The income statement is a financial statement that is used to help determine the past financial performance of the enterprise, predict future performance, and assess the capability of generating future cash flows. It is also known as the profit and loss statement (P&L), statement of operations, or statement of earnings.
The income statement consists of revenues (money received from the sale of products and services, before expenses are taken out, also known as the “top line”) and expenses, along with the resulting net income or loss over a period of time due to earning activities. Net income (the “bottom line”) is the result after all revenues and expenses have been accounted for. The income statement reflects a company’s performance over a period of time. This is in contrast to the balance sheet, which represents a single moment in time.
The balance sheet contains statements of assets, liabilities, and shareholders’ equity.
Assets represent things of value that a company owns and has in its possession, or something that will be received and can be measured objectively. They are also called the resources of the business, some examples of assets include receivables, equipment, property and inventory. Assets have value because a business can use or exchange them to produce the services or products of the business.
Liabilities are the debts owed by a business to others–creditors, suppliers, tax authorities, employees, etc. They are obligations that must be paid under certain conditions and time frames. A business incurs many of its liabilities by purchasing items on credit to fund the business operations.
A company’s equity represents retained earnings and funds contributed by its owners or shareholders (capital), who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment.
The relationship of these items is expressed in the fundamental balance sheet equation:
Assets = Liabilities + Equity
The meaning of this equation is important. Generally, sales growth, whether rapid or slow, dictates a larger asset base – higher levels of inventory, receivables, and fixed assets (plant, property, and equipment). As a company’s assets grow, its liabilities and/or equity also tends to grow in order for its financial position to stay in balance. How assets are supported, or financed, by a corresponding growth in payables, debt liabilities, and equity reveals a lot about a company’s financial health.
The balance sheet of a business provides a snapshot of its financial status at a particular point in time.
A Departmental Income Statement shows each departments contribution margin and net income from operating, after all expenses are allocated for. The Departmental Income Statement shows which departments of the company are the most profitable, and which departments are costing the company money
Normally, all direct expenses are charged to the respective departments, in case of indirect or general expenses, proper allocation among the departments must be made in order to ascertain the profit and loss made by each department. Each department is charged with proper business expenses.
Internal Control can be defined as a system designed, introduced and maintained by the company’s management and top-level executives, to provide a substantial degree of assurance in achieving business objective, while complying with the policies and laws, safeguarding the assets, maintaining efficiency and effectiveness in regular operations and reliability of financial statements.
Internal audit is a function that, even though operating independently from other departments and involves reporting directly to the audit committee, remains within an organization i.e. the company’s employees. Internal audits involve performing audits of both financial and non-financial nature within a wide of areas of operation in business, including those that are directed by the annual audit plan.
Statutory audit is an audit by a practising Chartered Accountant which has its operations exterior to the organization which it is auditing. Statutory Auditors are a part of the external audit process. Statutory auditors are focused on the various financial accounts or risks associated with the domain of finance and are appointed by the shareholders of the company.
Control policies and procedures must be established and executed to help ensure that management directives are carried out. They help ensure that necessary actions are taken to address risks to achievement of the organization’s objectives. Control activities occur throughout the organization, at all levels and in all functions. They include a range of activities as diverse as approvals, authorizations, verifications, reconciliations, reviews of operating performance, security of assets and segregation of duties.
Review each cycle to determine whether existing controls are sufficient to avoid potential problems.
Identify any outside policies or procedures in place to offset potential risks.
If controls do not exist or appear ineffective, establish new controls.
Identify any controls that are excessive or unnecessary and modify or eliminate them.
Remember that a good control environment is the first step toward establishing effective controls.
Departmental Accounting refers to maintaining accounts for one or more branches or departments of the company. Revenues and expenses of the department are recorded and reported separately. The departmental accounts are then consolidated into accounts of the head office to prepare financial statements of the company
Allocation and apportionment of overheads. This is also known as departmentalization or primary distribution of overheads.
Allocation of Expenses : Allocation is the process of identification of overheads with cost centres. An expense which is directly identifiable with a specific cost centre is allocated to that centre. So it is the allotment of whole item of cost to a cost centre or cost unit or refers to the charging of expenses which can be identified wholly with a particular department. For example, the whole of overtime wages paid to the workers relating to a particular department should be charged to that department. So, the term allocation means the allotment of the whole item without division to a particular department or cost centre.
Apportionment of Expenses : Cost apportionment is the allotment of proportions of items to cost centers or cost units on an equitable basis. The term refers to the allotment of expenses which cannot identify wholly with a particular department. Such expenses require division and apportionment over two or more cost centers or units. So cost apportionment will arise in case of expenses common to more than one cost centre or unit. It is defined as the allotment to two or more cost centers of proportions of the common items of cost on the estimated basis of benefit received. Common items of overheads are rent and rates, depreciation, repairs and maintenance, lighting, works manager’s salary etc
To use the direct cost method, first divide your company’s departments into operating and support departments. Operating departments are business functions that directly work toward production. For example, a beverage company may have bottling and mixing operating departments. Support departments provide services to other departments
Direct method costing only allocates costs from support departments to production departments. This can greatly reduce the number of allocations that you have to make. For example, if your company has four support departments and two production departments, you will make eight allocation calculations using the direct costing method.
Because support center costs are only allocated to operating departments, you focus costs of supporting the business toward production. While this may not be the most accurate method of allocating costs, it has a strong theoretical basis. If not for the production departments, the support centers would not be needed
The primary disadvantage of the direct costing method is accuracy. Because support departments’ costs are not allocated to other support departments, businesses systematically over-allocate production departments’ costs and under-allocates support departments’ costs. The extent of this inaccuracy depends on the amount of resources the production departments use compared to the support departments
The departmental overhead rate will skew when each department is responsible for multiple products varying in labor and machine hours. This is likely to occur when departments are large. This also creates redundancy since each department must measure and calculate its respective rate. Departmental overhead rates assume that costs can easily be separated from one department to another.
An allocation base is the basis upon which an entity allocates its overhead costs. An allocation base takes the form of a quantity, such as machine hours used, kilowatt hours consumed, or square footage occupied. Cost allocations are mostly used to assign overhead costs to produced inventory, as required by several accounting frameworks.