The income statement is generally followed by various schedules that give
detailed account of the items, listed on them. Information about these
schedules are given against each item in the financial statements.
One important objective in reporting revenue on an income
statement is to disclose the major source of revenue and to separate it from
miscellaneous sources. For most companies the major source of revenue is
the sale of goods and services.
Sales Revenue:
An income statement often reports several separate items in the
sales revenue section, the net of which is the net sales figure. Gross sales
is the total invoice price of the goods sold or services rendered during
the period. It should not include sales taxes or excise duties that may be
charged to the customers. Such taxes are not revenues but rather represent
collections that the business makes on behalf of the government and are
liabilities to the government until paid. Similarly, postage, freight or other
items billed to the customers at cost are not revenues. These items do not
appear in the sales figure but instead are an offset to the costs the company
incurs for them. Sales returns and allowances represent the sales values of
goods that were returned by customers or allowance made to customers
because the goods were defective. The amount can be subtracted from the
sales figure directly without showing it as a separate item on the income
statement. But it is always better to show them separately.
Sometimes called as cash discounts, sales discounts are the amount
of discounts allowed to customers for prompt payment. For e.g. If a
business offers a 3% discount to customers who pay within 7 days from
the date of the invoice and it sells rs.30,000 of goods to a customer who
takes advantage of this discount, the business receives only rs.29,100 in
cash and records the balance rs.900 as sales discount. There is another
kind of discount called as trade discount which is given by the wholesaler
or manufacturer to the retailers to enable them to sell at catalogue price
and make a profit: e.g. List less 30 percent. Trade discount does not appear
in the accounting records at all.
51
Miscellaneous Or Secondary Sources Of Revenues:
These are revenues earned from activities not associated with the
sale of the enterprise’s goods and services. Interest or dividends earned
on marketable securities, royalties, rents and gains on disposal of assets
are examples of this type of revenues. For e.g. In the case of ali akbar ltd.,
its operating loss has been converted into net profit only because of other
income, other than sales revenue. Schedule 13 gives details of other income
earned by ali akbar ltd.
Schedule 13 – Other Income
(rs.`000)
Income From Trade Investments
825
Interest On Bank Deposits & Others
1,042
Profit On Sale Of Investments
456
Profit On Sale Of Inventories
813
Miscellaneous Income
2,394
Factory Charges Recovered
9,081
Bottle Deposits Forfeited
25,336
39,947
Cost Of Goods Sold:
when income is increased by the sale value of goods or services
sold, it is also decreased by the cost of these goods or services. The cost
of goods or services sold is called the cost of sales. In manufacturing
firms and retailing business it is often called the cost of goods sold. The
complexity of calculation of cost of goods sold varies depending upon the
nature of the business. In the case of a trading concern which deals in
commodities it is very simple to calculate the most of goods sold and it is
done as follows:
Opening stock
xxx
Add: purchase
xxx
Freight
xxx
Goods available for sale xxx
Less: closing stock
xxx
Cost of goods sold
xxx
52
The calculation becomes a complicated process in the case of
manufacturing concern, especially when a number of products are
manufactured because it involves the calculation of the work in progress
and valuation of inventory. The cost of goods sold in the case of ali akbar
ltd., would have been calculated as given in illustration è’.
Illustration E:
Cost Of Goods Sold
(rs.`000)
Opening Stock
4,436
Raw Materials Consumed
22,151
Packing Materials Consumed
48,536
Excise Duty
7,805
82,928
Less: Closing Stock
4,242
Cost Of Goods Sold
78,686
Gross Profit:
The excess of sales revenue over cost of goods sold is gross margin
or gross profit. In the case of multiple-step income statement it is shown
as a separate item. Significant managerial decisions can be taken by
calculating the percentage of gross profit on sale. This percentage indicates
the average mark up obtained on products sold. The percentage varies
widely among industries, but healthy companies in the same industry tend
to have similar gross profit percentages.
Operating Expenses:
Expenses which are incurred for running the business and which
are not directly related to the company’s production or trading are
collectively called as operating expenses. Usually operating expenses
include administration expenses, finance expenses, depreciation and
selling and distribution expenses. Administration expenses generally
include personnel expenses also. However sometimes personnel expenses
may be shown separately under the heading establishment expenses.
Until recently most companies included expenses on research and
development as part of general and administrative expenses. But now-
53
a-days the financial accounting standards board (fasb) requires that this
amount should be shown separately. This is so because the expenditure
on research and development could provide an important clue as to how
cautious the company is in keeping its products and services up to date.
Operating Profit: operating profit is obtained when operating expenses are
deducted from gross profit.
Non-Operating Expenses:
These are expenses which are not related to the activities of the
business e.g. Loss on sale of asset, discount on shares written off etc.
These expenses are deducted from the income obtained after adding other
incomes to the operating profit. Other incomes or miscellaneous receipts
have already been explained. The resultant profit is called as profit (or)
earning before interest and tax (ebit).
Interest Expenses:
Interest expense arises when part of the expenses are met from
borrowed funds. The fasb requires separate disclosure of interest expense.
