Management Accounting

Chapter 5

 Management Accounting

5.1 Management Accounting

Managerial accounting, also known as cost accounting, is the process of

identifying, measuring, analyzing, interpreting, and communicating

information to managers for the pursuit of an organization's goals. The key

difference between managerial and financial accounting is managerial

accounting information is aimed at helping managers within the

organization make decisions, while financial accounting is aimed at

providing information to parties outside the organization.

Managerial Accounting

BREAKING DOWN Managerial Accounting

Managerial accounting encompasses all fields of accounting aimed at

informing management of business operation metrics. Managerial

accountants use information relating to the costs of products or services

purchased by the company. Budgets are also extensively used as a

quantitative expression of the business’s plan of operation. Individuals in

managerial accounting utilize performance reports to note deviations of

actual results from budgets.

Margin Analysis

Managerial accounting handles margin analysis to assess profits when

weighed against varying types of costs. Margin analysis flows into break-

even analysis, which involves calculating the contribution margin on

the sales mix to determine the unit volume at which the business’s gross

sales equal total expenditures. This information calculated by managerial

accountants is useful for determining price points for products and

services.

Constraint Analysis

Managerial accounting also manages constraints within a production line

or sales process. Managerial accountants determine where

principle bottlenecks occur and calculate the impact of these constraints

on revenue, profit, and cash flow.

Capital Budgeting

Managerial accounting involves utilizing information related to capital

expendituredecisions. Managerial accountants utilize standard capital

budgeting metrics, such as net present value and internal rate of return, to

assist decision makers on whether to embark on capital-intensive projects

or purchases. Managerial accounting involves examining proposals,

deciding if the products or services are needed, and finding the

appropriate way to finance the purchase. It also outlines payback periods

so management is able to anticipate future economic benefits.

Trend Analysis/Forecasting

Managerial accounting involves reviewing the trendline for certain costs

and investigating unusual variances or deviations. This field of accounting

also utilizes previous period information to calculate and project future

financial information. This may include the use of historical pricing, sales

volumes, geographical locations, customer tendencies, or financial

information.

Product Costing/Valuation

Managerial accounting deals with determining the actual costs of products

or services. Managerial accountants calculate and allocate overhead

charges to assess the true expenses related to the production of a product.

The overhead expenses may be allocated based on the quantity of goods

produced or other drivers related to the production, such as the square

foot of the facility. In conjunction with overhead costs, managerial

accountants use direct costs to properly assess the cost of goods sold and

inventory that may be in different stages of production.

For many people, creating and holding a presentation involves a great

deal of effort. It even leads to buck fever. To make matters worse, if the

presentation has to be given in English, it often entails double the effort

for native German speakers. We want to make your next presentation a

bit more effortless by introducing the most useful phrases and

expressions for an English-language performance.

Presentations have the advantage that many standard phrases can be

used at various points. Perhaps you wish to welcome the audience,

introduce the speaker and the topic, outline the structure, offer a

summary, or deal with questions. In all these situations, you can apply a

number of useful expressions that will make your presentation a

linguistic success.

WELCOME

At the beginning of each presentation, you should welcome your

audience. Depending on who you are addressing, you should extend a

more or less formal welcome.

Good morning/afternoon/evening, ladies and gentlemen/everyone.

On behalf of “Company X”, allow me to extend a warm welcome to you.

Hi, everyone. Welcome to “Name of the event”.

INTRODUCING THE SPEAKER

The level of formality of your welcome address will also apply to how

you introduce yourself. Customize it to match your audience.

Let me briefly introduce myself. My name is “John Miller” and I am

delighted to be here today to talk to you about…

First, let me introduce myself. My name is “John Miller” and I am the

“Position” of “Company X”.

I’m “John” from “Company Y” and today I’d like to talk to you about…

INTRODUCING THE TOPIC

After the welcome address and the introduction of the speaker comes

the presentation of the topic. Here are some useful introductory

phrases.

Today I am here to talk to you about…

What I am going to talk about today is…

I would like to take this opportunity to talk to you about…

I am delighted to be here today to tell you about…

I want to make you a short presentation about…

I’d like to give you a brief breakdown of…

EXPLANATION OF GOALS

It is always recommended to present the goals of your presentation at

the beginning. This will help the audience to understand your

objectives.

The purpose of this presentation is…

My objective today is…

STRUCTURE

After presenting the topic and your objectives, give your listeners an

overview of the presentation’s structure. Your audience will then know

what to expect in detail.

My talk/presentation is divided into “x” parts.

I’ll start with…/First, I will talk about…/I’ll begin with…

…then I will look at…

…next…

and finally…

STARTING POINT

After all this preparation, you can finally get started with the main part

of the presentation. The following phrases will help you with that.

