I'm Larry Walther, and this is PrinciplesofAccounting.com Chapter 5.
In this particular module, we'll now look at enhancements
to the income statement for a merchandising business.
First of all,
consider that companies may divide their expense items according to their nature.
Rather than just having operating expenses that consists of rent and salaries,
they may further divide into categories of selling expenses,
general administrative costs providing far more detail about the character of
the expenses that are being incurred.
We may also separately show peripheral transactions such as land sold at a gain,
things that are separately reported from ongoing revenues and expenses.
Financing costs such as interest expense may be broken out so
that we can see the difference between operating performance and
the cost of operating the business.
And taxes as well may be shown in a separate category.
This gives rise oftentimes to a presentation that we simply call
a multiple step income statement,
where we divide business operating results into separate categories.
Presumably, this simplifies the ability to understand the intricacies of a business'
operation.
So here's an example for Hunter Company of a multiple step income statement.
And first, note the category for sales.
Sales with potentially a great deal of detail showing the reductions for
the Sales Discounts and Sales Returns arriving at the net sales.
The cost of goods sold category is far more complex.
It consists of the beginning inventory plus the net purchases.
And the net purchases themselves might be calculated including the purchases
plus freight costs, minus purchase returns and allowances and
discounts and adjusted for the ending inventory balance.
So the calculation of cost of goods sold can become fairly complex.
The net sales minus the cost of goods sold gives profit,
from which we subtract our selling expenses and our administrative expenses.
We have our other items like land sale down in this particular item.
We have our interest expense shown down below.
And then we come down and show our income tax and finally our net income.
So you can see this can become a fairly involved presentation of income.
But certainly, the detail provided within gives a great sense about
what's going on in the business.
How their profits or losses are being generated.
What are the contributing factors?
A Single-Step Income Statement is a simpler presentation.
It may be more useful in terms of allowing a novice financial statement user to see
exactly really the bottom line effects by categories.
We put all revenues and gains together.
We group all of our expenses together.
And we subtract one from the other to arrive at net income.
However, when you look at a simple presentation or
a single-step income statement, one needs to be very careful.
The bottom line net income that most people focus on may not be fully revealing
the nature of the operations.
You may not be able to fully discern the components that make up operations.
What's core and ongoing?
And what's maybe an incidental or nonrecurring type event?
So great care needs to be taken in interpreting a single-step income
statement.
Here's an example of a single-step income statement.
I'm simply showing net sales, in this case, I've compressed the detail.
And I'm subtracting the expenses.
I did go ahead and break out the income tax,
showing it separately before I came to the net income.
This is also for Hunter Company.
if you look in your textbook, you'll find both of these illustrated in the book.
It's the same set of facts, just presented in a slightly different fashion.
Multiple-step verses single-step presentation.
Now, a detailed income statement does provide the opportunity
to do some analysis, to evaluate trends.
To provide various sub-calculations and ratios.
So I'm showing here a calculation of what we call a Gross Profit Margin.
It's simply the gross profit divided by the net sales.
Hunter Company's gross profit was 370,000.
Their net sales was 653,000.
So they had a 56.66% Gross Profit Margin.
The net profit looks at the bottom line of the company.
The net income of $39,000 divided by the sales, the net sales and
so they have almost a 6% net profit on sales ratio or margin.
In closing, I would like to point out that there are some global issues to consider
in looking at an income statement.
Recognize that in many countries revenue is referred to as turnover, so
that's a bit of a difference in terminology.
Essentially means the same thing.
International reporting standards in general do not
prescribe a detailed format for the income statement.
Expenses are oftentimes classified according to either their nature,
such as utilities, salaries, advertising, and so on.
Or they can be classified, the same set of expenses, reclassified according to their
functional areas, such as manufacturing, administrative, or sales.
Supplemental disclosures usually provide additional detail about
the nature of costs.
Global accounting rules tend to be more permissive than USA
rules when recording gains and losses on changes in value of long-term assets.
So an international company's income statement might have
additional line items reflecting re-valuations of property, plant, and
equipment assets that are not presently recognized under US GAP.
And the company needs to prepare an additional statement that reconciles
net income to these broader concepts of income.