Part 1: Introduction to Income Statement / Statement of Comprehensive Income
Part 2: Income Statement Components and Format, Classification using nature of expense, Classification using function of expense
Part 3: Single-step Income Statements
Part 4: Multi-step Income Statements
Part 5: Reporting Unusual gains and losses, Other incomes and losses of irregular nature, Discontinued Operations, Extraordinary Item
Introduction to Income Statement / Statement of Comprehensive Income
Statement of Comprehensive Income is one of the important financial statements in a complete set of final accounts of the entity. As opposed to Balance Sheet that tells the financial position of the entity at a particular date, Statement of Comprehensive Income reflects the financial performance of the entity over a period of time.
Financial performance of the entity is judged by comparing the two of the five elements of financial information namely income/revenue/gain and expense/cost/loss. The entity is supposed to be doing good if it is able to generate income that exceeds the cost that is incurred to generate such income. If the income exceeds the expenses entity is said to be making profits and if expenses are more than the income then entity is in losses. Mathematically it is represented as:
Profit/Loss = Income – Expense
Profit if: Income > Expenses
Loss if: Income < Expenses
Entity’s income is a sum of revenues and gains whereas expense is a sum of costs and losses incurred during the period.
Elements of Financial Statements – Revisited
There are in total five elements of financial statements as mentioned in IASB Framework:
- Assets
- Liabilities
- Equity
- Income
- Expense
The first three are used to measure entity’s financial position and are catered in Statement of Financial Position whereas the last two are used to measure entity’s financial performance and are catered in Statement of Comprehensive income (Income Statement).
Framework defines Income and Expenses as following:
- Income is increase in the economic benefits of the entity that may be a result of enhancement or inflow of asset or such decrease in the liability that cause equity to increase. However, this does not include additional investments made by shareholders.
- Expense is decrease in the economic benefits of the entity that may be a result in deterioration or outflow of asset or such increase in liability that cause equity to decrease. However, this does not include distributions to shareholders.
According to IASB’s Conceptual Framework for Financial Reporting the definition of income includes both revenue and gain and are explained as follows:
- revenue arises in the course of ordinary activities of the entity i.e. it result from such activities that constitutes entity’s business. For example selling furniture item is the business of furniture manufacturer. However, it may have different names like turnover, fee, royalty, dividend, sales etc. For example for a teacher the revenue is fee and thus the word fee will be used in the financial statements to represent benefits (cash flows) arising out of principal business activities.
- gain results from such activities that meet the definition of income but may or may not arise in course of ordinary activities of the business. The principal factor that differentiates gain from revenue is that they are not the result of activities that constitutes the business of entity. For example for furniture manufacturer selling wood cutter or drill machine is not the actual business activity of the business and thus any gain arising on such activity is not considered as revenue.However, even if they are different from revenue but they still represent increase in economic benefit therefore are not considered as separate element.
Similarly expenses include losses as well.
- Expenses arise in the course ordinary activities of business e.g. cost of units sold, salaries and wages of employees, depreciation of assets etc.
- Losses results from such activities that meet the definition of expense but may or may not arise in the course of ordinary activities of the business. For example loss on the sale of fixed asset of the entity is not part of activities that constitute actual business activity of the business.
Terms i.e. Income, Gain, Return, Revenue and Profit are often used interchangeably but in strict accounting environment these terms have different meanings and significance. To read the difference in detail read: What is the difference between revenue, income, profit, gain and return? In few words the difference can be summarized as follows:
Revenue is the amount received by the business from selling main goods or services to its customers during the period.
Income is term which is loosely used to mean the total earnings of the business. These earnings can be from the main activities of the business or any other activity which are not regularly undertaken by the business or such earnings are not generated as a result of activities that business perform as its real business.
Profit is what business is left with after deducting such expenses from revenue which made the receipt of revenue possible.
Gain is what business earns on selling such assets which is not an inventory of the business. Simply put, this sales activity is not the actual trading of the business and is not among those goods that business sell on regular basis.
Return is anything what business enjoys above principal amount of investment.
From the above definitions and the difference in the meanings of each term we can understand that benefit arising under each is of different nature from the other. The way certain incomes and expenses are reported depend on the nature of activity itself that can be classified as follows:
- activities that constitute actual business of the entity
- activities that are part of business but not actually the business
- activities that are one off in nature and are not expected to repeat in future
- activities that are unexpected or extraordinary in nature
- activities that affect owners’ equity indirectly
Such classifications help users understand the information in much better way. And that is the reason why financial performance is reported following a certain format that let the user know the nature of income and expenses that ultimately help deciding in a better way. Considering the different types of activities and the possible confusion that can arise IAS 1 separates the activities or items in two categories
- Profit or loss item; these items are reported in Income Statement. These items may arise out of continuing or discontinued operations of the entity. According to IAS 1 profit or loss is the total of income less expenses, excluding the items that are to be reported in Other Comprehensive Income.
- Other item; these items are reported in Other Comprehensive Income Statement. These items are broadly such items that affect owners’ equity indirectly even without any transactions with shareholders however, IAS 1 defines such items as those that are not presented in profit or loss due to the requirements of relevant accounting standards.
Primarily it is the Income Statement that reports on the financial performance of the entity
According to IAS 1 Para 81 entity may report its financial performance either in a single statement or in two separate statements as follows:
- Single statement i.e. Statement of Comprehensive Income combining Income Statement (as first section) with Other comprehensive Income Statement (as second section after Income statement) as a single Statement.
- Two separate statements i.e. Income Statement and Other Comprehensive Statements are kept separate