Let me start with some general information on…

Let me begin by explaining why/how…

I’d like to give you some background information about…

Before I start, does anyone know…

As you are all aware…

I think everybody has heard about…, but hardly anyone knows a lot

about it.

END OF A SECTION

If you have completed a chapter or section of your presentation, inform

your audience, so that they do not lose their train of thought.

That’s all I have to say about…

We’ve looked at…

So much for…

INTERIM CONCLUSION

Drawing interim conclusions is of utmost importance in a presentation,

particularly at the end of a chapter or section. Without interim

conclusions, your audience will quickly forget everything you may have

said earlier.

To sum up…

Let’s summarize briefly what we have looked at.

Here is a quick recap of the main points of this section.

I’d like to recap the main points.

Well, that’s about it for this part. We’ve covered…

TRANSITION

Use one of the following phrases to move on from one chapter to the

next.

I’d now like to move on to the next part…

This leads me to my next point, which is…

Turning our attention now to…

Let’s now turn to…

EXAMPLES

Frequently, you have to give examples in a presentation. The following

phrases are useful in that respect.

For example,…

A good example of this is…

As an illustration,…

To give you an example,…

To illustrate this point…

DETAILS

In a presentation, you may often need to provide more details

regarding a certain issue. These expressions will help you to do so.

I’d like to expand on this aspect/problem/point.

Let me elaborate further on…

LINKS

If you want to link to another point in your presentation, the following

phrases may come in handy.

As I said at the beginning,…

This relates to what I was saying earlier…

Let me go back to what I said earlier about…

This ties in with…

REFERENCE TO THE STARTING POINT

In longer presentations, you run the risk that after a while the audience

may forget your original topic and objective. Therefore, it makes sense

to refer to the starting point from time to time.

I hope that you are a little clearer on how we can…

To return to the original question, we can…

Just to round the talk off, I want to go back to the beginning when I…

I hope that my presentation today will help with what I said at the

beginning…

REFERENCE TO SOURCES

In a presentation, you frequently have to refer to external sources, such

as studies and surveys. Here are some useful phrases for marking these

references.

Based on our findings,…

According to our study,…

Our data shows/indicates…

GRAPHS AND IMAGES

Presentations are usually full of graphs and images. Use the following

phrases to give your audience an understanding of your visuals.

Let me use a graphic to explain this.

I’d like to illustrate this point by showing you…

Let the pictures speak for themselves.

I think the graph perfectly shows how/that…

If you look at this table/bar chart/flow chart/line chart/graph, you can

see that…

EMPHASIS

To ensure that your presentation does not sound monotonous, from

time to time you should emphasize certain points. Here are some

suggestions.

It should be emphasized that…

I would like to draw your attention to this point…

Another significant point is that…

The significance of this is…

This is important because…

We have to remember that…

PARAPHRASE

At times it might happen that you expressed yourself unclearly and your

audience did not understand your point. In such a case, you should

paraphrase your argument using simpler language.

In other words,…

To put it more simply,…

What I mean to say is…

So, what I’m saying is….

To put it in another way….

QUESTIONS DURING THE PRESENTATION

Questions are an integral part of a presentation. These phrases allow

you to respond to questions during a presentation.

Does anyone have any questions or comments?

I am happy to answer your questions now.

Please feel free to interrupt me if you have questions.

If you have any questions, please don’t hesitate to ask.

Please stop me if you have any questions.

Do you have any questions before I move on?

If there are no further questions at this point, I’d like to…

QUESTIONS AT THE END OF A PRESENTATION

To ensure that a presentation is not disrupted by questions, it is

advisable to answer questions at the very end. Inform your audience

about this by using these phrases.

There will be time for questions at the end of the presentation.

I’ll gladly answer any of your questions at the end.

I’d be grateful if you could ask your questions after the presentation.

INQUIRIES

After answering a question from the audience, check that the addressee

has understood your answer and is satisfied with it.

Does this answer your question?

Did I make myself clear?

I hope this explains the situation for you.

UNKNOWN ANSWER

Occasionally, it may happen that you do not have an answer to a

question. That is not necessarily a bad thing. Simply use one of the

following phrases to address the fact.

That’s an interesting question. I don’t actually know off the top of my

head, but I’ll try to get back to you later with an answer.

I’m afraid I’m unable to answer that at the moment. Perhaps, I can get

back to you later.

Good question. I really don’t know! What do you think?

That’s a very good question. However, I don’t have any figures on that,

so I can’t give you an accurate answer.

Unfortunately, I’m not the best person to answer that.

SUMMARY AND CONCLUSION

At the end of the presentation, you should summarize the important

facts once again.

I’d like to conclude by…

In conclusion, let me sum up my main points.

Weighing the pros and cons, I come to the conclusion that…

That brings me to the end of my presentation. Thank you for

listening/your attention.

Thank you all for listening. It was a pleasure being here today.

Well, that’s it from me. Thanks very much.

