Components of the Income Statement

The income statement also referred to as the “statement of earnings” or the “profit and loss” (P&L) statement, provides information on the financial performance of a company over a specified period of time. It shows the amount of revenue a company generated over the period of time under review as well as the expenses that were incurred in the process of generating the revenue.

Under both IFRS and US GAAP, the income statement may be presented as a separate statement followed by a statement of comprehensive income. The statement of comprehensive income begins with the profit or loss from the income statement, or alternatively, as a section of a single statement of comprehensive income.

Components of the Income Statement & Alternative Presentation Formats

IFRS requires certain items such as revenue, finance costs, and tax expenses, to be presented separately in the face of the income statement. IFRS also requires that line items, headings, and subtotals relevant to understanding a company’s financial performance to be presented, even if not specified.

Companies, however, enjoy flexibility in how they present the income statement. For example, some companies list the reporting years in increasing order, from left to right, with the most recent year in the right-most column. Other companies list the years in decreasing order, with the most recent year listed in the left-most column. It is, therefore, important for a user of the income statement to verify information on matters such as the order of years, how expense items are grouped and reported, and how to treat items that are presented in parentheses.

For illustration, figure 1 below presents a consolidated income statement for company ABC.

$$ \begin{array}{l|rr} {} & {\textbf{Year ended}} & {\textbf{31 December} } \\ {} & \bf {2016} & \bf {2015} \\ \hline {\textbf {Net revenue}} & {\bf{12,345}} & {\bf{9,629}} \\ {\text{Cost of goods sold}} & {(7345)} & {(5729)} \\ {\textbf{Gross profit}} & \bf {5,000} & \bf {3,900} \\ {\text {Selling, general and administrative expenses} } & {(1345)} & {(1049)} \\ { \text{Other revenue (expense)} } & {2,100} & {1,638} \\ { \textbf{Operating profit} } & \bf {5,755} & \bf {4,489} \\ { \text{Interest revenue} } & {1,178} & {919} \\ { \text{Interest expense} } & {(1,056)} & {(824)} \\ { \textbf{Earning before tax} } & \bf{5,877} & \bf {4,584} \\ { \text{Income tax} } & {(1,918)} & {(1,496)} \\ { \textbf{Income from fully consolidated companies } } & \bf {3,959} & \bf {3,088} \\ { \text{Share of profits from associated companies} } & {1,200} & {936} \\ { \textbf{Net income} } & \bf {5,159} & \bf {4,024} \\ \hline { \text{Attributable to the Group} } & {3,869} & {3,018} \\ { \text{Attributable to Minority interests} } & {1,290} & {1,006} \\ \hline \end{array} $$

As can be observed in figure 1, there are several components that are found in income statements. Each of the components is discussed below.

• Revenue – This is also referred to as sales or turnover, and is usually reported on the top line of the income statement. The term ‘net revenue’ is used whenever the revenue number is reported after adjustments such as cash or volume discounts.

• Expenses – This reflects the outflows, depletion of assets, and incurrence of liabilities in the course of business transactions. Expenses may be grouped according to their nature or function and reported in different formats, subject to specific requirements. For example, a company may choose to report a particular expense as a separate line item while another company may choose to combine that same expense with other costs and report the total in a single line item. Companies may also choose one of two ways to indicate that an amount on the income statement, an expense, results in a reduction in net income. One company may choose to show expenses, such as the cost of goods sold and selling expenses in parenthesis which will explicitly indicate that these are subtracted from revenue and will reduce net income. Another company may instead not use parenthesis but will assume that the user knows that the item is an expense that will have to be subtracted in deriving net income.

• Gross profit is the amount of revenue that is available after subtracting the costs of delivering goods or services. An income statement that shows a gross profit subtotal is said to use a multi-step format, rather than a single-step format. Other expenses that are related to running a company will be subtracted after gross profit.

• Operating profit sometimes referred to as Earnings Before Interest and Taxes (EBIT), is the result of subtracting operating expenses such as selling, general, and administrative expenses from gross profit. It reflects a company’s profits from its normal business transactions before making deductions for taxes or interest expenses (in the case of non-financial companies). Financial companies would include interest expenses in their operating expenses and would, therefore, be subtracted from the establishment of the operating profit.

• Net income also called “net earnings” or “profit or loss”, is reported at the bottom of the income statement. For this reason, it may also be referred to as the “bottom line”. Net income is often viewed as the single most important number which describes a company’s performance over time.

Information on how much net income is attributable to a company as well as to minority interests, or non-controlling interests, is usually presented below net income.

If a company presents the income statement in a consolidated format, then it will consolidate information on all subsidiaries over which it has control. This means that it will include all the revenues and expenses of its subsidiaries even if the company owns less than 100 percent.

Net income may also include ‘gains’ and ‘losses’, which represent increments and decrements in economic benefits, respectively.

Net income is effectively equal to: (i) revenue minus expenses in the normal activities of a company, plus (ii) other income minus other expenses, plus (iii) gains minus losses.

Question

Which of the following income statement components is known as the ‘bottom line?’

1. Net income.
2. Net revenue.
3. Operating profit.

Solution

The correct answer is A.

Net income is also referred to as the ‘bottom line’. It derives its name from the fact that it is written on the bottom line of the income statement.

B is incorrect. ‘Net revenue’ is reported on the top line of the income statement after making adjustments to revenue for volume and cash discounts.

C is incorrect.‘Operating profit’ results from subtracting operating expenses from gross profit.