Session 9: Preparation of Income Statements

Learning Objective

• Guiding participant on how to prepare Income Statements.

• Income statement.

1. Relevance
   This simply means the information is able to directly influence the decision making process of the user. To be relevant financial information should contain the past as well as present records and be able to provide a yard stick for the future. Relevance is also measured in relation to materiality. If an item or event is material, it is probably relevant to the user of financial statements. In other words, an item is material if the user would have done something differently if he or she had not known about the item.
   In assessing materiality of financial information it should not only be based on the financial value but also depends on the nature of the transaction. There are other items in financial statements which require strict accuracy as may have a large influence on the operations of the enterprise or may lead to misconception by users of financial information. Example includes the directors’ remuneration, because the directors act as agents of the shareholders any slight under statement in their remuneration may attract an outcry from the shareholders.
2. Understandability
   In addition to relevance, the users of financial statements will be able to make informed and better decision if they can be able to interpret the contents of financial statements.
   Understandability is about communicating an intended meaning. This depends on both the accountant and the decision maker. Accountants should produce financial information and present it in a form which can be easily understood and interpreted by their intended users. Example information which is produced for the loan application at the bank need to be more elaborate on the financial position of the enterprise which information for the Malawi revenue authority need to emphasize on profitability.
3. Reliability
   According to IASC’s Conceptual framework, to be reliable information must be neutral, that is free from bias. Financial statements are not neutral if, by the selection or presentation of information, they are influence the making of a decision or judgment in order to achieve a pre determined result or income.
   In order to be relied upon, the financial information requires the following attributes:
   • Faithful presentation of information.
   • Neutrality.
   • Substance over form i.e. accounting should be based on financial reality and not merely on legal form.
   • Prudence.
   • Completeness.
4. Comparability
   Another important character of accounting information is Comparability. Financial statements of the organization must be capable of be linked with other non financial information within the enterprise. User should also be able to compare financial statements of an enterprise through time in order to assess the trend in performance and financial position.
   In assessing the compatibility of financial information, the enterprise must also disclose on the accounting policies they have been adopting over the years. If possible the entity should apply accounting policies consistently to ensure meaningful comparison of the results over time.
   The financial information should be presented together with the corresponding information of the preceding periods for easy comparison.

Constraints on relevant and reliability information

1. Timeliness
   Delay in releasing information may result in information lose its relevance. Management may need to balance the relative merits of timely reporting and the provision of reliable information. In achieving a balance between relevance and reliability, the overriding factor is how best to satisfy the economic decision making of the users.
2. Cost- benefits analysis
   The cost of producing financial information should out weigh the cost of obtaining the information. In trying to minimize cost the character of relevance and reliability may be compromised. Of course, minimum levels of relevance and reliability must be reached for accounting information to be useful.
3. Balance between qualitative characteristics
   Accountants should use their professional judgment in balancing the qualities of relevance and reliability.
   The accountants should apply all acceptable accounting standards and other relevant general acceptable accounting principle in order to show that the information shows a true and fair view.

Income Statement

Income statement is the part of financial statements which is used to show the financial performance of an enterprise. An income statement shows the profit or loss made by the enterprise for a given accounting period.

• The write down of inventories to the net realizable value or property , plant and equipment to recoverable amount, as well as the reversal of such write downs.
• A restructuring of the activities of an enterprise and the reversal of any provisions for the costs of restructuring.
• Disposal of items of property, plant and equipment.
• Disposals of long-term investments.
• Discontinued operations.
• Litigation settlement; and
• Other reversals of provisions.

Income statement on expenses classified by function:

Income statement on expenses classified by their nature:

The enterprise can produce abbreviated income statement which may not contain all the above mentioned sections. IAS 8 requires that even if the enterprise produce abbreviated accounts but the following should still appear on the face of income statement.

1. Revenue.
2. The results of operating activities;
3. Finance costs;
4. Share of profits and losses of associates and joint ventures:
5. Tax expenses;
6. Extraordinary items;
7. Minority interest; and
8. Net profit or loss for the period.