That brings me to the end of my presentation. Thanks for your

attention.

HANDING OVER

If you are not the only speaker, you can hand over to somebody else by

using one of these phrases.

Now I will pass you over to my colleague ‘Jerry’.

‘Jerry’, the floor is yours.

CONCLUSION

We hope that our article will help you in preparing and holding your

next presentation. It goes without saying that our list is just a small

extract from the huge world of expressions and phrases. As always, the

Internet is an inexhaustible source of further information. Here are the

links to two websites that we would recommend to you in this context.

Auditing

Chapter 4 Auditing

Financial auditing is the process of examining an organization (or

individual) financial records to determine if they are accurate and in

accordance with any applicable rules (including accepted accounting

standards), regulations, and laws.

External auditors come in from outside the organization to examine

accounting and financial records and provide an independent opinion

on these records. Law requires that all public companies have their

financial statements externally audited.

Internal auditors work for the organization as internal employees to

examine records and help improve internal processes such as

operations, internal controls, risk management, and governance.

Auditing Standards

The Public Company Accounting Oversight Board (PCAOB) maintains

external auditing standards for public companies (issuers) registered

with the Securities and Exchange Commission (SEC).

As of 2012, PCAOB has 15 permanent standards approved by the SEC

and a number of interim standards that reflect generally accepted

auditing standards, as described in standards issued by the Auditing

Standards Board (ASB), which is part of the American Institute of

CPAs (AICPA).

The ASB also issues Statements on Auditing Standards (SASs) that

apply to preparing and releasing audit reports for nonissuers

(companies not required to register with the SEC). AICPA members

who audit a nonissuer are required by the AICPA Code of Professional

Conduct to comply with these standards. As of 2012, there are more

than 60 active standards.

For internal auditing, the Institute of Internal Auditors provides a

conceptual framework called the International Professional Practices

Framework (IPPF) that provides guidance for internal audits. Some of

the guidance is mandatory, while others are considered strongly

recommended, but not required by law.

Audit Planning

Audit planning includes deciding on the overall audit strategy and

developing an audit plan.

Auditing Standard No. 9 from the PCAOB describes an external

auditor's responsibility and the requirements for planning an audit.

According to standard No. 9, an audit plan is expected to describe the

planned nature, extent, and timing of the procedures for risk

assessment and the tests to be done on the controls and substantive

procedures, along with a description of other audit procedures

planned to ensure the audit meets PCAOB standards.

For internal auditing, the Institute of Internal Auditors provides

guidance for audit planning. Planning starts with determining the

scope and objectives of the audit.

Internal auditors need to understand the business, operations, and

unique characteristics of the department/unit being audited and to

develop an audit plan that defines the procedures needed to do an

efficient and effective audit

Auditor

An auditor is a person or a firm appointed by a company to execute

an audit. [1]  To act as an auditor, a person should be certified by

the regulatory authority of accounting and auditing or possess certain

specified qualifications. Generally, to act as an external auditor of

the company, a person should have a certificate of practice from the

regulatory authority.

Types of Auditor

 External auditor/ Statutory auditor is an independent firm

engaged by the client subject to the audit, to express an opinion

on whether the company's financial statements are free of

material misstatements, whether due to fraud or error.

For publicly traded companies, external auditors may also be

required to express an opinion over the effectiveness of internal

controls over financial reporting. External auditors may also be

engaged to perform other agreed-upon procedures, related or

unrelated to financial statements. Most importantly, external

auditors, though engaged and paid by the company being

audited, should be regarded as independent.

 Internal Auditors are employed by the organizations they audit.

They work for government agencies (federal, state and local); for

publicly traded companies; and for non-profit companies across

all industries. The internationally recognised standard setting

body for the profession is the Institute of Internal Auditors - IIA

(www.theiia.org). The IIA has defined internal auditing as follows:

"Internal auditing is an independent, objective assurance and

consulting activity designed to add value and improve an

organization's operations. It helps an organization accomplish its

objectives by bringing a systematic, disciplined approach to

evaluate and improve the effectiveness of risk management,

control, and governance processes"

4.2 Auditor-Client Realtionship

Consistent with our predictions, strong social exchange relationships

develop between auditors and their clients in response to auditor

perceptions of fair treatment and support received from the client.

Specifically, perceived client fairness predicts perceived client

support, and perceived client support predicts auditor commitment

to the client. Auditor tenure with the client also yielded greater

commitment to the client. We find that higher client commitment is

associated with more value-added services. Also, as expected, more

experienced auditors provide their clients with more value-added

audit services. Figure 1 depicts our results. We also separated

respondents into two groups and tested the predictions for each

group. The staff group consisted of staff and seniors, and the

management group consisted of managers, senior managers, and

partners. We divided the sample this way because staff and seniors

perform different types of audit procedures compared to

engagement management (Hirst and Koonce 1996; Trompeter and

Wright 2010; Han et al. 2011; Luippold and Kida 2012). The type of

work performed by staff and seniors, or their relative lack of business

experience, may limit their ability to provide insights on more

complex business processes or accounting issues. Indeed, our

analyses revealed that the management group provided clients with

significantly higher levels of value-added services compared to the

staff group. Nevertheless, our predictions were supported for each

group. Thus, our research model was effective in predicting variation

in value-added audit services for auditors at both higher and lower

levels.

