections of Errors

Result from:

 mathematical mistakes.

 mistakes in application of accounting principles.

 oversight or misuse of facts.

Corrections treated as prior period adjustments.

Adjustment to the beginning balance of retained earnings.

Retained Earnings Statement

Net income increases retained earnings. A net loss decreases retained earnings. Both cash and share
dividends decrease retained earnings. Change in accounting principles(generally) and prior
adjustments may increase or decrase retained earnings. The reconciliations of the beginning to the
ending balance in the retained earnings provides information about why net assets increased or
decrased during the year.

Increase : Net income, Change in accounting principle, Prior period adjustment

Decrease : Net loss, Dividends, Change in accounting principle, Prior period adjustment

Restrictions of Retained Earnings


In notes to the financial statements.

As Appropriated Retained Earnings

Comprehensive Income

All changes in equity during a period except those resulting from investments by owners and
distributions to owners.


 all revenues and gains, expenses and losses reported in net income, and

 all gains and losses that bypass net income but affect equity.

Two approaches to reporting Comprehensive Income:

1. A second income statement: placing net income as the starting point in the
comperehensive income statement highlights the relationship of the statement to
the traditional income statement.

2. A combined statement of comprehensive income: the second approach to reporting

other comprehensive income provides a combined statement of comprehensive
income. In this approach, the traditional net income is a subtotal, with total
comprehensive income shown as a final total .

Statement of Changes in Equity

Required, in addition to a statement of comprehensive income.

Generally comprised of share capital—ordinary, share premium—ordinary, retained earnings, and

the accumulated balances in other comprehensive items.

Reports the change in each equity account and in total equity for the period.

1. Comprehensive income for the period.

2. Contributions (issuances of shares) and distributions (dividends) to owners.

3. Reconciliation of the carrying amount of each component of equity from the

beginning to the end of the period.