What is an Income Statement?
Income Statement also commonly called a profit and loss statement, one of the key financial statements (considered together with balance sheet and cash flow statement) which shows the revenues and expenses, as well as the gains and losses of a company for a given period. In other words, it presents the financial performance/profitability of a business over a specified accounting period.
Income statement of a company includes either the net profit/ net loss incurred by a company during an accounting period which is written in the bottom line of the statement. The net income derived from the profit and loss statement is shown in the balance sheet under ‘retained earnings’ and in the cash flow statement is shown under ‘operating cash flow in the balance sheet.
Objectives of Income Statement
- It provides a clear picture to the management about the performance of the company during the period and the effect on profitability and whether there is any scope for improvement.
- It is useful to the potential investor to analyze and decide whether he should invest in the company or not.
- It also helps the investors to analyze the credit worthiness of the company.
- It also shows the credit worthiness of a company and its ability to pay off its current obligation and is important for the creditors of the company as it serves as an indicator of the company’s financial standing.
Types of Income Statement
Under GAAP( Generally Accepted Accounting Principles), there are two types of income statement formats prescribed- single-step and multi-step. In single step, all the revenues and gains are totaled and then all the expenses and losses are subtracted to get the bottom line(Net Income= [Revenue and Gains]-[Expenses and Losses]) whereas multiple step, as the name suggests, involves a three step process to determine the net income of the company:
- Calculate Gross profit/Gross margin
- Calculate operating income
- Calculate net income.
In multi-step, the revenue and expenses are separated into operating and non operating heads. Under IFRS( International financial reporting standards) , no special format is needed to be followed but should include items as prescribed such as profit or loss for the period, revenue, tax expense, finance cost etcetera. Even though there are some extraordinary/ nonrecurring items not recognized in the statement under IFRS, GAAP allows these line items in the profit and loss statement.
Format of Multiple Step Income Statement
| Particulars | Year Amount |
| Sales (Net) | xxx |
| Less: Cost of Goods Sold | (xxx) |
| Gross Profit | xxx |
| Less: Operating Expenses | (xxx) |
| Office Expenses | (xxx) |
| Non-recurring items | (xxx) |
| Operating Profit | xxx |
| Add: Non-Operating Incomes | xxx |
| Less: Non-Operating Expenses | (xxx) |
| Profit Before Interest and Tax/EBIT | xxx |
| Less: Interest Expense | (xxx) |
| Less: Tax Paid | (xxx) |
| Net Income | xxx |
The following are included while preparing an income statement
- Net Sales: It is the gross sales, that is, initial revenue from the sales less sales returns (returns inward).
- Cost of Goods Sold: It is the cost of producing the goods sold by the company. It is also known as direct cost. For example, if a publisher wants to publish a book, his direct costs will be paper, ink, printing etcetera. It is calculated as:
- Opening stock + Net Purchases Direct Expenses- Closing Stock
- Net Sales – Gross Profit.
Gross Profit: This refers to the difference between net sales and Cost of goods sold.
Gross Profit= Net Sales- Cost of Goods Sold.
This is important because,
(a) It shows how much is left for the other expenses like interest expenses and losses from disposing of fixed assets. If the profit is lesser than the operating expenses, it can be immediately known that the business is not profitable.
(b) It shows the efficiency of a business, that is, how much of the amount is going towards the direct cost (the lower the cost, the better it is).
Operating Expenses: These are the expenses which a business incurs for its operational activities. It includes: (a) Office and Administrative Expenses (b) Selling and Distribution Expenses (c) Bad debts and provision for doubtful debts (d) Cash Discount to customers (e)Depreciation (if the asset is used in production) (f) Research and Development etcetera.
Non-operating income: This refers to the income which is not related to the major revenue producing activities. It includes (a) rent received (b) dividend income (c) interest received on long term investment (d) sale of assets (e) foreign exchange rates etcetera.
Non-operating expenses: These refer to the losses or expenses which are not related to the company’s major operations. It includes (a) interest expense such as interest paid on long –term loans (b) Loss on sale of fixed assets (c) Interest on debentures (d) Amortization of intangible and fictitious assets etcetera.
Profit before tax: It shows the company’s profit earned before deducting tax. By deducting operating expenses and non-operating expenses and by adding the other incomes we get profit before tax.
Net income: After deducting the amount of income tax from the profit before tax we get the net income/profit after tax.