4.1 Charts And Graphs

Accounting data is often presented in the form of tables of numbers, sometimes

simply as a print out from a spreadsheet or reports from an accounting software

package. While this style of presentation provides detailed figures, it may not

always be the most effective way to present and communicate information. It

may be that some key information should be highlighted, perhaps relationships

between certain figures should be emphasised, or trends identified. Appropriate

presentation of data in the form of graphs or charts can be a useful analysis tool

and if the data is then effectively interpreted this can facilitate the decision-

making process. The syllabus for Papers MA2 and F2/FMA require that

candidates should be able to describe the key features of different charts,

identify suitable charts in particular situations and interpret data presented in

charts. The material in this article is also relevant for candidates sitting Paper

MA1.

There are many software packages that allow the user to create charts that look

very professional but it is important to consider the different types of charts

available and select an appropriate chart type for the data being presented.

Presenting data in an inappropriate chart can convey information which may be

misleading. The term ‘chart’ is generally considered to include all types of graphs

and any other type of chart used to give a pictorial presentation of the data.

Some types of charts tend to be described as graphs while others use the term

chart, eg it is more common to hear the term line graph but the term bar chart.

The words ‘chart’ and ‘graph’ are considered to be interchangeable for the

purposes of this article.

A variety of chart types will be reviewed in this article, and the features that

make a particular chart type appropriate for the type of data being presented

will be highlighted. Some useful tips on presentation will also be provided,

together with guidance on interpreting the data presented in the charts. To

illustrate the point of ensuring that an appropriate chart type is selected, some

data has been presented using an inappropriate chart type resulting in

ineffective communication of information.

Column, bar and line charts for a single data set (Charts 1-5)

In each of the Charts 1-5, a single series of data is represented on the graph.

Often the data being presented in this type of chart spans a number of time

periods such as years, quarters or months but these types of charts can also be

used to represent data from one time period but, for example, from different

regions or perhaps for different output levels. These charts are drawn with two

axes, with the independent variable being shown on the x-axis and

the dependent variable shown on the y-axis.

Charts 1 and 2 are examples of simple column charts. The columns represent the

value of the data vertically and each column will be of a uniform width. Note that

the heights of the columns vary to reflect the data values but the width of each

column on a specific graph will be the same. Although the two charts are the

same basic chart type, there are some minor differences in style that are worth

pointing out. Chart 1 shows data for total sales over a five-year period with the

years being shown on the x-axis and the $ amounts on the y-axis. A key or legend

is displayed emphasising that the data relates to Total Sales and while a legend is

often included automatically by the charting software it is not necessary when

there is only one data series as long as the chart has an appropriate title. Chart 2

is also a simple column chart but the data relates to one year only and each

column represents a division of the business so the x-axis is not years but the

divisions, North, South, East and West. Notice also that the style of the chart has

slightly changed as it is presented in a 3D format, the legend has been removed

and the y-axis scale is in round thousands with the axis label having been

changed appropriately.

Tax Accounting

Chapter 3 

Tax Accounting

What is Tax Accounting

Tax accounting is a structure of accounting methods focused on taxes

rather than the appearance of public financial statements. Tax

accounting is governed by the Internal Revenue Code, which dictates

the specific rules that companies and individuals must follow when

preparing their tax returns.

3.1Depreciation

What is Depreciation

Depreciation is an accounting method of allocating the cost of a

tangible asset over its useful life and is used to account for declines in

value. Businesses depreciate long-term assets for both tax and

accounting purposes. For tax purposes, businesses can deduct the

cost of the tangible assets they purchase as business expenses;

however, businesses must depreciate these assets according

to IRS rules about how and when the company can take

the deduction.

Depreciation

BREAKING DOWN Depreciation

Depreciation is often a difficult concept for accounting students as it

does not represent real cash flow. Depreciation is an accounting

convention that allows a company to write off an asset's value over

time, but it is considered a non-cash transaction.

Depreciation Example

For accounting purposes, depreciation expense does not represent a

cash transaction, but it shows how much of an asset's value the

business has used over a period. For example, if a company buys a

piece of equipment for $50,000, it can either write the entire cost of

the asset off in year one or write the value of the asset off over the

assets 10-year life. This is why business owners like depreciation.

