The net income is a calculation to help determine the viability of a company. Th

Question

The net income is a calculation to help determine the viability of a company. The revenue from any source, minus expenses, equals the net income. This initially seems simple, but when analyzing the net income, you should factor in timeliness and match up expenses with the income derived. Answer the following questions related to presentation of information in an income statement: Why caution must be exercised when using the net income figure derived in an income statement for analysis? What are the objectives of generally accepted accounting principles in their application to the income statement? Can the income numbers be overstated or understated?

Explanation / Answer

Income statement reveales the profitability of the company. The investors needs to know the financial status of the company. Companies rely on the rules frameed in GAAP. A standard reporting is to understand the direct comparision between two companies.

While reporting net income under the GAAP, the company should follow the principles of GAAP as the financial reports are based on the principles of GAAP.

The obectives of reporting of income statement:

1] Separate Entity: The company is considered as separate entity apart from its owner, creditors and others.

2] Money Measurement Concept: The transactions are reported in money measurement. If the transactions are not expressed in monetary value, how ever important they are they are not recored in the accounts.

3] Dual Aspect Concept: For every debit the is a corresponding credit. This is also known as ' Double enrty Principle' . For example, a business started with 10,000 it can be stated as

Capital (10,000)= Cash (10,000)

4] Going Concern Concept : It is assumed that the business will exist for a long time. the transactions are recored form this point of view. The expenses spend will render the benefit for a long period and it will be within the year. The concerned entity will exist only for a limited time, the accounting record will be kept accordingly.

5] Dual Accept Concept: Each transaction has two aspects, if a business has acquired an asset

i] some other asset has been given up (Cash paid to acquired an asset)

ii] the obligation to pay ( the asset acquired on credit basis)

iii] the owner contributed money for acquisition of the asset. At any time

Assets = Liabilities + Capital or

Capital = Assets - Liabilities

This is called the Accounting Equation

6] Realisation Concept : Accounting is a historical record of transactions, it records what has happened. Stopping the companies from inflating the profits by recording sales and incomes they are likely to accrue. No sale can be said to have taken place and no profit or income can be said to have arisen.

7] Accrual Concept : All the transactions are settled in cash but even if cash sttlement has not taken place. Income or profit arises only out of business operations. Profits results only when the total of revenues exceeds the total expenses or losses.

Profit = Revenues - Expenses

The income can not be overstated or understated. As it result in the wrong assumption of the financial status of the company. The transactions should be recored in such a manner as to reflect the true legal position. It is necessary to keep the accounts in such a manner as to permit results being ascertaind and presented for each financial period usually a year. Even though the business will continue for a long time.   

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