Lesson 9: Income Statement

Limitations of the Income Statement

1. Companies omit items from the income statement that they cannot measure reliably 2. Income numbers are affected by the accounting methods employed 3. Income measurement involves judgement Several limitations of the income statement reduce the usefulness of its information for predicting the amounts, timing, and uncertainty of future cash flows.

Usefulness of the Income Statement

1. Evaluate the past performance of the company. 2. Provide a basis for predicting future performance. 3. Help assess the risk or uncertainty of achieving future cash flows. Information in the income statement—revenues, expenses, gains, and losses—helps users evaluate past performance. It also provides insights into the likelihood of achieving a particular level of cash flows in the future.

What can the income statement be used to assess?

Creditworthiness The business and investment community uses the income statement to determine profitability, investment value, and creditworthiness. Creditworthiness is the measure that a company has sufficient income to cover its expenses. Both revenue and expenses are found on the income statement.

Expenses

Expenses are decreases in net assets or incurrence of liabilities from primary business activities. Decrease in assets: DR: Expense CR: Cash Increase in liabilities: DR: Expense CR: Accounts payable or accrued liabilities

What limitation of an income statement occurs when one company uses an accelerated depreciation method while another company uses straight-line depreciation?

Income numbers are affected by the accounting methods employed. Depreciation is an accounting method. If one company uses accelerated depreciation while another uses straight-line, comparing the income of the statements for the two would be affected.

What does the income statement reveal about an organization?

Net earnings (net income) of the organization for a period of time The income statement reports net earnings (net income) for a period of time, such as month or a year.

Gains or Losses

Gains and losses are from incidental activities. Examples: Gains or losses from sale of assets

What is true about the information provided in the income statement?

It helps in evaluating the past performance of the enterprise. Examining revenues and expenses indicates how the company performed and allows comparison of its performance to its competitors.

Revenues

Revenues (sales) are increases in net assets or settlement of liabilities from primary business activities. Increase in assets: DR: Cash or Accountant Receivable CR: Revenue or Sales Decrease in Liabilities: DR: Unearned Revenue CR: Revenue or Sales