Most business owners prefer to expense only a portion of the cost,

which artificially boosts net income. In addition, the company can

scrap the equipment for $10,000, which means it has a salvage value

of $10,000. Using these variables, the analyst calculates depreciation

expense as the difference between the cost of the asset and the

salvage value, divided by the useful life of the asset. The calculation

in this example is ($50,000 - $10,000) / 10, which is $4,000.

This means the company's accountant does not have to write off the

entire $50,000, even though it paid out that amount in cash. Instead,

the company only has to expense $4,000 against net income. The

company expenses another $4,000 next year and another $4,000 the

year after that, and so on, until the company writes off the value of

the equipment in year 10.

Depreciating Values

Besides an accounting convention, companies also use depreciation

to refer to the loss of market value. Currency and real estate are two

examples of assets that can depreciate or lose value. During the

infamous Russian ruble crisis in 1998, the ruble lost 26 percent of its

value in one day. During the housing crisis of 2008, homeowners in

the hardest-hit areas, such as Las Vegas, saw the value of their homes

depreciate by as much as 60 percent

3.2 Reduce Your Tax Burden

For many people, taxes will be their largest expense over their

lifetime. In addition, income taxes are often linked to many other

areas of our financial lives. Income taxes can affect how much money

we have available to spend, when we can retire, the return that we

get on our investments, and even how our financial affairs are

conducted after we pass away. Yet, many people spend very little

time thinking about how they can legally reduce their income tax

burden or better coordinate their income tax planning with other

areas of their financial lives.

At Planned Solutions, we believe that no financial plan is complete

without a review of how a client’s income tax situation can be

managed to reflect their financial goals. When it all comes down to it,

financial goals are most often funded with a client’s after-tax

financial resources. Therefore, reducing the income tax burden may

free-up financial resources that can be used to fund other goals.

Tax Preparation

As part of our services, we prepare income tax returns for clients –

and others looking for a trained professional to complete their taxes. 

Our fees are competitive with the major chains and tax firms.

We pride ourselves on preparing thorough and accurate tax returns

and helping clients do appropriate tax planning – matching

withholding or estimated tax payments with expected income rather

than over-withholding; maximizing the use of appropriate

deductions; and planning ahead for required minimum distributions

.

3.3 What Is Analytical Exposition?

Tracking costs and revenues is one of the most fundamental internal

procedures an organization can utilize. In business, analytical

accounting is a name for the financial component of project

management. It relies on financial data to make determinations

about how, when and why a business spends and receives money.

Analytical Accounting Overview

Analytical accounting uses many of the same financial measurements

that businesses track and record for their budgeting and financial

statements. The key difference is that it displays financial data in a

number of ways based on an analyst's needs and questions, rather

than simply balancing accounts. For example, a project manager

overseeing a new product launch may this method to review

marketing costs week-by-week or from one geographic location to

another.

Analytical Accounting Tools

Most analytical accounting uses software tools to make the process

accurate and to reduce the time it takes to compile and organize

data. Computer programs from major software makers enable users

to create modules, or plans, that track specific types of costs and

revenues. Large businesses may create their own software to serve

their specific needs or address the types of costs and revenues their

industry generates. Analytical accounting tools are similar to, but not

the same as, general accounting software, although some general

accounting programs include basic analytical functionality.

Reasons for Using Analytical Accounting

Businesses use analytical accounting for several reasons, all of which

rely on the additional information it makes available to assist with

decision making processes. One purpose is to identify costs that arise

over time with hopes of reducing them. This is also a useful way of

recognizing temporary or regionally specific revenue increases so

business leaders can attempt to sustain them. In a more general

sense, businesses can develop more personalized views of their

finances, which have more value to managers.

Investment and Interpretation

To perform analytical accounting, a business needs to invest in both

software and personnel to manage the system. This means taking on

a considerable cost with uncertain results. Managers also need to be

able to interpret the data and use it to make strategic decisions. This

means that analytical accounting, on its own, has limited utility.

However, in an ideal scenario, a business can use it to reduce project

costs, accurately project revenue and gain a competitive advantage in

its industry.

Basic Consept of financial Accounting

Bab 2 

Basic Consept of financial Accounting

1.1 What is Financial Accounting

Financial accounting is the process of recording, summarizing and

reporting the myriad of transactions resulting from business

operations over a period of time. These transactions are summarized

in the preparation of financial statements, including the balance

sheet, income statement and cash flow statement, that record the

company's operating performance over a specified period.01:35

Financial Accounting

BREAKING DOWN Financial Accounting

Financial accounting utilizes a series of established accounting

principles. The selection of accounting principles to use during the

course of financial accounting depends on the regulatory and

reporting requirements the business faces. For U.S. public

companies, businesses are required to perform financial accounting

in accordance with generally accepted accounting principles (GAAP).

International public companies also frequently report financial

statements in accordance to International Financial Reporting

Standards. The establishment of these accounting principles is to

provide consistent information to investors, creditors, regulators and

tax authorities.