This item of expense is deducted from income or earnings before interest
and tax. The resultant figure is profit (or) earnings before tax (ebt).
Income Tax: the provision for tax is estimated based on the quantum of
profit before tax. As per the corporate tax laws, the amount of tax payable
is determined not on the basis of reported net profit but the net profit
arrived at has to be recomputed and adjusted for determining the tax
liability. That is why the liability is always shown as a provision.
Net Profit:
This is the amount of profit finally available to the enterprise for
Appropriation. Net profits is reported not only in total but also per
share of stock. This per share amount is obtained by dividing the total
amount of net profit by the number of shares outstanding. The net profit
is usually referred to as profit or earnings after tax. This profit could either
be distributed as dividends to shareholders or retained in the business.
Just like gross profit percentage, net profit percentage on sales can also be
calculated which will be of great use for managerial analysis.
54
1.3.3.4 Statement Of Retained Earnings
The term retained earnings means the accumulated excess of
earnings over losses and dividends. The statement of retained earnings
is generally included with almost any set of financial statements although
it is not considered to be one of the major financial statements. A typical
statement of retained earnings starts with the opening balance of retained
earnings, the net income for the period as an addition, the dividends as
a deduction, and ends with the closing balance of retained earnings. The
statement may be prepared and shown on a separate sheet or included at
the bottom of the income statement. The balance shown by the income
statement is transferred to the balance sheet through the statement of
retained earnings after making necessary appropriations. This statement
thus links the income statement to the retained earning item on the balance
sheet. This statement can be prepared in `t’ shape also when it is called as
profit and loss appropriation account. Illustration `f ’ gives the statement
of retained earning of ali akbar ltd.
Illustration – F Ali Akbar Ltd.
For The Year Ended 31st March 2012
(Rs.`000)
Retained Earnings At The Beginning Of
700
The Year
5,625
Add: Net Income
6,325
Less: Dividends
5,600
General Reserve
625
6,225
Retained Earnings At The End Of The Year
100
1.3.3.5 Balance Sheet
The balance sheet is basically a historical report showing the
cumulative effect of past transactions. It is often described as a detailed
expression of the following fundamental accounting equation:
Assets = Liabilities + Owners’ Equity (Capital)
Assets are costs which represent expected future economic benefits to the
business enterprise. However, the rights to assets have been acquired by
the Enterprise as a result of past transactions.
55
Liabilities also result from past transactions. They represent
obligations which require settlement in the future either by conveying
assets or by performing services. Implicit in these concepts of the nature
of assets and liabilities is the meaning of owners’ equity as the residual
interest in the assets of the enterprise.
1.3.3.6 Form And Presentation Of A Balance Sheet
Two objectives are dominant in presenting information in a balance
sheet. One is clarity and readability; the other is disclosure of significant
facts within the framework of the basic assumptions of accounting. Balance
sheet classification, terminology and the general form of presentation
should be studied with these objectives in mind.
It is proposed to explain the various aspects of the balance sheet with the
help of the following typical summarized balance sheet of an imaginary
Partnership firm:
56
Illustration A:
Sundaram & Sons
Balance Sheet As At 31st December 2011
Liabilities &
Rs
Rs
Assets
Rs
Rs
Capital
Current Liabilities
Current Assets
Bills Payable
7,000
Cash
1.000
Creditors
7,000
Bank
2,000
Outstanding
Marketable
Expenses
Securities
3,000
Income Received
7,000
Bills Receivables
3,000
In Advance
Debtors
10,000
Provision For
1,000
Less Provision
Income
32,000 For Doubtful
Tax
10,000
Debts
1,000
9,000
Total Current
Inventory
12,000
Liabilities
Prepaid
3,000
Long Term
Expenses
33,000
Liabilities
Total Current
Mortgage Loan
20,000 Assets
Owners’ Equity
Investments:
S’s Capital
10,000 Long Term
A’s Capital
15,000 Securities
U’s Capital
20,000 AtCosts
3,000
General Reserve
10,000 Fixed Assets:
Furniture &
Fixtures Less:
Accumulated
Dep. Plant &
Machinery
900
Less:
Accumulated
Dep.
1,000
8,000
Land
100
20,000
Buildings
Intangible Assets 10,000
Patents
2,100
Trade Marks
2,000
11,000
Goodwill
9,000
Total Assets
1,07,000 Total Liabilities
1,07.000
& Owners’
Equity
57
Conventions Of Preparing The Balance Sheet:
There are two conventions of preparing the balance sheet, the
american and the english. According to the american convention, assets
are shown on the left hand side and the liabilities and the owners’ equity
on the right hand side. Under the english convention just the opposite is
followed i.e. Assets are shown on the right hand side and the liabilities and
owners’ equity are shown on the left hand side. In the illustration à’, the
american convention has been followed.
