Before we look at the content and format of the Income Statement, let us observe one important facet of accounting. Accounting is not designed to provide only periodical statements like Income Statement and Balance Sheet but also (and more importantly) to help managers achieve the results revealed by these statements. A well-designed, modern accounting system keeps a continuous watch on the business' operations by generating various kinds of reports for the managers on a daily basis.

Financial Statements and GAAP

Generally Accepted Accounting Practices or GAAP of the country determines the content and format of the financial statements prepared by companies. Income Statement is one of the four major financial statements that also include the Balance Sheet, Statement of Retained Earnings and Statement of Cash Flow, and Notes on Accounts/Operations.

The Income Statement follows a standard format to summarize the revenues and expenses of the business during the period covered, under meaningful categories. The revenues and expenses are strictly apportioned to relate only to the period covered by the report and this involves including due but unpaid income and expenses, and excluding paid but not due items (such as advance payments). If the revenues exceed the expenses, the business has made a profit; in the reverse case, the business has incurred a loss.

The Statement of Retained Earnings

The Statement of Retained Earnings is closely related to the Income Statement in that it shows the accumulated income less dividends paid to shareholders and some other allowed adjustments. It will show the balance brought forward from previous periods, and the income or loss, and also dividends and any other adjustments, for the current period leaving the balance to be carried forward to future periods. The statement is often combined with the Income Statement.

Format of the Income Statement

The following format generally follows the US GAAP requirements and standard practice:

Statement of Income of (Company Name) for the year ended (Year-ending date)

(Amounts in Millions of Dollars)

Current Year | Previous Year

1. Sales
2. Cost of Sales
3. Gross Margin (1 – 2)
4. Selling Expenses
5. General and Administrative Expenses
6. Research and Development Expenses
7. Other Business Income / Expenses
8. Income from Operations (3 – (4 + 5 + 6 +/- 7))
9. Financial Income / Expenses
10. Income before Taxes (8 +/- 9)
11. Income Taxes
12. Income after Taxes (10 – 11)
13. Minority Interests
14. Income from Continuing Operations (12 – 13)
15. Discontinued Operations
16. Net Profit or Loss (14 + 15)

Note: In the above illustration, we have numbered the items and denoted the computations involved using the item numbers. This is not part of the GAAP requirement and is included only for ease of understanding.

The columns under Current Year and Previous Year will show the relevant amounts for those years, enabling comparison of performance for the two years. Let us now briefly look at the items in the Income Statement:

Sales and Cost of Sales:

Cost of Sales includes only the direct costs attributable to the quantity sold. It is typically computed as follows: Opening Inventory of Merchandise plus Purchases and Direct Costs minus Closing Inventory of Merchandise. The inventories will be valued at cost and not at selling prices.

Expenses:

Expenses are incurred for different purposes, such as selling, administration and research, and are shown classified along these lines, thus providing greater insight into any increases (or decreases) in expenses.

Incomes of Different Types:

The statement shows Income from Operations, Income before Taxes, and Income after Taxes. This division shows income from regular (and continuing) operations of the business, Income from both operational and non-regular sources (such as profit on sale of retired equipment) before tax and Income after thetax expense.

Minority Interest:

This is an item that is included when a company consolidates the revenues and expenses of a subsidiary into its accounts, and represents the Income after Taxes that belongs to the minority shareholders of the subsidiary.

Discontinued Operations:

The income computations so far are for operations of businesses that are still continuing. The income or losses from any businesses that have been discontinued during the year are shown separately here.

Net Profit or Loss:

This is the final amount that is available to shareholders of the company and the Income Statement will go on to show an Earnings per Share amount to clearly show how much return has been earned on each share.

The Statement of Retained Earnings will generally take the following format:

Current Year | Previous Year

1. Profit or Loss Brought forward from previous Years
2. Net Profit or Loss as per Income Statement for current Year
3. Total available for Distribution to Shareholders (1 + 2)
4. Dividend Declared for the Year
5. Retained Earnings Carried forward to future Years (3 – 4)

In the next article, we will look at the Balance Sheet.