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
Income Statement Components and Format
Title
Every financial statement in the complete set of accounts of the entity is required to have clear title on it. Though it is recommended that entity uses the names as mentioned in IAS 1, however, entity is free to use any other name that conveys the purpose of financial statement clearly and does not cause confusion.
Components
Following are basic items that form the component of Income Statement and may have more line items in addition to the ones listed below:
- Revenue / Sales / Turnover
- Cost of sales
- Administration and distribution costs
- Finance costs
- Tax expense
- Gain or loss on discontinued operations
IAS 1 permits the inclusion of additional line items, subtotals and headings in the statements if such additions and alterations are relevant to the understanding of the users. The way a certain income or expense is classified and presented in the Income Statement or Other comprehensive Income depends on the nature, frequency, materiality and function of the item.
An entity is not permitted to offset income and expenses i.e. to report on net basis unless it is permitted by the relevant accounting standards. Usually income and expenses are reported separately.
IAS 1 strictly prohibits classifying and presenting any item as extraordinary item in the statements and also in the disclosure. There is no concept of extraordinary items in International Financial Reporting Standards.
IAS 1 requires entity to provide analysis of expenses in the Income statement in which classification is either based on nature of expense or function of expense. For the same reason accountants either group expenses by considering nature or function of the item. The type of classification selected surely affects the format and they way items are presented in the statements. Following are the proforma under each case:
Classification using nature of expense
This is the simpler method than the alternative available. In this irrespective of the application and where the expense is incurred, if the nature is same then they will be added up together. For example depreciation expense whether it is related to manufacturing unit’s machine or office equipment for administrative purposes will be added up as depreciation expense.
This method is followed mostly by small scale entities where users are limited i.e. just the owner himself or few partners who already have the idea of expenses incurred.
Possible disadvantage however is apparent from the discussion itself that user who has no connection with the business will find it hard to understand what proportion of certain expense relate to particular function of the entity. For example as depreciation is given in total user will not be able to understand what amount relates to manufacturing activity and what relates to administrative and distribution activities of the business
| Revenue | X | |
| Other income | X | |
| Changes in inventory level | X | |
| Raw material consumed | X | |
| Employee benefits expense | X | |
| Depreciation and amortisation expense | X | |
| Transportation expense | X | |
| Other expenses | X | |
| Total expenses | (X) | |
| Profit before tax | X |
Classification using function of expense
In this method of classification expenses are grouped on the basis of functions to which they relate and is the widely used method around the world to prepare Income Statement. This method is also known as Cost of Sales classification method.
Under this method at least three classifications are available namely; cost of sales, administrative expenses, distribution expenses. One of the reason for its widely accepted use that it provides information in a much more understandable manner.
Possible drawbacks of this method include extra efforts that are required to track the expenses according to their function and in that process sometimes it is hard to clearly classify one expense from the other and thus require the use of judgement and arbitrary basis of division among functions which may affect the accuracy of information.
| Revenue | X |
| Cost of sales | (X) |
| Gross profit/(loss) | X/(X) |
| Distribution cost | (X) |
| Administrative expenses | (X) |
| Operating profit/(loss) | X/(X) |
| Other expenses | (X) |
| Other income | X |
| Profit before tax | X |
The question which classification method is best depends on circumstances surrounding the entity. It is left on management to decide which method will help reflect the financial performance of the entity better given the conditions and norms of industry, nature of entity’s operation. The ultimate goal shall be to give relevant and reliable information to the user therefore, management must decide which method achieves this objective.