FIN 320 Principles of Finance Lecture Notes Part 4
The income statement is the financial statement in charge of providing information about
previous performance, making predictions about future performance, and assessing the
organization's capacity to make profits in the future. It has also been referred to as a profit and
loss statement, a statement of operations, or a statement of profits. The income statement
includes revenues, costs, and the net income or loss that results over time as a result of earning
activities. The outcome after all revenues and costs have been taken into account is called net
income, or the "bottom line." The income statement shows how a business has performed over
time. The balance sheet, on the other hand, only depicts one point in time. The single-step
procedure is the most typical way to create an income statement. This entails computing all
period revenues, followed by calculating and deducting all period costs to obtain the net income.
The more intricate multi-step income statement, as its name suggests, involves numerous
processes to determine the net income. The first step is to deduct operational costs from gross
earnings. Operating income is produced through this. Then, additional revenues are included and
additional costs are deducted. This generates earnings before taxes. Taxes must be subtracted as a
last step to get the measured period's net income.
Revenue and costs are included in the operational section. Cash inflows or other improvements
to an entity's assets constitute revenue. It's frequently referred to as gross profit or sales profit.
Costs include monetary withdrawals, other asset depletions, and the creation of obligations. Cost
of Items Sold (COGS): The direct expenses incurred by a company to create and sell goods. It
covers things like the price of raw materials and direct labor. Selling, General and Administrative
Expenses (SG&A): total payroll expenses, excluding any direct labor that has been accounted
for. Depreciation and amortization are costs associated with physical and intangible assets that
have been capitalized on the balance sheet for a particular accounting period. "Research &
Development (R&D): costs associated with the innovation"
If an item is noteworthy, it must be stated individually in the notes (significant). This could
involve things like reorganizations, ceased operations, and sales of investments or real estate,
machinery, and equipment. In order for users to more accurately forecast future cash flows,
irregular items are provided individually. The final line of an income statement, net income, is
frequently referred to as the bottom line. This is what's left over after all costs are deducted from
income. Investors use this figure to estimate the profit available to shareholders at the conclusion
of the fiscal year.
The fact that revenue is recorded according to accounting standards and frequently does not
represent money changing hands is one of the constraints of the income statement. The matching
principle, which calls for costs to be matched to revenues and reported simultaneously, may be to
blame for this. Up until the product is sold, production costs are not included in the income
statement. The approach taken to compute inventory, either FIFO or LIFO, is another aspect of
income statements that change often. First-in, first-out (FIFO) assumes that the oldest things in
the inventory are recorded as having been sold first, whereas LIFO assumes that the most recent
products generated are recorded as having been sold initially.
These financial statements can be restricted by intentional deception in addition to variations in
good faith in the interpretation and reporting of financial facts in income statements. One such
instance is earnings management, which happens when managers utilize discretion in financial
reporting and transaction structure to manipulate financial reports. Typically, this entails
artificially inflating (or deflating) statistics for revenues, profits, or earnings per share. To sway
opinions about the company's finances is the aim of earnings management. While revealing the
inaccuracy is a kind of fraud, aggressive earnings management is not. For a variety of reasons,
managers could try to manage profits.