Accrual Method vs. Cash Method

Financial accounting may be performed using either the accrual

method, cash method or a combination of the two. Accrual

accounting entails recording transactions when the transactions have

occurred and the revenue is recognizable. Cash accounting entails

recording transactions only upon the exchange of cash. Revenue is

only recorded upon the receipt of payment, and expenses are only

recorded upon the payment of the obligation.

Financial Accounting Reporting

Financial reporting occurs through the use of financial statements.

The financial statements present the five main classifications of

financial data: revenues, expenses, assets, liabilities and equity.

Revenues and expenses are accounted for and reported on the

income statement. Financial accounting results in the determination

of net income at the bottom of the income statement. Assets,

liabilities and equity accounts are reported on the balance sheet. The

balance sheet utilizes financial accounting to report ownership of the

company's future economic benefits.

Financial Accounting Vs. Managerial Accounting

The key difference between financial and managerial accounting is

that financial accounting aims at providing information to parties

outside the organization, whereas managerial accounting

information is aimed at helping managers within the organization

make decisions. Financial statement preparation using accounting

principles is most relevant to regulatory organizations and financial

institutions. Because there are numerous accounting rules that do

not translate well into business operation management, different

accounting rules and procedures are utilized by internal management

for internal business analysis.

Accounting Certifications

The most common accounting designation demonstrating an ability

to perform financial accounting within the United States is

the Certified Public Accountant (CPA) license. Outside of the United

States, holders of the Chartered Accountant (CA) license demonstrate

the ability as well. The Certified Management Accountant

(CMA) designation is more demonstrative of an ability to perform

internal management functions than financial accounting.

2.2 Income Statement

What is an Income Statement

An income statement is one of the three important financial

statements used for reporting a company's financial

performance over a specific accounting period, with the other two

key statements being the balance sheet and the statement of cash

flows. Also known as the profit and loss statement or the statement

of revenue and expense, the income statement primarily focuses on

company’s revenues and expenses during a particular period.

An Introduction To The Income Statement

BREAKING DOWN Income Statement

Income statement is an important part of the company’s

performance reports that must be submitted to the Securities and

Exchange Commission (SEC). While a balance sheet provides the

snapshot of company’s financials as of a particular date (like, as on 30

September 2018), the income statement reports income through a

particular time period and its heading indicates the duration which

may read as “For the (fiscal) year/quarter ended September 30,

2018,” (See also, What is the difference between an income

statement and a balance sheet?)

The income statement focuses on the four key items -

 revenue, expenses, gainsand losses. It does not

cover receipts (money received by the business) or the cash

payments/disbursements (money paid by the business). It starts with

the details of sales, and then works down to compute the net

income and eventually the earnings per share (EPS). Essentially, it

gives an account of how the net revenue realized by the company

gets transformed into net earnings (profit or loss).

The following are covered in the income statement, though its format

may vary depending upon the local regulatory requirements, the

diversified scope of the business and the associated operating

activities:

Revenues and Gains:

1. Operating Revenue: Revenue realized through primary

activities is often referred to as operating revenue. For a

company manufacturing a product, or for a wholesaler,

distributor or retailer involved in the business of selling that

product, the revenue from primary activities refers to revenue

achieved from sale of the product. Similarly, for a company (or

its franchisees) in the business of offering services, revenue

from primary activities refers to the revenue or fees earned in

exchange of offering those services.

2. Non-operating Revenue: Revenues realized through

secondary, non-core business activities are often referred to as

non-operating recurring revenues. These revenues are sourced

from the earnings which are outside of purchase and sale of

goods and services, and may include income from interest

earned on business capital lying in the bank, rental income

from business property, income from strategic partnerships

like royalty payment receipts or income from an advertisement

display placed on business property.

1. Gains: Also called as other income, gains indicate the net

money made from other activities, like sale of long-term

assets. These include the net income realized from one-time

non-business activities, like a company selling its old

transportation van, unused land, or a subsidiary company.

Revenue should not be confused with receipts. Revenue is usually

accounted for in the period when sales are made or services are

delivered. Receipts are the cash received, and are accounted for

when the money is actually received. For instance, a customer may

take goods/services from a company on 28 September which will

lead to the revenue being accounted for in the month of September.

Owing to his good reputation, the customer may be given a 30-day

payment window. It will give him time till 28 October to make the

payment which is when the receipts are accounted for.

Expenses and Losses:

1. Expenses linked to primary activities: All expenses incurred for

earning the normal operating revenue linked to the primary

activity of the business. They include cost of goods sold

(COGS), selling, general and administrative expenses

(SG&A), depreciation or amortization, and research and

development (R&D)expenses. Typical items that make up the

list are employee wages, sales commissions, and expenses for

utilities like electricity and transportation.