Forms Of Presenting The Balance Sheet:
There are two forms of presenting the balance sheet – account
form and report form. When the assets are listed on the left hand side and
liabilities and owners’ equity on the right hand side, we get the account
form of balance sheet. It is so called because it is similar to an account. An
alternative practice is the report form of balance sheet where the assets
are listed at the top of the page and the liabilities and owners’ equity are
listed beneath them. In illustration à’ we have followed the account form
of balance sheet. Now-a-days joint stock companies present balance sheet
in the form of a statement in the annual reports. To illustrate, the balance
sheet of ali akbar ltd. Pondicherry as on 31-3-2012 is given below:
58
Illustration `b’:
Ali akbar ltd.Balance sheet as on 31-3-2012
2004-05
2005-06
Rs. ‘000
Rs. ‘000
Sche-
dule
I. Sources of Funds
1. Shareholders’ Funds
Capital
1
1,40,00
1,40,00
Reserves And Surplus
2
12,11,94
12,73,93
2. Loan Funds
Secured Loans
3
2,45,15
2,67,62
Unsecured Loans
4
24
15,97,09
16,81,79
Ii. Application of
Funds
1. Fixed Assets
Gross Block
5
14,19,93
13,73,59
Less: Depreciation
4,64,56
3,81,38
Net Block
9,55,37
9,92,21
Capital Work-In-
16,27
Progress
2. Investments
3. Current Assets
6
9,55,37
10,08,48
Loans And Advances
76,39
63,07
Inventories
Sundry Debtors
2,37,55
Cash And Bank
1,55,71
3,16,52
Balances
7
3,59,65
74,55
Loans And Advances
8
69,52
2,11,60
Less: Current
9
2,22,03
8,40,22
Liabilities &
10
8,06,91
Provisions
Liabilities
1,74,77
Provisions
1,85,58
55,21
11
56,00
12
2,29,98
Net Current Assets
2,41,58
5,65,33
6,10,24
15,97,09
16,81,79
59
Notes On The Accounts:
Schedules 1 to 12 and 19 referred to above, form an integral part of
the balance sheet.
From the above balance sheet it would have been found that previous
years figures are also given. As per the companies act, 1956 it is mandatory
for the companies to give figures for the previous year also. Further one
would have noticed the “schedule” column in the above balance sheet. The
schedules attached to the balance sheet give details of the respective items.
For e.g. Schedule 3 gives details of the secured loan as given below:
Schedule 3 – Secured Loans Rs. ‘000
From banker 2004-05 2003-04
Term loan (secured by charge on certain 17,00
28,00
Plant & machinery)
Cash credit-account (secured by hypothecation 2,28,15 2,39,62
Of raw materials, stock-in-progress, finished
Goods, stocks and other current assets) 2,45,15 2,67,62
1.3.3.7 Listing Of Items On The Balance Sheet
Assets in balance sheet are generally listed in two ways – i) in the
order of liquidity or according to time i.e. In the order of the degree of
ease with which they can be converted into cash or ii) in the order of
permanence or according to purpose i.e., in the order of the desire to keep
them in use. Some assets cannot be easily classified. For e.g. Investments
can be easily sold but the desire may be to keep them. Investments may
therefore be both liquid and semi-permanent that is why they are shown
as a separate item in the balance sheet. Liabilities can also be grouped in
two ways; either in the order of urgency of payment or in the reverse order.
The various assets and liabilities grouped in the two orders will appear as
follows:
60
Order Of Liquidity
Liabilities
Assets
Bank Overdraft
Cash
Bills Payable
Bank
Creditors
Marketable Securities
Outstanding Expenses
Debtors
Income Received In Advance
Inventory
Provision For Income-Tax
Bills Receivable
Mortgage Loan
Prepaid Expenses
Debentures
Investments
Owners’ Equity
Furniture And Fixtures
Plant And Machinery
Land And Buildings
Patents
Trade Marks
Goodwill
Preliminary Expenses
Order Of Permanence
Liabilities
Assets
Owners’ Equity
Goodwill
Debentures
Trade Marks
Mortgage Loan
Patents
Provision For Income-Tax
Land And Buildings
Income Received In Advance
Plant And Machinery
Outstanding Expenses
Furniture And Fixtures
Creditors
Investments
Bills Payable
Prepaid Expenses
Inventory
Debtors
Marketable Securities
Bank
Cash
Bills Receivables
Whatever is the order, it is always better to follow the same order
for both assets and liabilities. In the illustration à’ the order of liquidity
has been followed.
61
1.3.3.8 Classification Of Items In The Balance Sheet
Although each individual asset or liability can be listed separately
on the balance sheet, it is more practicable and more informative to
summarize and group related items into categories called as account
classifications. The classifications or group headings will vary considerably
depending on the size of the business, the form of ownership, the nature
of its operations and the users of the financial statements. For e.g. While
listing assets, the order of liquidity is generally used by sole traders,
partnership firms and banks, whereas joint stock companies by law follow
the order of permanence. As a generalization which is subject to many
exceptions, the following classification of balance sheet items is suggested
as representative:
Assets
Current assets
Investments
Fixed assets
Intangible assets
Other assets
Liabilities
Current liabilities
Long term liabilities
Owners’ Equity
Capital
Retained earnings
Classification Of Assets
Consumed Current Assets:
Current assets are those which are r