Analyzing Income Statements: formula sheet

Key formulas

Basic income statement equation

Net income = Revenue − Expenses + Gains − Losses

Gains and losses are from non-ordinary activities; they may be shown net or gross on separate lines.

Gross profit

Gross profit = Revenue − Cost of goods sold

Appears only in the multi-step format (and in function-based expense presentation).

Operating profit

Operating profit = Gross profit − Operating expenses (SG&A, R&D, depreciation, etc.)

Also called EBIT in many analyses, though definitions vary when other income is included.

Profit before tax

Profit before tax = Operating profit + Non-operating income − Interest and other non-operating expenses

Non-operating items include investment income and finance costs.

Net income

Net income = Profit before tax − Income tax expense

Net income from continuing operations; discontinued operations are shown separately after tax.

Gross vs net revenue (agent)

Net revenue (agent) = Gross amount billed − Amount passed to the supplier

Net income is unchanged; only revenue and margin ratios change.

Gross profit margin

Gross margin = Gross profit ÷ Revenue

Rises when a firm moves from gross to net presentation of the same sales.

Core principle

Revenue = consideration expected × transfer of control to customer

Recognize when (or as) control of the good or service passes to the customer.

Five steps

Contract → Performance obligations → Transaction price → Allocate → Recognize

Memorize the order. Exam items often ask which step an action belongs to.

Allocation of transaction price

Allocated price(i) = Transaction price × [SSP(i) ÷ Σ SSP]

SSP is standalone selling price. Use estimates if no observable price exists.

Over-time progress (input method)

Progress % = Costs incurred to date ÷ Total expected costs

Cumulative revenue = progress % × transaction price. Period revenue = cumulative revenue − revenue already recognized.

Contract position

Revenue recognized > cash billed → contract asset; cash received > revenue recognized → contract liability

Contract liability is also called deferred or unearned revenue.

Principal vs agent

Principal: gross revenue. Agent: net fee or commission

Test is whether the entity controls the good or service before it passes to the customer.

Inventory identity

Ending inventory = Beginning inventory + Purchases − COGS

Rearrange to find COGS: COGS = Beginning inventory + Purchases − Ending inventory.

Straight-line depreciation

(Cost − Salvage value) ÷ Useful life

Same charge every year.

Declining balance depreciation

Rate × Opening carrying amount; double-declining rate = 2 ÷ Useful life

Salvage value is not subtracted before applying the rate, but the asset is not depreciated below salvage value.

Units-of-production depreciation

(Cost − Salvage value) ÷ Total expected units × Units produced in period

Use when wear follows usage.

Bad debt expense

Bad debt expense = Ending allowance − Beginning allowance + Write-offs charged against the allowance (net of recoveries), or Estimated % × Credit sales under the income statement approach

The roll-forward version holds when the allowance account is rolled forward: Beginning allowance + Expense − Write-offs = Ending allowance.

Rising-price rule

Rising prices: COGS LIFO > weighted average > FIFO; profit and ending inventory the reverse

Assumes stable or growing inventory quantities. Reverse the order when prices fall.

Net income structure

Net income = Income from continuing operations + Income (loss) from discontinued operations, net of tax

Discontinued operations are already after tax. Exclude the line when forecasting.

After-tax adjustment of a pre-tax item

After-tax amount = Pre-tax amount × (1 − tax rate)

Use this when removing an unusual or infrequent item that sits in continuing operations.

Adjusted (normalized) net income

Adjusted net income = Reported net income − After-tax gains + After-tax losses − Discontinued operations income (or + loss)

Remove gains, add back losses, and strip out discontinued operations.

Adjusted EPS

Adjusted EPS = Adjusted net income available to common ÷ Weighted average shares

Use the same share count as reported EPS unless told otherwise.

Classification rule (IFRS)

Discontinued operation = component disposed of or held for sale, and a separate major line or geographical area

Presented as a single after-tax amount; prior periods restated. Extraordinary items are not allowed under IFRS.

Basic EPS

Basic EPS = (Net income − Preferred dividends) ÷ Weighted average ordinary shares outstanding

Deduct preferred dividends declared on non-cumulative preferred, or for the period on cumulative preferred, whether or not declared.

Weighted average shares

Σ (shares outstanding × fraction of period outstanding)

Restate for splits and stock dividends as if they happened at the start of the earliest period shown.

Diluted EPS (general)

Diluted EPS = [(Net income − Preferred dividends) + Preferred dividends on convertible preferred + Convertible debt interest × (1 − t)] ÷ [Weighted average shares + Shares from conversion of preferred + Shares from conversion of debt + Net shares from options]

Include an item only if it reduces EPS.

If-converted: convertible bonds

Numerator add-back = Interest × (1 − tax rate); Denominator add = shares from conversion

Assume conversion at the start of the period or at issue date if later.