2. Expenses linked to secondary activities: All expenses linked to

non-core business activities, like interest paid on loan money.

3. Losses: All expenses that go towards loss-making sale of long-

term assets, one-time or any other unusual costs, or expenses

towards lawsuits.

While primary revenue and expenses offer insights into how well the

company’s core business is performing, the secondary revenue and

expenses account for the company’s involvement and its expertise in

managing the ad-hoc, non-core activities. Compared to the income

from sale of manufactured goods, a substantially high interest

income from money lying in the bank indicates that the business may

not be utilizing the available cash to its full potential by expanding

the production capacity, or it is facing challenges in increasing its

market share amid competition. Recurring rental income gained by

hosting billboards at the company factory situated along a highway

indicates that the management is capitalizing upon the available

resources and assets for additional profitability.

Income Statement Structure - From Revenues to Net Income

Mathematically, the Net Income is calculated based on the following:

Net Income = (Revenue + Gains) – (Expenses + Losses)

To understand the above details with some real numbers, let’s

assume that a fictitious sports merchandise selling business which

additionally provides training is reporting its income statement for

the most recent quarter.

2.3 Financial Statements - Definition

What Are Financial Statements

Financial statements are written records that convey the business

activities and the financial performance of a company. Financial

statements include the balance sheet, income statement, and cash

flow statement. Financial statements are often audited by

government agencies, accountants, firms, etc. to ensure accuracy and

for tax, financing, or investing purposes.

Financial Statements

What Do Financial Statements Tell You

Investors and financial analysts rely on financial data to analyze the

performance of company and make predictions about its future

direction of the company's stock price. One of the most important

resources of reliable and audited financial data is the annual report,

which contains the firm's financial statements.

The financial statements are used by investors, market analysts, and

creditors, to evaluate a company's financial health and earnings

potential. The three major financial statement reports are the

balance sheet, income statement, and statement of cash flows.

Balance Sheet

The balance sheet provides an overview of assets, liabilities, and

stockholders' equity as a snapshot in time. The date at the top of the

balance sheet tells you when the snapshot was taken, which is

generally the end of the fiscal year.

How To Calculate and Identify the Balance Sheet

The balance sheet totals will be calculated already, but here's how

you identify them.

1. Locate total assets on the balance sheet for the period.

2. Total all liabilities, which should be a separate listing on the

balance sheet.

3. Locate total shareholder's equity and add the number to total

liabilities.

4. Total assets should equal the total of liabilities and total equity.

What Does the Balance Sheet Tell You?

The balance sheet identifies how assets are funded, either with

liabilities, such as debt, or stockholders' equity, such as retained

earnings and additional paid-in capital. Assets are listed on the

balance sheet in order of liquidity. Liabilities are listed in the order in

which they will be paid. Short-term or current liabilities are expected

to be paid within the year, while long-term or noncurrent liabilities

are debts expected to be paid in over one year.

Example of items on a Balance Sheet

Below are examples of items listed on the balance sheet:

Assets 

 Cash and cash equivalents are liquid assets, which may include

Treasury bills and certificates of deposit.

 Accounts receivables are the amount of money owed to the

company by its customers for the sale of its product and

service.

 Inventory

Liabilities 

 Debt including long-term debt

 Rent, tax, utilities

 Wages payable

 Dividends payable

Shareholders' equity

 Shareholders' equity is a company's total assets minus its total

liabilities. Shareholders' equity represents the amount of

money that would be returned to shareholders if all of

the assets were liquidated and all of the company's debt

was paid off.

 Retained earnings are part of shareholders' equity and are the

percentage of net earnings that were not paid to

shareholders as dividends. 

Real World Example of a Balance Sheet 

Below is a portion of Exxon Mobil Corporation's (XOM) balance

sheet as of September 30, 2018. 

 We can total assets were $354,628 (highlighted in green).

 Total liabilities were $157,797 (1st red highlighted area).

 Total equity was $196,831 (in red).

 Total liabilities and equity were $354,628, which equals the

total assets for the period.

Income Statement

Unlike the balance sheet, the income statement covers a range of

time, which is a year for annual financial statements and a quarter for

quarterly financial statements. The income statement provides an

overview of revenues, expenses, net income and earnings per share.

It usually provides two to three years of data for comparison.

How To Calculate the Income Statement

1. Total all revenue or sales for the period.

2. Total all expenses and costs of operating the business.

3. Subtract total expenses from revenue to achieve net income or

the profit for the period.

What Does the Income Statement Tell You?

An income statement is one of the three important financial

statements used for reporting a company's financial

performance over a specific accounting period. Also known as

the profit and loss statement or the statement of revenue and

expense, the income statement primarily focuses on a company’s

revenues and expenses during a particular period. Once expenses are

subtracted from revenues, the statement produces a company's

profit figure called net income.

