Understanding Financial Statements –

Income Statement

Day 3
 Financial Statements

• Financial statements are summary of

accounting transactions & are
presented in a manner to enable users
know the operating performance of the
organization and also its impact on the
overall value of the organization.
– Balance Sheet
– Profit & Loss A/c or Income Statement
– Cash Flow Statement

1–2
Questions asked by owners/managers

• Was it a good year or bad year?

• What was the volume of operations?
• What was the margin available on
sales realization?
• The answer…

Profit and Loss Account

1–3
 Profit and Loss Account

• While a Balance Sheet

• Reports value of assets, liabilities and owners
equity at a particular point in time
• And Reflects net change in owner(s) equity
brought about by operations

• A Profit & Loss Account shows a company's

earnings and expenses over a given period of
time
• It exclusively summarizes revenue and expenses
of the period and shows the net difference i.e.,
profit or loss of the period

1–4
 Gains & Losses
• Gains are increases in Equity resulting from
transactions and economic events other than
those that either generate Revenue or are
investments by owners.

• Losses are decreases in Equity resulting

from transactions and economic events other
than those that either generate Expenses or
are distribution to owners.

1–5
 Difference between Revenue & Gains
REVENUES
Result from a firm’s principal
activities or Central Operations.
Usually EARNED.
Reported GROSS.
Cost of the inventory sold and
expenses incurred to earn them
are not deducted. Expenses are
reported by function or nature
separately in I/S.
GAINS
Result from Entity’s Incidental or
Peripheral Activities and not from
its central operations.
Usually REALIZED
Reported NET.
Cost of the asset & expenses
incurred to realize the gain are
deducted from sales proceeds to
obtain Gains and this amount is
reported .
Difference between Expense & Losses

Expenses Losses
Result from a firm’s principal Result from Entity’s Incidental or
activities or Central Operations. Peripheral Activities and not from
its central operations.

Incurred during earning process Usually result from Non

Reciprocal Transactions or other
Economic Events not related to
an Earnings Process.

Reported GROSS. Reported NET.

 Net Income
Net Income is the change in equity that results
from the Operations of an entity during an
accounting period.
– net effect of Revenue, Expenses, Gains and
Losses for the period Net Income
• Net Income is Positive when
– (Revenue + Gains) is greater than (Expenses +
Losses
– This Increases the Equity of the Owners
• Net Income is Negative when
– (Revenue + Gains) is less than (Expenses +
Losses)
– This Decreases the Equity of the Owners

1–8
 Revenue vs. Receipt

• Retailer gives 30 days to pay to the

customer in December.
• An attorney requires client to prepay Rs
10,000 before researching the case.
• A manufacturer sells a products & gets
cash immediately on sale in December.

1–9
Profit & Loss A/c or Income Statement
• Shows the operating results of the entity during
the period.
• Flow report.
• Focuses on earnings activities (or operating
activities).

Assets = Liabilities + Owner(s) Equity…(1)..(from the B/S)

Owner(s) Equity = Contributed Capital + Retained Earnings

Retained earnings = Revenue – Expenses … (2)

From (1)
Assets = Liabilities + Contributed Capital + Revenue - Expenses ... (3)

(2) is referred to as Profit & Loss A/c

1–10
 Profit & Loss Account: Single Step

• Sample format:
– INCOME
• Operating income
• Non-operating income
– EXPENDITURE
• Manufacturing expenses
• Administration expenses
• Selling & distribution expenses
• Depreciation
• Interest expenses
– Profit before tax (INCOME- EXPENDITURE)
• Provision for tax
– Profit after tax (Profit before tax – Provision for tax)
1–11
Income Statement Single-Step
ACC Ltd.
SINGLE STEP INCOME STATEMENT

1–13
Hindalco

1–14
1–15
BEL

1–16
1–17
Multiple Step Income Statement/P&L a/c
• Revenue or Sales = TOP LINE ITEM
• Cost Of Goods Sold: The cost the company incurred to
purchase and convert material into the finished products sold to
customers.
• Gross Profit / Margin: The difference between revenues and
cost of goods sold. Otherwise referred to as gross profit.
• Operating Expenses: Expenses of an operating nature, such
as general, marketing, administrative expenses, incurred in the
generation of revenues.
• Operating Profit / Income: gross margin less operating
expenses
• EBIT/PBIT: Operating income plus other income & Gains minus
other expense & Losses.
• Interest expenses: Debt servicing charges
• Income Taxes: tax as per books of accounts
• EAT / PAT: = On the Line Item 1–18
 Infosys
MULTI-STEP INCOME STATEMENT

1–21
Schedule III
Indian Companies
Act 2013

1–22
1–23
Hindalco

1–24
Hindalco

1–25
Asian Paints

1–26
Exide Industries.

1–27
Tata Projects Ltd.

