The Income Statement or Profit and Loss Account Explained

July 28, 2015 by Ed Becker

The Income Statement, or the Profit and Loss Account, reports income expenses and the amount of profit and loss for stated accounting period. It offers information to measure the performance of the company over the entire accounting period. As well as offering information for financial evaluation of the company when reviewed with other financial statements for the period. In this segment of our series we will discuss the Income Statement in detail.

Income statements are prepared using the accrual basis of accounting, meaning that income is recognized when it is earned not when it is received. Expenses are realized and recorded in the same manner, when they are incurred, no matter when they were paid.

The income statement does not report owners’ transactions, therefore dividends and proceeds from shares are not shown as expense or income respectively. These transactions are shown separately on the Statement of Changes in Equity.

The following are the main items included on the income statement:

• Revenue

This includes earned income from the principal business of the company. This does not include income from other sources not considered the principal business activities.

• Cost of Sales

This is the cost of goods sold or services performed during the accounting period. This will be figured differently depending on the type of business performed. For example a retailer will figure this from the total inventory at the beginning of the period plus purchases of inventory. But a manufacturer would include cost of production of goods: labor, material, depreciation and overhead costs would all be included in cost of goods sold.

• Other Income

Other income includes any income earned that is not related to the main activities of the business, which would be included in revenue. This could include interest on deposits, gain on sales of assets, etc.

• Distribution Cost

These are costs incurred from the delivering of goods to customers. Examples of this would be shipping costs, postage, tariffs and such.

• Administrative Expenses

These expenses include support functions that are not directly related to the production or supply of goods and/or services the company sells, therefore not included in cost of goods sold. These may include upper management salaries, legal and other professional fees, rental and office expenses for administration and/or management offices and cost of departments such as human resources and administration.

• Other Expenses

All expenses that cannot be categorized into any other classification would belong here.

• Finance Charges

This includes interest expenses on loans and debentures, and other finance charges or fees.

• Income Tax

Income tax that is current period estimated tax charges, prior period adjustments to taxes and any deferred tax expenses.

• Prior Period Comparatives

In the layout of the Income Statement the financial information from the prior period is recorded side-by-side to allow comparisons of performance. The prior period must relate to a similar period as the current period. An example would be if you are preparing an income statement for year ending 2013 then the prior period would be year ending 2012. This allows comparison of a like period.

The income statement is an important element in the financial statements overall. It shows changes in revenue during the accounting period and the comparison of the previous period. It shows increases or decreases in net profit, operating profit and gross profit and profit margins. Comparisons can be made with other companies in similar industries by using the income statement. In the next segment we will discuss the Statement of Cash Flow.