Definition
Income Statement, also known as Profit & Loss Account, is a report of income, expenses and the resulting profit or loss earned during an accounting period.
Example
Following is an illustrative example of an Income Statement prepared in accordance with the format prescribed by IAS 1 Presentation of Financial Statements.
Income Statement for the Year Ended 31st December 2020
| Notes | 2020 | 2019 | |
|---|---|---|---|
|
|
USD |
USD |
|
|
Revenue |
16 |
120,000 |
100,000 |
|
Cost of sales |
17 |
(65,000) |
(55,000) |
|
Gross profit |
55,000 |
45,000 |
|
|
a |
|||
|
Other income |
18 |
17,000 |
12,000 |
|
Distribution Cost |
19 |
(10,000) |
(8,000) |
|
Administrative expenses |
20 |
(18,000) |
(16,000) |
|
Other expenses |
21 |
(3,000) |
(2,000) |
|
Finance charges |
22 |
(1,000) |
(1,000) |
|
|
(15,000) |
(15,000) |
|
|
a |
|||
|
Profit before tax |
40,000 |
30,000 |
|
|
Income tax |
23 |
(12,000) |
(9,000) |
|
Net profit |
28,000 |
21,000 |
|
Basis of preparation
Income statement is prepared on the accruals basis of accounting.
This means that income (including revenue) is recognized when it is earned rather than when receipts are realized (although in many instances income may be earned and received in the same accounting period).
Conversely, expenses are recognized in the income statement when they are incurred even if they are paid for in the previous or subsequent accounting periods.
Income statement does not report transactions with the owners of an entity.
Hence, dividends paid to ordinary shareholders are not presented as an expense in the income statement and proceeds from the issuance of shares is not recognized as an income. Transactions between the entity and its owners are accounted for separately in the statement of changes in equity.
Components
Income statement comprises of the following main elements:
Revenue
Revenue includes income earned from the principal activities of an entity. So for example, in case of a manufacturer of electronic appliances, revenue will comprise of the sales from electronic appliance business. Conversely, if the same manufacturer earns interest on its bank account, it shall not be classified as revenue but as other income.
Cost of Sales
Cost of sales represents the cost of goods sold or services rendered during an accounting period.
Hence, for a retailer, cost of sales will be the sum of inventory at the start of the period and purchases during the period minus any closing inventory.
In case of a manufacturer however, cost of sales will also include production costs incurred in the manufacture of goods during a period such as the cost of direct labor, direct material consumption, depreciation of plant and machinery and factory overheads, etc.
You may refer to the article on cost of sales for an explanation of its calculation.
Other Income
Other income consists of income earned from activities that are not related to the entity’s main business. For example, other income of an entity that manufactures electronic appliances may include:
- Gain on disposal of fixed assets.
- Interest income on bank deposits.
- Exchange gain on translation of a foreign currency bank account.
Distribution Cost
Distribution cost includes expenses incurred in delivering goods from the business premises to customers.
Administrative Expenses
Administrative expenses generally comprise of costs relating to the management and support functions within an organization that are not directly involved in the production and supply of goods and services offered by the entity.
Examples of administrative expenses include:
- Salary cost of executive management.
- Legal and professional charges.
- Depreciation of head office building.
- Rent expense of offices used for administration and management purposes.
- Cost of functions / departments not directly involved in production such as finance department, HR department and administration department.
Other Expenses
This is essentially a residual category in which any expenses that are not suitably classifiable elsewhere are included.
Finance Charges
Finance charges usually comprise of interest expense on loans and debentures.
The effect of present value adjustments of discounted provisions are also included in finance charges (e.g. unwinding of discount on provision for decommissioning cost).
Income tax
Income tax expense recognized during a period is generally comprised of the following three elements:
- Current period’s estimated tax charge.
- Prior period tax adjustments.
- Deferred tax expense.
Prior Period Comparatives
Prior period financial information is presented along side current period’s financial results to facilitate comparison of performance over a period.
It is therefore important that prior period comparative figures presented in the income statement relate to a similar period.
For example, if an organization is preparing income statement for the six months ending 31 December 2013, comparative figures of prior period should relate to the six months ending 31 December 2012.
Purpose & Use
Income Statement provides the basis for measuring performance of an entity over the course of an accounting period.
Performance can be assessed from the income statement in terms of the following:
- Change in sales revenue over the period and in comparison to industry growth.
- Change in gross profit margin, operating profit margin and net profit margin over the period.
- Increase or decrease in net profit, operating profit and gross profit over the period.
- Comparison of the entity’s profitability with other organizations operating in similar industries or sectors.
Income statement also forms the basis of important financial evaluation of an entity when it is analyzed in conjunction with information contained in other financial statements such as:
- Change in earnings per share over the period.
- Analysis of working capital in comparison to similar income statement elements (e.g. the ratio of receivables reported in the balance sheet to the credit sales reported in the income statement, i.e. debtor turnover ratio).
- Analysis of interest cover and dividend cover ratios.
Template
Download a free blank excel template of income statement.