IAS 1 states that, at the minimum, the income statement must include line items that present the following items: revenue, finance costs, share of profits and losses of associates and joint ventures accounted for by the equity method, tax expense, discontinued operations, profit or loss, minority interest, net profit attributable to equity holders in the parent.
It also says that, a company should not report any items of income or expense as extraordinary items, in the separate income statement or the statement of comprehensive income. (FYI: The U.S. GAAP allows recognizing extraordinary gains and losses when specific criteria are met.) Also, a company should present all items of income and expense in a period in the income statement.
So what are the major components of a company income statement, and how are the presented? Before that, let’s have a look at income statement manner of presentation, first. Read on
Income Statements Manner Of Presentation
While the objective of the line items are uniform across all reporting companies, the manner of presentation may differ. Specifically, IAS 1 offers preparers two different ways of classifying operating and other expenses: BY NATURE or BY FUNCTION.
While companies are encouraged to apply one or the other of these on the face of the income statement, putting it in the notes is not prohibited. A company should present an analysis of expenses within profit or loss using a classification based on either the ‘nature of expenses’ or their ‘function’ within the company, whichever provides information that is reliable and more important.
The ‘classification by nature’ identifies costs and expenses in terms of their character, such as salaries and wages, raw materials consumed, and depreciation of plant assets. On the other hand, the ‘classification by function’ presents the expenses in terms of the purpose of the expenditure, such as for manufacturing, distribution, and administration.
Note: Finance costs must be so identified regardless of which classification is employed.
IFRS allows for expenses to be classified according to function or by nature, whichever provides more reliable and relevant information, whereas under US GAAP, expenses are classified by function only. Here are examples of the income statement (profit or loss) ‘classification by the nature of expense” and ‘classification by the function of expense’ methods:
Under the ‘function of expense’ or “cost of goods sold” method an company should report, at a minimum, its cost of sales separately from other expenses. This method can provide more relevant information to the users of the financial statements than the classification under the “nature of expense” method, but allocating costs to functions may require arbitrary allocations based on judgment.
IAS 1 furthermore stipulates that if a reporting company discloses expenses by function, it must also provide information on the nature of the expenses, including depreciation and amortization and staff costs (salaries and wages). The standard does not provide detailed guidance on this requirement, but companies need only provide a note indicating the nature of the allocations made to comply with the requirement.
While IAS 1 does not require the inclusion of subsidiary schedules to support major captions in the income statement, it is commonly found that detailed schedules of line items are included in full sets of financial statements. Next, these will be illustrated item-by-item to provide a more expansive discussion of the meaning of certain major sections of the income statement.
Major Components of Income Statement
Here are major components of income statement and how they should be presented under the IAS-1:
1. Revenue – The term “ordinary activities,” formerly found in IAS 1, was eliminated by the IASB’s 2003 Improvements Project. However, companies typically show their regular trading operations first and then present any items to which they wish to direct analysts’ attention. Sales or other operating revenues are charges to customers for the goods and/or services provided to them during the period. This section of the income statement should include information about discounts, allowances, and returns, to determine net sales or net revenues.
2. Cost Of Goods Sold (COGS) – Cost of goods sold is the cost of the inventory items sold during the period. In the case of a merchandising firm, net purchases (purchases less discounts, returns, and allowances plus freight-in) are added to beginning inventory to obtain the cost of goods available for sale. From the cost of goods available for sale amount, the ending inventory is deducted to compute cost of goods sold. An Example of schedule of cost of goods sold is shown below:
A manufacturing enterprise computes the cost of goods sold in a slightly different way. Cost of goods manufactured would be added to the beginning inventory to arrive at cost of goods available for sale. The ending finished goods inventory is then deducted from the cost of goods available for sale to determine the cost of goods sold. Example of schedules of cost of goods manufactured and Cost Of Goods Sold are shown below:
Cost of goods manufactured is computed by adding to raw materials on hand at the beginning of the period the raw materials purchases during the period and all other costs of production, such as labor and direct overhead, thereby yielding the cost of goods placed in production during the period. When adjusted for changes in work in process during the period and for raw materials on hand at the end of the period, this results in the calculation of goods produced.
3. Operating Expenses – Operating expenses are primary recurring costs associated with central operations, other than cost of goods sold, which are incurred to generate sales. Operating expenses are normally classified into the following two categories:
- Distribution costs (or selling expenses) – Distribution costs are those expenses related directly to the company’s efforts to generate sales (e.g., sales salaries, commissions, advertising, delivery expenses, depreciation of store furniture and equipment, and store supplies).
- General and administrative expenses – General and administrative expenses are expenses related to the general administration of the company’s operations (e.g., officers and office salaries, office supplies, depreciation of office furniture and fixtures, telephone, postage, accounting and legal services, and business licenses and fees).
4. Other Revenue and Expenses – Other revenues and expenses are incidental revenues and expenses not related to the central operations of the company (e.g., rental income from letting parts of premises not needed for company operations).
5. Separate Disclosure Items – Separate disclosure items are items that are of such size, nature, or incidence that their disclosure becomes important in order to explain the performance of the enterprise for the period. Examples of items that, if material, would require such disclosure are as follows:
- Write-down of inventories to net realizable value, or of property, plant, and equipment to recoverable amounts, and subsequent reversals of such write-downs
- Costs of restructuring the activities of an enterprise and any subsequent reversals of such provisions
- Costs of litigation settlements
- Other reversals of provisions
6. Income Tax Expense – The total of taxes payable and deferred taxation adjustments for the period covered by the income statement.
IFRS 5 creates a new “held for sale” category of asset into which should be put assets, or “disposal groups” of assets, and liabilities that are to be sold. Such assets or groups of assets are to be valued at the lower of carrying value and fair value, less selling costs. Any resulting write-down appears, net of tax, as part of the caption “discontinued operations” in the income statement.
The other component of this line is the post-tax profit or loss of discontinued operations. A discontinued operation is defined as a component of an company that either has been disposed of, or has been classified as held for sale. It must also: (a) be a separate major line of business or geographical area of operations; (b) be a part of a single coordinated plan for disposal; or (c) is a subsidiary acquired exclusively with a view to resale.
The two elements of the single line of income statement have to be analyzed in the notes, breaking out the related income tax expense between the two, as well as showing the components of revenue, expense, and pretax profit of the discontinued items.
For the asset or disposal group to be classified as held for sale, and its related earnings to be classified as discontinued, IFRS 5 says that sale must be highly probable, the asset must be saleable in its current condition, and the sale price must be reasonable in relation to its fair value.
The appropriate level of management in the group must be committed to a plan to sell the asset and an active program has been embarked upon. Sale should be expected within one year of classification and the standard sets out stringent conditions for any extension of this, which are based on elements outside of the control of the company.
Where an operation meets the criteria for classification as discontinued, but will be abandoned within one year rather than be sold, it should also be included in discontinued operations. Assets or disposal groups categorized as held for sale are not depreciated further.