Income Statement or Profit and Loss Statement

Income Statement or Profit and Loss Statement provides information regarding financial performance of the entity over specific period of time to the users of financial statements.

By financial performance it means how successfully entity (management) has used the available resources. To be precise financial performance is determined by measuring how much cost is incurred to earn specific amount of benefits. If benefits are more than the costs incurred we say entity has made a profit and if costs outweigh the benefits we call it a loss. Mathematically it can be written as follows:

Profit/Loss = Income – Expenses

If Income > Expense then Profit

If Income < Expense then Loss

Putting it simply financial performance is about measuring entity’s income and expenses over a period of time.

However, information regarding incomes and expenses is presented following a certain format and that report is called Income Statement or Profit and Loss Statement.

Another important point to emphasize is that unlike Balance Sheet which provides information regarding financial position of the entity at a particular day of the year, Income Statement provides information regarding financial performance of the entity over a span of days, weeks, months, quarters or a year.

In short, income statement deals with a range of time instead of particular point in time. Format of Income Statement or Profit and Loss Statement As entity earns income from different sources and make expenses of different nature therefore, in order to make sense of each type of income and expenses they need to be reported following a particular format.

A sample income statement is given below:

Income Statement – Advanced

Just like Assets and Liabilities have their own independent definitions, incomes and expenses are more of a dependent components of financial information. That is the reason IASB Framework has defined Income and Expenses on the basis of changes in Assets and Liabilities:

• Entity earns income if the assets increase (or will increase) or liabilities decrease (or will decrease) as a result of business transaction and will ultimately increase owner’s equity
• Entity incurs expense if the asset decrease (or will decrease) or liabilities increase (or will increase) as a result of business transaction and will ultimately decrease owner’s equity.

Reading the definitions above we can understand the picture i.e. income statement reports on financial performance of the entity which is determined by measuring incomes and expenses of the entity in particular period. Measuring incomes and expenses ultimately means how well the entity has utilized resources available to it in the shape of assets that are bought either using funds invested by owner or bought on credit. In short financial performance is not just about a single number of profit or loss but of much deeper importance as it connects entity’s activities with its assets and liabilities.

In other words if the financial performance of the entity deteriorates then financial position will be affected by it as well. If the entity is making losses that actually means that entity is consuming resources more than the benefits it is getting and this will ultimately lead to shortage of resources. On other hand profits mean that benefits are more than the resources consumed and entity’s overall resources will grow over time.

For example if entity has incurred Rs. 20 in producing one unit of product and sold it for Rs. 15 then it is having a loss of Rs. 5. If this continues for long time then entity will have less cash available and ultimately will not be able to pay its liabilities.

However, care must be taken while understand the changes in equity because equity increases or decreases not only because of incomes and expenses but also because additional investments, disinvestment, issuing dividends to shareholders etc. Such transactions are not considered as incomes or expenses.

Income Statement Format – Advanced

According to IASB Framework the term income includes revenues and gains. Similarly the term expense includes losses as well. Although the definition of income and expense includes other terms as well but they do have distinctive meaning and thus the distinction is considered while preparing income statement. For example revenue is generated by selling products, whereas gains are considered to be the profits on selling non-current assets.

According to IAS 1, incomes and expenses are to be presented:

1. either as a single report named Statement of Comprehensive Income
2. or in two reports:
   1. Income statement; and
   2. Statement of Other Comprehensive Income

Its up to management of the entity whether they like to report financial performance either in a single report or in two report design. There is no compulsion to following a certain way.

Classification of Income and Expenses

IAS 1 permits two ways of classifying incomes and expenses:

1. classification based on nature of expenses
2. classification based on function of expense or cost of sales method

Again there is no compulsion to follow a certain method and preparors are free to select the one they deem fit. However, cost of sales method is widely used especially in countries following IFRSs.

A sample of income statement with incomes and expenses classified on the basis of nature of expense is as follows:

A sample of income statement with incomes and expenses classified on the basis of function of expense is as follows: