Essential Parts of an Income Statement, Part 2

In an income statement, the two most important components that perhaps most people will also look at first are profit and the cost of goods sold expense.  But looking at it more closely, every part of the income statement is important as these make up the be-all and end-all of it. The income statement is but the sum of all its parts in which each should be taken with precision, consistency and accuracy.

Other than the sales report and the cost of goods sold expense is the depreciation expense report. Most businesses consider depreciation a major expense and its reporting requires critical analysis. In reporting this type of expense, a business can use a short-life or longer life method. The short-life method is where most of the expenses incurred are loaded over the first few years while the longer life method is where the expense is distributed evenly over the years. 

The line that reports pension and post retirement benefits of a business’s employees is considered as another complex component in an income statement. The rule stated on the GAAP, or Generally Applied Accounting Principles is somewhat complex and the business must also make some key estimates for this particular expense among which includes the portfolio of fund’s expected rate of return, which is set aside for possible future obligations. This estimate, along with other estimates can greatly affect the recorded amount of expense. 

In addition, there are many products available that are expressly sold with expressly guaranteed with warranties. In this case, the business should make a careful estimate of the cost of warranties, which are considered obligations that may arise in the future course of the business. This amount should be treated as an expense in the period that is similar as to when the goods are sold alongside the cost of goods expense. Even though a business may not necessarily wait until a customer returns a product for repair or replacement before this can actually be considered an expense, warranty costs should still be forecast as a portion of the total products sold.

Furthermore, there are other operating expenses reported in the income statement that may require estimate or timing considerations. There are also expenses that are normally discretionary – meaning that it is up to the management’s discretion to determine the cost that was spent during the year.

Earnings before interest and tax (EBIT) measures the difference between the sales revenue and other expenses aforementioned. EBIT largely depends on all decisions arrived for recording sales revenue and expenses as well as the accounting methods used.