Question

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Think It Through: Which Income Statement Format Do I Choose? You are an accountant for a small retail store and are tasked with determining the best presentation for your income statement. You may choose to present it in a multi-step format or a simple income statement format. The information on the statement will be used by investors, lenders, and management to make financial decisions related to your company. It is important to the store owners that you give enough information to assist management with decision- making, but not too much information to possibly deter investors or lenders. As you begin to create your presentation, consider the following: . What is the purpose of an income statement for a retail business? • Which statement format do you choose? Why did you choose this format? What are the benefits and challenges of your statement choice for each stakeholder group? You will be assessed on: Detailed answers and explanations for each of the four questions Organization and style of the essay (including APA formatting) Submit a paper, addressing the questions listed above, using Microsoft Word or a compatible word processor (LibreOffice, Google Docs, etc.). Your paper must be 2 to 3 pages in length using 12 point, Times New Roman font, and include an introduction, body, and conclusion. You must also cite sources using APA format. . .

Answer 1

Income statement

Every business organisation, summarise all its financial transactions for the year by preparing two important financial statements, via. (i) Income statement and (ii) Balance sheet. An income statement is prepared to show its financial performance, ie. whether the firm made a profit or loss for the current year. The main purpose of business is to make profit, so every business firms wants to know the amount of profit or loss made by them. Income statement includes all incomes and expenses to arrive at profit or loss and is prepared on accrual basis. All incomes earned and expenses incurred is taken into account irrespective of the fact that whether the amount is paid or not. If the total of the income exceeds the total of expenses, then it result into a profit. On the other hand if the total of expenses exceeds the total of incomes, it’s a loss. This statement is mainly used for the purpose of external reporting.

Purpose of an income statement

1. To show the financial performance over a period of time. Profit and loss can be calculated and presented for various time periods, such as monthly, quarterly, half yearly, yearly, etc., depending up on the users requirements.

2. To adhere with the provisions of Company’s Act and other statutory requirements. It is mandatory for every companies to prepare income statement at the end of every financial year, get it audited, publish it and to send a personal copy to each and every shareholder before the Annual General Meeting. Even the Income Tax authorities will also require every business firms to prepare income statements to assess the tax for each year.

3. To inform the users that what are the business activities that they have undertaken to generate profit.

4. To satisfy the requirements of various stakeholders, such as

Ø Investors and potential investors:- Owners would be interested to know the profit as their return on the investment will depend on the amount of distributable profit available with the firm. Potential investors would take their investment decision based the expected return by analyzing the income statements over a period of time. If the firm is not performing well they will not put their money in such a venture.

Ø Managers :- They have to take operational and strategic decisions based on the economic information provided by the accountant through this statements.

Ø Lenders:- They would be interested in knowing whether the business is making enough income to repay their loan and interest.

Ø Creditors:- Short term creditors would like to assess the creditworthiness and repayment capacity by analyzing the income statement

Which statement format do you choose?

            Income statements can be prepared using different format depending up on the size and complexity of business, type of organisation, stakeholders requirements, etc. commonly there are two types of format:

1. Single step income statement

2. Multiple step income statement

1. Single step income statement

As the name indicate, under this format profit is calculated just by using only one subtraction.

Profit = (Revenue + Gains) - (Expenses + Losses)

Here is typical single step income statement format which is very simple for everyone to understand.

	$
Revenue and Gains
Sales	xx
Interest received	xx
Commission received	xx
Gain on sale of assets	xx
Total Revenue and Gains	xxxx
Expenses and Losses
Cost of goods sold	xx
Office and administration expenses	xx
Advertising expenses	xx
Electricity expenses	xx
Interest expenses	xx
Loss from lawsuit	xx
Total Expenses and Losses	xxxx
Profit / Loss	xxx

1. Multiple step income statement

Another format which uses multiple subtractions to calculate the net profit is called multiple step income statement. This format segregates the whole items into direct and indirect expenses and revenues. Indirect expenses and incomes are again divided into operating items and non-operating incomes and revenues. First part of the income statement will consider only direct income and expenses and will compute Gross profit. Second part will consider all indirect items which will be classified under different headings such as operating expenses, non-operating income and non-operating expenses. Multiple step income statement format is given below

	$
Sales	xx
Cost of goods sold	xx
Gross profit	xx
Operating Expenses
Selling expense
Advertising expenses	xx
Salesman salary	xx
Administrative expense
Stationary	xx
Office salary	xx
Total Operating Expenses	xx
Operating income	xx
Non-Operating
Interest income	xx
Gain on sales of assets	xx
Interest expense	xx
Loss on lawsuit	xx
Total Non-operating	xx
Profit or loss	xx

Under this format profit is calculated as follows:

Step 1 : Sales – Cost of sales = Gross profit

Step 2 : Gross profit – Total operating expenses = Operating income

Step 3 : Operating income + Total non operating = Net profit

While calculating non operating items, incomes should be added and expenses should be deducted to get total non-operating. If it’s a positive figure it must be added, or if it’s a negative figure it must be deducted from the operating income to arrive at the net profit.

It would be better to choose Multiple step income statement format for preparing income statement.

Why did you choose this format?

1. It states clearly gross profit, the result of trading which many users will be looking for.

2. Managers can easily take economic decisions as all spit up figures are available.

3. It segregates the profit into operating and non-operating activities which will help the readers to understand clearly how much income earned from primary business activities and how much from other non-operating activities.

4. Helps to control expenses as each and every items are available separately.

5. It provides relevant information to various stakeholders in detail.

6. Will help to attract more investors as they could take economic decisions based on the detained information presented to them.

Challenges for the format

1. Detail and length of this format will bring confusion to readers as compared to single step income statement format.

2. This format preparation takes much longer time than single step income statement.

3. It is expensive compared to single step format.

4. Difficult to interpret.

Conclusion

Single step income statement format will be suitable only for small businesses with simple structure, like sole traders and simple partnership. But to attract new investors and to get a public image, it would be better to choose Multi step income statement format.