The income statement (profit and loss statement) tells the story of how well the company is performing.
The income statement presents information over a period of time. This time period is referred to as an accounting cycle. Most small businesses use a monthly cycle for regular reporting purposes and an annual cycle for reporting to outside creditors and the government.
As the bookkeeper, it is your job to present the report in a well organized format. In addition, you need to evaluate the report for errors prior to releasing to management. This lesson explains all three bookkeeping functions.
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 a fourth and 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). With 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. This report could reach a more fully expanded version. It is recommended not to print 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 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 have 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). This is stated so that you do not get trapped by the old fashion thinking that cost of sales cannot exceed a certain percentage of net sales.
If you are an inexperienced bookkeeper, your 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 you would politely inform them of the underlying issue(s).
As an example, a former client 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. He was simply reminded that there were three payrolls processed during that accounting period driving up the cost of sales and expenses (administration payroll).
Summary – Income Statement Presentation
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.
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