Treasury stock method

Net new shares = Options × (Average price − Exercise price) ÷ Average price

Options with an exercise price above the average market price are antidilutive and are ignored.

Common-size line item

Line item % = Line item ÷ Revenue × 100

Vertical analysis. Revenue is the base, so revenue = 100%.

Gross profit margin

Gross profit ÷ Revenue, where Gross profit = Revenue − Cost of sales

Measures profit after direct production costs only.

Operating profit margin

Operating profit (EBIT) ÷ Revenue

Operating profit = Gross profit − operating expenses. It is before interest and tax.

Pretax margin

Earnings before tax (EBT) ÷ Revenue

EBT = EBIT − interest expense. Includes the effect of financing costs.

Net profit margin

Net income ÷ Revenue

Net income is after tax. Use net income as given unless the question says to use income attributable to owners.

Change in margin

Margin change (in percentage points) = Margin year 2 − Margin year 1

Report as percentage points, not as a percentage.

Comprehensive income

Comprehensive income = Net income + Other comprehensive income

Use after-tax amounts. OCI can be negative.

Change in equity from OCI

Ending AOCI = Beginning AOCI + OCI for the period

Any reclassification to net income is already part of the period's OCI as an offset.

Total change in equity

Δ Equity = Comprehensive income + Share issues − Buybacks − Dividends

Owner transactions are excluded from comprehensive income.

Comprehensive income attributable to parent

Parent's share = Total comprehensive income − Non-controlling interest share

Both net income and OCI are split between parent and non-controlling interests.

Quick revision

• Gross profit = revenue − cost of sales; operating profit = gross profit − operating expenses.
• Revenue model steps: identify the contract, identify obligations, set the price, allocate the price, recognise revenue as obligations are satisfied.
• Under IFRS, revenue is recognised when control transfers, not when cash is received.
• In rising prices, FIFO gives lower cost of sales and higher profit than LIFO; LIFO is not allowed under IFRS.
• Weighted average cost falls between FIFO and LIFO results.
• Discontinued operations are shown separately, net of tax, below continuing operations.
• Basic EPS = (net income − preferred dividends) ÷ weighted average ordinary shares.
• Diluted EPS includes the effect of convertibles, options and warrants only when they are dilutive (reduce EPS); antidilutive securities are excluded.
• Treasury stock method: assumed proceeds from exercise buy back shares at the average market price.
• Gross margin = gross profit ÷ revenue; net margin = net income ÷ revenue.
• Common-size income statements express every line as a percentage of revenue.
• Comprehensive income = net income + other comprehensive income.

Common mistakes

• Including interest expense or non-operating gains in operating profit. Fix: Stop at operating expenses for operating profit. Treat interest and investment items as below the operating line.
• Thinking net reporting lowers net income. Fix: Net reporting removes the same amount from revenue and from cost. Net income is unchanged; only revenue and margins differ.
• Allocating the discount to only one item Fix: Allocate on relative SSP so the discount is spread across all obligations, unless the standard's specific criteria show it belongs to some of them.
• Allocating by contract list prices instead of standalone selling prices Fix: Always use SSP. Contract prices matter only if they equal SSP.
• Assuming LIFO always gives lower profit. Fix: Check price direction first. In falling prices LIFO gives higher profit than FIFO.
• Subtracting salvage value under declining balance before applying the rate. Fix: Apply the rate to opening carrying amount. Only stop when carrying amount reaches salvage value.
• Tax-effecting the discontinued operations line again. Fix: Discontinued operations are reported net of tax. Only tax-effect pre-tax items in continuing operations.
• Subtracting a loss instead of adding it back. Fix: Remove means reverse its effect. A loss lowered income, so add it back. A gain raised income, so subtract it.
• Using year-end shares instead of the weighted average. Fix: Always time-weight issues and buybacks by months outstanding divided by 12.
• Time-weighting a stock split. Fix: A split or stock dividend is applied to the whole period and prior periods. Multiply earlier share counts by the split factor and do not weight by date.

Exam tips

• Questions are three-option and standalone, so first decide the concept (format, classification or gross versus net), then eliminate. A wrong subtotal option is usually an intermediate figure from your own working.
• For gross versus net, the safe fact is that net income is identical. Any option saying otherwise is wrong.
• Watch for margin direction: net presentation raises margin ratios because revenue shrinks while profit stays the same.
• Read each line's position carefully. Items like interest, investment income or discontinued operations sit below operating profit.
• Pace at about 90 seconds per question. Subtotal arithmetic is quick, so do not spend extra time on it.
• Questions are three-option and standalone. Start by deciding whether the item tests timing, amount or analysis, then eliminate options that contradict control transfer.
• Do the allocation maths with fractions of total SSP. Check that your parts add up to the price.
• Remember that cumulative minus prior revenue gives the period figure. Wrong options often show the cumulative amount.