Types of Revenue

Operating revenue is the revenue earned by selling a company's

products or services. The operating revenue for an auto

manufacturer would be realized through the production and sale of

autos. Operating revenue is generated from the core business

activities of a company.

Non-operating revenue is the income earned from non-core

business activities. These revenues fall outside the primary function

of the business. Some non-operating revenue examples include:

 interest earned on cash in the bank,

 rental income from a property,

 income from strategic partnerships like royalty payment

receipts,

 income from an advertisement display located on the

company's property.

Other income is the revenue earned from other activities. Other

income could include gains from the sale of long-term assets such as

land, vehicles, or a subsidiary.

Types of Expenses

Primary expenses are incurred during the process of earning revenue

from the primary activity of the business. Expenses include cost of

goods sold (COGS), selling, general and administrative expenses

(SG&A), depreciation or amortization, and research and development

(R&D). Typical expenses include employee wages, sales commissions,

and utilities such as electricity and transportation.

Expenses that are linked to secondary activities include interest paid

on loans or debt. Losses from the sale of an asset are also recorded

as expenses.

The main purpose of the income statement is to convey details of

profitability and the financial results of business activities. However,

it can be very effective in showing whether sales or revenue is

increasing when compared over multiple periods. Investors can also

see how well a company's management is controlling expenses to

determine whether a company's efforts in reducing the cost of sales

might boost profits over time.

Real World Example of an Income Statement

Below is a portion of Exxon Mobil Corporation's (XOM) income

statement as of September 30, 2018. 

 We can see total revenues were $76,605 for the period.

 Total costs were $67,525 for the period.

 Net income or profit was $6,240 for the period.

Cash Flow Statement

The cash flow statement (CFS) measures how well a company

generates cash to pay its debt obligations, fund its operating

expenses, and fund investments. The cash flow statement

complements the balance sheet and income statement.

What Does the Cash Flow Statement Tell You?

The CFS allows investors to understand how a company's operations

are running, where its money is coming from, and how money is

being spent. The CFS also provides insight as to whether a company is

on a solid financial footing.

There is no formula, per se for calculating a cash flow statement, but

instead, it contains three sections that report the cash flow for the

various activities that a company has used its cash. Those three

components of the CFS are listed below.

Operating Activities 

The operating activities on the CFS include any sources and uses of

cash from running the business and selling its products or services.

Cash from operations includes any changes made in cash, accounts

receivable, depreciation, inventory, and accounts payable. These

transactions also include wages, income tax payments, interest

payments, rent, and cash receipts from the sale of a product or

service.

Investing Activities 

Investing activities include any sources and uses of cash from a

company's investments into the long-term future of the company. A

purchase or sale of an asset, loans made to vendors or received from

customers or any payments related to a merger or acquisition are

included in this category. Also, purchases of fixed assets such

as property, plant, and equipment (PPE) are included in this section.

In short, changes in equipment, assets, or investments relate to cash

from investing.

Financing Activities 

Cash from financing activities include the sources of cash from

investors or banks, as well as the uses of cash paid to shareholders.

Financing activities include debt issuance, equity issuance, stock

repurchases, loans, dividends paid, and repayments of debt.

The cash flow statement reconciles the income statement with the

balance sheet in three major business activities.

Real World Example of a Cash Flow Statement

Below is a portion of Exxon Mobil Corporation's (XOM) cash flow

statement as of September 30, 2018. We can see the three areas of

the cash flow statement and their results.

 Operating activities generated a positive cash flow of $27,407

for the period.

 Investing activities generated negative cash flow or cash

outflows of -$10,862 for the period. Additions to property,

plant, and equipment made up the majority of cash outflows,

which means the company invested in new fixed assets.

 Financing activities generated negative cash flow or cash

outflows of -$13,945 for the period. Reductions in short-term

debt and dividends paid out made up the majority of the cash

outflows.

Key Takeaways

 Financial statements are written records that convey the

business activities and the financial performance of a company.

 The balance sheet provides an overview of assets, liabilities,

and stockholders' equity as a snapshot in time.

 The income statement primarily focuses on a company’s

revenues and expenses during a particular period. Once

expenses are subtracted from revenues, the statement

produces a company's profit figure called net income.

 The cash flow statement (CFS) measures how well a company

generates cash to pay its debt obligations, fund its operating

expenses, and fund investments. 

Limitations of Financial Statements

Although financial statements provide a wealth of information on a

company, they do have limitations. The statements are open to

interpretation, and as a result, investors often draw vastly different

conclusions about a company's financial performance. For example,

some investors might want stock repurchases while other investors

might prefer to see that money invested in long-term assets. A

company's debt level might be fine for one investor while another

might have concerns about the level of debt for the company. When

analyzing financial statements, it's important to compare multiple

periods to determine if there are any trends as well as compare the

company's results its peers in the same industry.