1–28
1–29
 Earnings per Share (EPS)

• Used to judge a company’s performance and

to compare it with the performance of other
companies
• Presented on the face of the income
statement
– Disclosed just below the net income
 Basic Earnings per Share

Net Income
EPS =
Weighted - Average Common Shares Outstandin g

• If the number of common shares changed, or

the company paid preferred stock dividends
during the year, the weighted average must be
calculated.
• If a company has nonconvertible preferred
stock, the dividend must be subtracted from
net income before EPS for common stock is
computed.
 Basic EPS

Net Income
Basic EPS =
Weighted - Average Common Shares Outstandin g

Vistula Corporation had net income of

$669,000 and 200,000 shares of common
stock outstanding.

$669,000
Basic EPS = = $3.35 per share
200,000 shares
 Calculating Weighted-Average
Suppose that from Jan. 1 to March 31, Vistula had 200,000
shares outstanding;
from April 1 to Sept. 30, it had 240,000 shares outstanding; &
from Oct. 31 to Dec. 31, 260,000 shares were outstanding. It
had net income of $669,000.
200,000 shares × 3/12 year 50,000
240,000 shares × 6/12 year 120,000
260,000 shares × 3/12 year 65,000
Weighted-average common shares outstanding 235,000

$669,000
Basic EPS = = $2.85 per share
235,000 shares
Dividends for nonconvertible preferred stock outstanding
should be subtracted from net income before earnings per
share for common stock are computed.
 Recap
• On Dec 1 a firm borrowed $100,000 at 12% per year.
The interest will be paid quarterly, with the first
payment due on March 1. What should the company
report on its income statement for Dec?
• The combination of Selling Expenses and
Administrative Expenses is referred to as?
• Interest earned on investments would appear in which
section of an income statement? Operating/Non
operating
• Is a retailer's Interest Expense an operating expense
or a non-operating expense?
• Is it acceptable that some of the expenses reported on
the income statement be estimates?
• If a company's stock is publicly traded, is it a
requirement that the earnings per share appear on the
income statement?
 Other Financial Statements

• Segment Reporting.
• Earning per share statement.
• Consolidated Financial Statements

1–35
ONGC – Segmental Reporting

1–36
 Chap 5 – E5-7
(a) Yanik Company

Sales ...................................................................... $ 90,000)

*Sales returns and allowances ($90,000 – $84,000). (6,000)
Net sales ............................................................... $ 84,000)

Net sales ............................................................... $ 84,000)

Cost of goods sold ................................................. (58,000)
*Gross profit ............................................... $ 26,000)
Gross profit ............................................................ $ 26,000)
Operating expenses ............................................... (14,380)
*Net income ............................................................ $ 11,620)
Nunez Company

*Sales ($100,000 + $5,000) ..................................... $105,000)

Sales returns and allowances ................................. (5,000)
Net sales ............................................................... $100,000)

Net sales ............................................................... $100,000)

*Cost of goods sold ($100,000 – $40,000) .............. (60,000)
Gross profit ........................................................... $ 40,000)

Gross profit ........................................................... $ 40,000)

*Operating expenses ($40,000 – $17,000) .............. (23,000)
Net income ............................................................ $ 17,000)

*Indicates missing amount

1–37
 Chap 5 – E5-7
(b) Yanik Nunez

Profit margin $11,620 ÷ $84,000 = 14% $17,000 ÷ $100,000 = 17%

Gross profit rate $26,000 ÷ $84,000 = 31% $40,000 ÷ $100,000 = 40%

(c) Nunez has a higher profit margin than Yanik. Each dollar of net sales by
Nunez results in 17 cents of net income compared to only 14 cents for
Yanik. Nunez also has a higher gross profit rate. For each dollar of
Nunez’s net sales, 60 cents is required to cover cost of goods sold
leaving 40 cents to cover other expenses and produce net income.
Yanik’s gross profit of .31 indicates that only 31 cents of each dollar of
net sales is available to cover other expenses and produce net income.

1–38
E5-8

I/S for year ended 31/12/12 Add Other Gains / Nil

Losses
Sales Revenue 2,210
Sales Discount 160 2,050 Interest Revenue 65

Less Cost of Goods Sold -987 Less Loss on -83.5 -18.5

Disposal
Gross Profit 51.9% 1,063
Less Operating Expenses 885 EBIT 159.5
Less Interest Expenses -71.0
Salaries & Wages 465
EBT 88.5
Depreciation & Utilities 420
Exp (310+110) Less Income Taxes -25.0
Operating Income 178 Net Income 3.1% 63.5
Loss on disposal of plant assets is non-recurring. Without it, NI = 63.5+83.5=147, ==> Net Profit
Margin = 7.1% of Sales. Therefore, performance in 2014 is better than that in 2013.
 Chap 5 – E5-8
(a) GAVIN COMPANY
Income Statement
For the Year Ended December 31, 2014