Example of income statement
From the following information, prepare the Income Statement of ABC ltd.
| Particulars | ($) |
| Sales | 5,50,000 |
| Sales return | 50,000 |
| Cost of good sold | 40% |
| Office and administrative expenses | 45,000 |
| Selling and Distribution Expenses | 55,000 |
| Other Incomes | 20,000 |
| Other Expenses | 10,000 |
| Tax Rate | 50% |
Solution:
ABC LTD Income Statement for the year 2018
| Particulars | ($) |
| Gross Sales | 5,50,000 |
| Less: Returns | 50,000 |
| Net Sales | 5,00,000 |
| Less: Cost of Goods Sold | 3,00,000 |
| Gross Profit | 2,00,000 |
| Less: Operating Expenses | |
| Office and Administrative Expenses | 45,000 |
| Selling and Distribution Expenses | 55,000 |
| Total Operating Expenses | 1,00,000 |
| Operating Profit (Gross profit –Total Operating expenses) | 1,00,000 |
| Add: Non Operating Income | 20,000 |
| Less: Non operating Expenses | 10,000 |
| Net Profit Before Tax | 1,10,000 |
| Less: Tax @ 50% | 55,000 |
| Net Profit After tax | 55,000 |
Comparative Income Statement
Comparative income statement is prepared by taking the income and expenditure of two or more years so that the rate of income can be compared based on different accounting periods or with different companies and it can be analyzed to get information about the performance of the company.
Example of comparative income statement
From the following figures, prepare a comparative income statement of ABC Ltd:
| Particulars | 2018 ($) | 2019($) |
| Sales | 5,50,000 | 4,40,000 |
| Sales return | 50,000 | 40,000 |
| Gross Profit Ratio | 40% | 50% |
| Office and administrative expenses | 45,000 | 25,000 |
| Selling and Distribution Expenses | 55,000 | 45,000 |
| Other Incomes | 20,000 | 10,000 |
| Other Expenses | 10,000 | 10,000 |
| Tax Rate | 50% | 50% |
Comparative Income Statement for the years 2018 and 2019
| Particulars | 2018 ($) | 2019 ($) | Absolute Change ($) | Proportionate Change (%) |
| Gross Sales | 5,50,000 | 4,40,000 | (1,10,000) | -20 |
| Less: Returns | 50,000 | 40,000 | -10,000 | -20 |
| Net Sales | 5,00,000 | 4,00,000 | (1,00,000) | -20 |
| Less: Cost of Goods Sold | 3,00,000 | 2,00,000 | (1,00,000) | -33.33 |
| Gross Profit (A) | 2,00,000 | 2,00,000 | - | - |
| Less: Operating Expenses | ||||
| Office and Administrative Expenses | 45,000 | 25,000 | -20,000 | -44.44 |
| Selling and Distribution Expenses | 55,000 | 45,000 | -10,000 | -18.18 |
| Total Operating Expenses (B) | 1,00,000 | 70,000 | -30,000 | -30 |
| Operating Profit ( A –B) | 1,00,000 | 1,30,000 | 30,000 | 30 |
| Add: Non Operating Income | 20,000 | 10,000 | -10,000 | -50 |
| Less: Non operating Expenses | 10,000 | 10,000 | - | - |
| Net Profit Before Tax | 1,10,000 | 1,30,000 | 20,000 | 18.18 |
| Less: Tax @ 50% | 55,000 | 65,000 | 10,000 | 18.18 |
| Net Profit After tax | 55,000 | 65,000 | 10,000 | 18.18 |
Comment
Here we can say that the figures in respect to sales, expenses and profit are not favorable. Net profit increases by 18.18%
The following are the steps for the preparation of Comparative Income Statement:
- In the first column, we have to enter the items of income and expenditure.
- In the second column, the amount of previous year’s income statement must be entered.
- · In the third column, the present year’s amount must be entered.
- ·In the fourth column, the amount of Absolute changes (Current year amount –Previous year’s amount) must be entered.
- ·In the fifth column, the percentage changes must be entered (Absolute changes×100/Previous year’s figure).
Common Mistakes and Pitfalls
- Balance sheet shows the financial situation of the company at a specific point of time whereas the income statement shows the financial situation of the company for a period of time.
- Balance sheet includes assets, liabilities and equity. On the other hand, an income statement consists of indirect incomes and indirect expenses.
- Balance sheet is used in the firm to determine liquidity position of the firm, whether the firm will be able to meet its obligations in future or not whereas an income statement is used to dial issues that need correction.
Context and Applications
This topic is significant in the professional exams for both undergraduate and graduate courses, especially for
- Bachelor in Commerce
- Masters in Commerce
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