Important Parts of an Income Statement, Part 3

There are some lines in the income statement that rely on forecasts or estimates, but the line on interest expense is but a simple equation. However, in computing for the income tax expense, a business can apply different accounting procedures for some of its expenses other than computing for taxable income. If these accounting methods were used, the result would be hypothetical taxable income, which serves as basis in determining the calculated tax return. 

The income tax, which is based on the hypothetical taxable income, is actually the income tax expense that is reflected in the income statement. The income tax expense is reconciled with the actual amount of income tax owed, with respect to the accounting procedures that were used in computing the income tax. Reconciliation of the two contrasting income tax amounts is shown in the footnote of the income statement. 

Net income may be similar to the earnings before interest and tax (EBIT). Its results may vary considerably depending on the accounting methods used in reporting sales revenue and expenses. This process may be a possible cause for ‘profit smoothing’ or sometimes known as ‘creative accounting, an act that is done in order to maneuver earnings. This is done by some businesses in order to increase their profit even when actual figures do not really show. Profit smoothing violates the principle of following standard set of rules that are stipulated in the Generally Applied Accounting Principles or GAAP and the application of sound judgment in the implementation of these methods. Businesses that are caught practicing such an offense may be legally held liable and may even cause potential harm to the business.

It is a must for business owners and managers alike to make careful and calculated decisions in choosing the appropriate accounting methods that should be used in measuring the business’ profit as well as in its actual implementation process. In many cases, managers may be required to answer questions about the business’s financial reports which is why it is important that he or she should be very well-versed with how the financial reports of the business are prepared and how it has reached to such results. Also, it is critical for accountants to be very keen on details, zeroing in on every possible factor that may affect the income statement. Accounting methods as well as its implementation vary from one business to another. It may be that a business’s methods can fall to the left, right or hitting right exactly at the GAAP’s core.