Sales
Sales revenue.............................. $2,210,000
Less: Sales discounts ................ 160,000
Net sales ............................................. $2,050,000
Cost of goods sold ............................. 987,000
Gross profit ......................................... 1,063,000
Operating expenses
Salaries and wages expense...... 465,000
Depreciation expense ................. 310,000
Utilities expense ......................... 110,000
Total operating expenses .................. 885,000
Income from operations ..................... 178,000
Other revenues and gains
Interest revenue .......................... 65,000
Other expenses and losses
Loss on disposal of
plant assets .............................. 83,500
Interest expense ......................... 71,000 154,500
Income before income taxes ............. 88,500
Income tax expense ........................... 25,000
Net income .......................................... $ 63,500
1–40
 Chap 5 – E5-8

(b) Profit margin: $63,500 ÷ $2,050,000 = 3%

Gross profit rate: $1,063,000 ÷ $2,050,000 = 52%

(c) During the current year Gavin had a loss on the sale of property,
plant, and equipment of $83,500. This loss is not part of operating
income, and it is most likely a non-recurring event, meaning that we
wouldn’t expect it to happen again next year. If we ignore this loss,
then Gavin Company’s net income would have been $147,000
($63,500 + $83,500) and its profit margin would have been 7.2%
($147,000 ÷ $2,050,000). Therefore, while the loss is not good news,
it is less of a concern than a similar drop in income from operations.

1–41
 • Sales = 911-28-18 =
SUNDBERG CO. 865
P5- 5A • Freight Out = 33
• Rent Revenue = 4
• S&W Exp = 80 +6+3 +
47 = 136
• Commission Payable
=3
• Depreciation = 10
• Advertising = 13
• Dividend=18
• Utilities Exp = 12
• Interest Exp = 2
• Rent Exp =24 – 6 = 18
• Prepaid Rent = 6
• IT = 25% x PBT
 Sundberg Co. I/S for year ended • Sales = 911-28-18 = 865
31/12/14
• Freight Out = 33
Sales Revenue 911
• Rent Revenue = 4
Less Sales Returns -28
Less Sales Discount -18
• S&W Exp = 80 +6+3 + 47 =
136
Net Sales 865
Less COGS -555
• Commission Payable = 3
Gross Profit 310 • Depreciation = 10
Less Operating Expenses • Advertising = 13
• Dividend=18
Freight-Out 33
• Utilities Exp = 12
Salaries & Wages 136
• Interest Exp = 2
Depreciation 10
• Rent Exp =24 – 6 = 18
Advertising 13
Utilities 12
• Prepaid Rent = 6
Rent 18 • IT = 25% x PBT
Total Operating Exp -222 Less Interest Expenses -2
Operating Profit/Income 88 PBT/EBT 90
Add Other Revenue: Rent 4 Less Income Taxes -22.5
@25%
PBIT/EBIT 92 Net Income/Profit 67.5
 SUNDBERG COMPANY
Income Statement
For the Year Ended December 31, 2014

Sales
Sales revenue ........................................ $911,000
Less: Sales returns and
allowances ................................. $28,000
Sales discounts ......................... 18,000 46,000
Net sales ................................................ 865,000
Cost of goods sold ....................................... 555,000
Gross profit ................................................... 310,000
Operating expenses
Salaries and wages expense* .............. 136,000
Freight-out ............................................. 33,000
Rent expense ($24,000 – $6,000) ......... 18,000
Advertising expense ............................. 13,000
Utilities expense ................................... 12,000
Depreciation expense ........................... 10,000
Total operating expenses ............. 222,000
Income from operations ............................... 88,000
Other revenues and gains
Rent revenue ......................................... 4,000
Other expenses and losses
Interest expense ................................... 2,000
Income before income taxes ....................... 90,000
Income tax expense ..................................... 22,500
Net income .................................................... $ 67,500

*($80,000 + $6,000 + $3,000 + $47,000)

1–44
Extra Problem

1–45
 Solution
Problem 1-2 Assets = Liabilities Equity Revenue Expense
Invested Capital Cash 20 20
Warehouse Rent Deposit Cash -5
Rent 5
Loan from Yes Bank Cash 30 30
Purchase of Goods Inventory 380 380
Sales Cash 480 480
VAT deposited with the Government Cash -20 -20
Commission paid Cash -32 -32
Salary, Courier, Transport, etc. Cash -18 -18
Rent Cash -3 -3
Cost of Goods Sold Inventory -320 -320
Payment to suppliers Cash -360 -360
Interest Payable 3 -3
Interest paid Cash -3 -3
154 50 20 480 -396
1–46
 Solution
Balance Sheet as on June 30, 2015
Profit and Loss Account for the period ending June 2015 (six months)
Equtiy 20
Add: Profit for the period 84 104
Revenue 480
Loan 30
Less VAT 20 460 Payables (Suppliers Due) 20
Less: Cost of Goods Sold 320
Commission paid 32 Total 154
Salary, Courier, Transport, etc. 18
Inventory 60
Rent 3 Rent Deposit 5
Cash 89
Interest 3 376
Profit for the period 84 Total 154

1–47