As the bookkeeper it is your job to present the report in a well organized, formatted way. In addition, you need to evaluate the report for errors prior to releasing to management. This lesson explains all three bookkeeping functions.
Contents
Organization of the Income Statement
There are three primary sections to the income statement (profit and loss statement). The first section identifies the sources of revenues; the second section offsets the revenues by categorizing the costs associated with those revenues; the final section covers the overhead or general expenses of the operation. Sometimes there are fourth and a fifth sections; most often they are not reported but include:
- Other Expenses and Revenues – Reports unusual and extraordinary events via the gross or net methods; see Lesson 19 for a more thorough explanation.
- Capitalization and Taxation – Businesses with capital intensive requirements a separate section covers the costs associated with financing the fixed assets along with the costs of taxation.
Summary Organization
Below is an example of the income statement in a summary format for a contractor; note the three primary sections of revenue, cost of sales and expenses.
. Nailed It Construction Inc. .
. Income Statement (Summary Format) .
. For the 12 Months Ending December 31, 2016 .
Revenues
Contract Income $1,747,805
. Adjustments (134,241)
. Adjusted Contract Income 1,613,564
Cost of Construction
. Direct Costs 987,242
. Indirect Costs 253,811
. Gross Profit 372,511
Expenses 167,709
Profit from Operations $204,802
In summation format the emphasis is on the three primary types of accounts:
1) Revenue
2) Cost of Sales
3) Expenses
The only deviation with this particular profit and loss statement is in cost of construction (cost of sales). In the construction industry, costs are divided between those directly assignable to a project (contract) and those costs that are spread across all projects such as:
- Project management payroll including taxes and benefits for project managers
- Transportation (trucks and equipment movement to include the cost of fuel, insurance, maintenance and repairs)
- Communications consist of cell phones, radios and job-site phone lines
- Insurance consisting of worker’s compensation, general liability and contract bonds
- Other includes equipment costs, safety gear and tooling
Although the summary format is informative, the detailed presentation generates real value for the management team in identifying problem areas and where the profit is really generated.
Detailed Organization Presentation
This organizational format is the most common in small business. It allows the reader to evaluate performance of the business quickly and easily. Let’s expand on the summary organization from above.
. Nailed It Construction, Inc.
. Income Statement (Detailed Format)
. For the 12 Months Ending December 31, 2016
Revenue
Contract Income $1,747,8052
. Adjustments:
. Closing Costs ($99,805)
. Allowances (34,436)
. Sub-Total Adjustments (134,241)
Adjusted Contract Income 1,613,564
Cost of Construction
. Direct Costs:
. Materials 340,018
. Labor 242,801
. Subcontractors 310,987
. Equipment 51,774
. Other 41,662
. Sub-Total Direct Costs 987,242
. Indirect Costs:
. Management 175,792
. Transportation 18,619
. Communications 16,203
. Insurance 13,992
. Other 29,205
. Sub-Total Indirect Costs 253,811
Gross Profit 372,511
Expenses
. Admin Payroll 72,613
. Facilities 27,210
. Insurance 11,447
. Office Operations 23,210
. Marketing/Advertising 15,805
. Other 17,424
. Sub-Total Expenses 167,709
Income From Operations $204,802
Many of the accounts in the expenses section are set up as parent-child accounts. So this report could reach a more fully expanded version. I would recommend against printing income statements with that much detail. Non-Accounting individuals are easily distracted from the purpose of this financial report when there are too many details; they tend to focus on their pet peeves and bypass the primary purpose of the income statement.
After reviewing the detail presentation format you can see how much more informative the report is over the summary presentation. Again, key in on the three types of accounts as use with the income statement.
Format of the Income Statement
The formation of the income statement should match the format of the corresponding balance sheet. As I explained in Lesson 20, there are essentially three columns of information.
The first column identifies the type of account involved, i.e. the three major groups of revenue, cost of sales and expenses. Within this column there will be account group identifiers such as specific account names. The second column will identify the ledger values associated with the respective subgroups or individual accounts. For example in the detailed presentation report above, facilities has a dollar value of $27,210. Facilities is a parent child account consisting of sub accounts of rent, common area maintenance fees, building insurance, utilities, maintenance and any taxes associated with the property. The summed value for facilities is in this second column.
The third column is the summation value for the respective account types and any corresponding profit lines such as net revenues, total cost of sales, gross profit, total overhead (expenses) and of course the net profit. Please review the detailed report above for clarity.
Also note that the title of the report has the name of the business; type of report (most accounting software do not indicate if the report is in a summary or detailed form) and the accounting period covered. Since this report is often presented with the balance sheet; the balance sheet’s date should match the final date of the income statement accounting period.
Please be sure the accounting cycle is stated in the long form not the last day of the accounting cycle. Examples include:
- For the Month Ending {Date}
- For the 3 Months Ending {Quarterly Date}
- For the 12 Months Ending {End of the Accounting Year Date}; OR
- For the Year Ending {Date}
A single date is a balance sheet presentation format.
Analysis of the Income Statement
Each industry is different in how they present the income statement. Some allocate overhead to cost of sales (manufacturing) while others give more emphasis to labor costs within their cost of sales section (service industry). I state this so that you do not get trapped by the old fashion thinking that cost of sales can not exceed a certain percentage of net sales.
If you are an inexperienced bookkeeper you best characteristic is a desire to learn. Over several accounting cycles you’ll begin to see a pattern develop. Patterns include:
- Total labor as a percentage of sales
- Materials become consistent as a percentage of sales
- There will be a minimum gross profit to cover a standard set of overhead costs, mistakenly referred to as a breakeven point
- Unexpected expenses distorting the financial results (insurance premiums, tax payments, abnormal payroll, seasonal commitments)
Make notes to yourself about these unusual discrepancies. If asked or if management expresses alarm I would politely inform them of the underlying issue(s).
As an example, one of my former clients is in the carpet cleaning business. They paid their employees every two weeks. Based on this, every sixth month there would be three payroll runs. Every time the owner read his sixth month financial report he would be upset at the low profit for that month. I would simply remind him that there were three payrolls processed during that accounting period driving up the cost of sales and expenses (administration payroll).
Summary
The income statement is presented in two primary formats. First is the summation form where all three types of accounts are displayed with a gross profit and a net income (net profit). The second form uses the three column presentation format where values of subgroups of similar accounts are identified and in the second column and the total group type is reported in the third column.
Formatting includes proper header business name, report format and date structure; that is the accounting period covered, not a single date. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you. If interested in my services as an accountant/consultant; click on ‘My Services‘ in the footer of this article.
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