Question

1) When speaking about the income statement, financial analysts often talk about “above the line” and “below the line” items. What specific item is “the line”?

2) What three (or four) items can appear below the line and how are these items reported differently than items that appear above the line?

3) What are the two primary components of pretax income and what differentiates these items from one another?

4) What are the two primary components of operating income?

Answer 1

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1) When speaking about the income statement, financial analysts often talk about “above the line” and “below the line” items. What specific item is “the line”?

The “line” generally refers to gross profit. Above that line on the income statement, typically, are sales and COGS (cost of goods sold) or COS (cost of sales or cost of services). Below the line are operating expenses, interest, and taxes. Items listed above the line tend to vary more (in the short term) than many of those below the line, and so tend to get more managerial attention.

2) What three (or four) items can appear below the line and how are these items reported differently than items that appear above the line?

Below the Line refers to items in a profit and loss account that show no noticeable effect on a company’s revenue for the year. It is an unofficial term used by people who deal with below and above the line expenses regularly. It includes exceptional and extraordinary items that are relevant to another accounting period or do not apply to the current accounting period. Publicly held firms may attempt to recharacterize some of the expenses in their income statements as being below the line, attempting to convince investors that the underlying operations of the firm are performing better than the total reported profits (or loss) of the organization. Doing so results in non-GAAP earnings, for which the SEC has specific reporting requirements.

Examples are:

1. Earnings from discontinued operations

2. The seizure of assets by a foreign government

3. The Losses from abnormal activities like blizzard, earthquake, etc.

4. Prior period items

3) What are the two primary components of pretax income and what differentiates these items from one another?

The two primary components are Operating Income and Interest Expense.

Operating Income: Deducting Selling, General & Administrative expenses from a company's gross profit produces operating income. This figure represents a company's earnings from its normal operations before any so-called non-operating income and/or costs such as interest expense, taxes and special items. Income at the operating level, which is viewed as more reliable, is often used by financial analysts rather than net income as a measure of profitability.

Interest Expense: This item reflects the costs of a company's borrowings. Sometimes companies record a net figure here for interest expense and interest income from invested funds.

4) What are the two primary components of operating income?

Operating income is defined as a corporation's operating revenues minus its operating expenses. Operating income will be shown as a subtotal on many corporations' income statements. The amount of operating income is shown before the provision for income tax and before investment income, interest expense, or other non-operating income or expense items.

Major Components of Operating Income The operating revenues are often described as net sales, while the operating expenses will include the cost of goods sold, selling, general and administrative expenses (SG&A), and perhaps impairment charges. Some of the SG&A expenses may appear as separate amounts such as depreciation and amortization, and research and development.