Income Statement (P&L)

The income statement (statement of income, statement of operations, or profit and loss statement) reports the financial performance of an entity over a defined period. It presents revenues, expenses, gains, and losses, and arrives at net income or net loss for the period. Under Accounting Standards for Private Enterprises (ASPE), the income statement is governed principally by Section 1520 Income Statement and Section 3400 Revenue.

PURPOSE AND USERS

• Owners and shareholders: assessment of profitability, return on investment, and capacity to pay distributions.

• Lenders: evaluation of the ability to service debt, frequently measured through interest coverage and debt service coverage covenants.

• Management: performance measurement against budget and prior periods, and cost control.

• Tax authorities: the income statement is the starting point for the computation of net income for tax purposes.

FORMATS OF PRESENTATION

Single-step format

All revenues and gains are grouped together, all expenses and losses are grouped together, and net income is determined in a single subtraction. The format is simple and is commonly used by service entities and small owner-managed businesses.

Multi-step format

Revenues and expenses are separated into operating and non-operating categories, and intermediate subtotals are presented. The standard sequence is:

1. Sales revenue, less sales returns and allowances and sales discounts, equals net sales.

2. Net sales less cost of goods sold equals gross profit (gross margin).

3. Gross profit less operating expenses (selling expenses and general and administrative expenses) equals operating income.

4. Operating income plus other revenues and gains, less other expenses and losses (including interest expense), equals income before income taxes.

5. Income before income taxes less income tax expense (corporations only) equals net income.

Classification of expenses

Expenses may be classified by function (cost of sales, selling, administrative) or by nature (salaries, rent, amortisation, utilities). ASPE does not prescribe one method, but requires separate disclosure of certain items, including amortisation, interest expense, income taxes, government assistance, and any unusual items, where material.

REVENUE RECOGNITION (ASPE SECTION 3400)

Revenue is recognised when it is earned and collection is reasonably assured. Specifically:

• Sale of goods: revenue is recognised when the seller has transferred the significant risks and rewards of ownership to the buyer, retains no continuing managerial involvement or effective control, the consideration is measurable, and collection is reasonably assured.

• Rendering of services and long-term contracts: revenue is recognised as the service is performed, using either the percentage-of-completion method or the completed-contract method, whichever better relates revenue to the work accomplished.

• Interest, royalties, and dividends: interest is recognised on a time-proportion basis; royalties as they accrue under the terms of the agreement; and dividends when the right to receive payment is established.

• Amounts collected on behalf of third parties, such as GST/HST, are excluded from revenue and recorded as liabilities.

Publicly accountable enterprises reporting under IFRS apply IFRS 15 Revenue from Contracts with Customers, which uses a five-step model: identify the contract; identify the performance obligations; determine the transaction price; allocate the transaction price to the performance obligations; and recognise revenue when (or as) each performance obligation is satisfied.

COST OF GOODS SOLD

Cost of goods sold represents the cost of inventory sold during the period. Under a periodic inventory system it is determined by the following formula:

• Opening inventory + Purchases (net of returns, allowances, and discounts) + Freight-in = Cost of goods available for sale.

• Cost of goods available for sale − Closing inventory = Cost of goods sold.

Under a perpetual system, cost of goods sold is recorded at the time of each sale. Inventory is measured at the lower of cost and net realisable value (ASPE Section 3031), using specific identification for items that are not ordinarily interchangeable, and otherwise first-in, first-out (FIFO) or weighted average cost. The last-in, first-out (LIFO) method is not permitted under ASPE or IFRS, nor for Canadian income tax purposes.

THE MATCHING PRINCIPLE AND ACCRUAL ACCOUNTING

Expenses are recognised in the same period as the revenues they help to generate. Costs that cannot be directly associated with revenue are recognised either in the period incurred (period costs, such as administrative salaries) or through systematic allocation over the periods expected to benefit (such as amortisation of capital assets). Accrual-basis measurement is required under ASPE and IFRS, and for income tax purposes for businesses, with limited exceptions for farming and fishing businesses, which may elect the cash method.

PERFORMANCE RATIOS

• Gross profit margin = Gross profit ÷ Net sales.

• Operating margin = Operating income ÷ Net sales.

• Net profit margin = Net income ÷ Net sales.

• Expense ratio = Specific expense ÷ Net sales, used to monitor individual cost categories over time.

• Interest coverage (times interest earned) = Earnings before interest and taxes ÷ Interest expense.

• EBITDA = Net income + Interest + Income taxes + Amortisation; a non-GAAP measure commonly used in lending and valuation.

• Return on equity = Net income ÷ Average equity. Return on assets = Net income ÷ Average total assets.

ACCOUNTING INCOME AND TAXABLE INCOME

Net income determined under ASPE is not the same as net income for tax purposes. The Income Tax Act requires that accounting income be adjusted for permanent and timing differences. The principal adjustments are:

• Amortisation is added back and replaced with capital cost allowance (CCA) claimed under the Income Tax Regulations, Schedule II classes.

• Fifty per cent of meals and entertainment expenses is added back (subsection 67.1(1)).

• Non-deductible items are added back, including fines and penalties imposed by law, interest and penalties on late tax payments, club membership dues, and income tax expense.

• Reserves and accruals not deductible until paid or realised are adjusted, such as accrued bonuses unpaid more than 179 days after year-end.

• Non-taxable or partially taxable items are deducted, including the non-taxable 50% of capital gains and taxable dividends received by a corporation from other Canadian corporations (section 112).

Reporting forms

• Sole proprietors and members of partnerships: Form T2125, Statement of Business or Professional Activities, filed with the T1 return; partnerships required to file also report on Form T5013.

• Corporations: GIFI Schedule 125 (Income Statement Information) presents the accounting income statement, and Schedule 1 (Net Income (Loss) for Income Tax Purposes) reconciles accounting income to net income for tax purposes. Schedule 8 supports the CCA claim.

SOURCES

• CPA Canada Handbook, Accounting, Part II (ASPE): Section 1520 Income Statement; Section 3400 Revenue; Section 3031 Inventories.

• IFRS 15 Revenue from Contracts with Customers.

• Canada Revenue Agency, Guide T4002 Self-employed Business, Professional, Commission, Farming, and Fishing Income.

• Canada Revenue Agency, T2 Corporation Income Tax Guide (T4012).

• Income Tax Act, ss. 9, 18, 20, 67.1, 78, 112.