Contents
- What is an income statement?
- Single statement approach
- Two statement approach
- Corrections and changes
- Income statement insights
What is an income statement?
An income statement is a financial report that provides an overview of an entity’s income and expenses for a specific period. An Income Statement is often referred to as a profit and loss statement.
The income statement’s primary objective is to present an entity’s financial performance for a specific period, typically a fiscal quarter or year. It allows stakeholders to gauge the entity’s ability to generate profits and manage costs effectively.
In Australia, as in many other countries, entities have the flexibility to choose between two main approaches for presenting their income statement. These two approaches are:
- Single Statement Approach
- Two Statement Approach:
Single statement approach
Under the single statement approach, the income statement is presented as a single, comprehensive financial statement.
This single statement, known as the Statement of Profit or Loss and Other Comprehensive Income, includes all items of income and expense recognised during the period, with specific exceptions as dictated by other accounting standards.
Notably, corrections of errors and changes in accounting policies are presented as retrospective adjustments of prior periods rather than as part of the current period’s profit or loss. Additionally, certain items of other comprehensive income are recognised outside of profit or loss.
The single statement approach provides a holistic view of an entity’s financial performance, combining both profit or loss and other comprehensive income items in one statement.
Minimum line Items in the income statement
At the very least, an entity must include specific line items in its profit and loss statement and comprehensive income statement to represent the following financial amounts for the reporting period:
- Revenue: The total income generated from the entity’s core operations.
- Finance Costs: The expenses incurred due to interest on loans or other financing arrangements.
- Share of Profit or Loss of Investments: If the entity holds investments in associates and joint ventures accounted for using the equity method, their share of profit or loss should be included.
- Tax Expense: The amount of income tax incurred during the period.
- Discontinued Operations: This includes any operations that the entity has ceased or plans to discontinue, along with post tax gains or losses related to the impairment of assets in discontinued operations.
- Profit or Loss: This line item represents the entity’s net profit or loss for the period, excluding other comprehensive income items.
- Other Comprehensive Income: Items of other comprehensive income, classified by nature and grouped into those that will or will not be reclassified subsequently to profit or loss under specific conditions.
- Share of Other Comprehensive Income: If the entity has investments in associates and joint ventures accounted for using the equity method, their share of other comprehensive income should be disclosed.
- Total Comprehensive Income: This represents the entity’s overall financial performance for the period and may use alternative terminology if there are no other comprehensive income items.
Separate disclosures
In addition to the presentation of the above items, the income statement also requires separate disclosures for:
- Profit or Loss Attributable to Non controlling Interests and Owners of the Parent.
- Total Comprehensive Income Attributable to Non controlling Interests and Owners of the Parent.
These disclosures ensure that stakeholders can distinguish the financial performance and contributions of non controlling interests and the owners of the parent entity.
Two statement approach
Under the two statement approach for presenting financial performance, there are two separate financial statements involved:
Statement of profit or loss
This is the first statement presented and serves as the primary document to showcase the financial performance of the entity. It includes specific line items that cover various financial elements, such as:
- Revenue
- Finance costs
- Share of profit or loss from investments in associates and joint ventures accounted for using the equity method
- Tax expenses
- Amounts related to discontinued operations and post tax gains or losses resulting from asset impairment in discontinued operations
- Profit or loss for the period (with this being the final line)
Statement of comprehensive income
Following the Statement of Profit or Loss, the Statement of Comprehensive Income is presented. This statement starts with the profit or loss figure from the previous statement as its first line. The Statement of Comprehensive Income includes additional line items that present the following:
- Various items of other comprehensive income, which may be classified by nature and grouped into those that will or will not be reclassified subsequently to profit or loss under specific conditions (as outlined in the standard)
- Allocations for the period, showing profit or loss for the period attributable to non controlling interests and owners of the parent, as well as total comprehensive income for the period attributed to both groups.
This two statement approach ensures a more detailed and transparent presentation of an entity’s financial performance by separating the primary elements of profit or loss from other comprehensive income items. It provides a clearer picture of how the entity has performed during the specified reporting period.
It’s important to note that switching between the two approaches is considered a change in accounting policy and is subject to specific guidelines outlined in accounting standards.
Corrections and changes
Corrections of errors and accounting policy changes
One of the fundamental principles in accounting is the need for accuracy. To uphold this principle, entities are required to correct errors and address changes in accounting policies in a specific manner.
Regardless of the approach chosen for the income statement (single statement or two statement), any corrections of errors or changes in accounting policies should be presented as retrospective adjustments of prior periods.
In simpler terms, if a mistake is discovered in a prior financial statement or if an accounting policy change is made, it should be reflected as if it had always been applied. This ensures historical financial statements are corrected to reflect accurate information.
Encouragement for additional line items
Entities are encouraged to go beyond the minimum line items when presenting their financial statements. This applies to both the statement of profit or loss and other comprehensive income. The reasoning behind this encouragement is to provide stakeholders with a better understanding of the entity’s financial performance.
By adding extra line items, headings, or subtotals, an entity can offer a more detailed breakdown of its income and expenses. This can be particularly useful for investors, creditors, and other interested parties who seek a comprehensive view of the entity’s financial health.
Elimination of extraordinary items
Historically, financial statements often included a category known as extraordinary items to highlight significant events or transactions that were rare, unusual, and not expected to recur in the ordinary course of business.
However, in line with international accounting standards, the use of the term extraordinary items is now discouraged.
Entities should avoid presenting or describing any items of income and expense as extraordinary. Instead, all material events and transactions should be presented in a transparent and comprehensive manner within the financial statements or accompanying notes.
Analysis of expenses
Entities have two methods of classifying expenses:
Analysis by Nature of Expense: Under this method, expenses are grouped in the financial statements according to their nature. For example, costs related to depreciation, material purchases, transport, employee benefits, and advertising are aggregated without being reallocated among different functions within the entity. This approach provides insights into the types of expenses incurred.
Analysis by Function of Expense: Alternatively, expenses can be grouped based on their function within the entity. For instance, expenses related to the cost of sales, distribution, or administrative activities are aggregated separately. This method helps stakeholders understand how expenses contribute to specific business functions and cost categories.
The choice between these two methods should be based on what provides more reliable and relevant information about the entity’s financial performance. The aim is to enhance transparency and help stakeholders gain a clear understanding of how expenses are incurred within the organisation.
Income statement insights
Beyond showcasing total revenue and expenses, an income statement plays a pivotal role in various aspects of business management:
Break Even Point Analysis: An income statement helps determine the break even point, indicating how many sales are needed to cover all costs. It provides a fundamental understanding of when a business becomes profitable.
Scenario Planning: Businesses can use the income statement to model various scenarios, such as the impact of price increases or discounts on sales. This allows for informed decision making and strategic planning.
Viability Assessment: The income statement provides insights into the overall viability of a business model. It helps identify whether the entity’s revenue generation is sustainable and profitable.
Cost Management: By analysing expenses and cost structures, businesses can identify opportunities to cut costs and improve efficiency. This, in turn, contributes to increased profitability in the long term.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.