The income statement presents information on the financial results of a company’s business activities over a period of time. The income statement communicates how much revenue and other income the company generated during a period and the expenses it incurred to generate that revenue and other income. Revenue typically refers to amounts charged for the delivery of goods or services in the ordinary activities of a business. Other income includes gains, which may or may not arise in the ordinary activities of the business. Expenses reflect outflows, depletions of assets, and incurrences of liabilities that decrease equity. Expenses typically include such items as cost of sales (cost of goods sold), administrative expenses, and income tax expenses and may be defined to include losses. Net income (revenue plus other income minus expenses) on the income statement is often referred to as the “bottom line” because of its proximity to the bottom of the income statement. Net income may also be referred to as “net earnings,” “net profit,” and “profit or loss.” In the event that expenses exceed revenues and other income, the result is referred to as “net loss.”
Income statements are reported on a consolidated basis, meaning that they include the income and expenses of subsidiary companies under the control of the parent (reporting) company. The income statement is sometimes referred to as a statement of operations or profit and loss (P&L) statement. The basic equation underlying the income statement is Revenue + Other income – Expenses = Income – Expenses = Net income.
In general terms, when one company (the parent) controls another company (the subsidiary), the parent presents its own financial statement information consolidated with that of the subsidiary. (When a parent company owns more than 50 percent of the voting shares of a subsidiary company, it is presumed to control the subsidiary and thus presents consolidated financial statements.) Each line item of the consolidated income statement includes the entire amount from the relevant line item on the subsidiary’s income statement (after removing any intercompany transactions); however, if the parent does not own 100 percent of the subsidiary, it is necessary for the parent to present an allocation of net income to the minority interests. Minority interests, also called non-controlling interests, refer to owners of the remaining shares of the subsidiary that are not owned by the parent. The share of consolidated net income attributable to minority interests is shown at the bottom of the income statement along with the net income attributable to shareholders of the parent company. Exhibit 5 presents the income statement of the Volkswagen Group from its Annual Report 2009.Exhibit 5. Income Statement of the Volkswagen Group for the Period 1 January to 31 December*
|Cost of sales||2||–91,608||–96,612|
|Other operating income||5||7,904||8,770|
|Other operating expenses||6||–6,352||–6,339|
|Share of profits and losses of equity-accounted investments||7||701||910|
|Other financial result||9||972||1,180|
|Profit before tax||1,261||6,608|
|Income tax income/expense||10||–349||–1,920|
|Profit after tax||911||4,688|
|Profit attributable to shareholders of Volkswagen AG||960||4,753|
|Basic earnings per ordinary share in €||11||2.38||11.92|
|Basic earnings per preferred share in €||11||2.44||11.98|
|Diluted earnings per ordinary share in €||11||2.38||11.88|
|Diluted earnings per preferred share in €||11||2.44||11.94|
*The numbers are as shown in the annual report and may not add because of rounding.
Exhibit 5 shows that Volkswagen’s sales revenue for the fiscal year ended 31 December 2009 was €105,187 million. Subtracting cost of sales from revenue gives gross profit of €13,579 million. After subtracting operating costs and expenses and adding other operating income, the company’s operating profit totals €1,855 million. Operating profit represents the results of the company’s usual business activities before deducting interest expense or taxes. Operating profit (also called operating income) is thus often referred to as earnings before interest and taxes (EBIT). Next, operating profit is increased by Volkswagen’s share of the profits generated by certain of its investments (€701 million) and by profits from its other financial activities (€972 million) and decreased by finance costs (i.e., interest expense) of €2,268 million, resulting in profit before tax of €1,261 million. Total income tax expense for 2009 was €349 million, resulting in profit after tax (net income) of €911 million.
After allocating the losses attributable to minority interest ownership in Volkswagen subsidiary companies, the profit attributable to shareholders of Volkswagen for 2009 was €960 million. Allocating the losses attributable to minority interest ownership resulted in the allocation to shareholders of the parent company, Volkswagen AG, exceeding net income (profit after tax). Volkswagen’s disclosures indicate that its minority interests relate primarily to Scania AB, a subsidiary in which Volkswagen owns about 72 percent of the voting rights (with the minority interests owning the remaining 28 percent).
Companies present both basic and diluted earnings per share on the face of the income statement. Earnings per share numbers represent net income attributable to the class of shareholders divided by the relevant number of shares of stock outstanding during the period. Basic earnings per share is calculated using the weighted-average number of common (ordinary) shares that were actually outstanding during the period and the profit or loss attributable to the common shareowners. Diluted earnings per share uses diluted shares—the number of shares that would hypothetically be outstanding if potentially dilutive claims on common shares (e.g., stock options or convertible bonds) were exercised or converted by their holders—and an appropriately adjusted profit or loss attributable to the common shareowners.
Volkswagen has two types of shareholders, ordinary and preferred, and presents earnings per share information for both, although there is no requirement to present earnings per share information for preferred shareowners. Volkswagen’s basic earnings per ordinary share was €2.38. A note to the company’s financial statements explains that this number was calculated as follows: €960 million profit attributable to shareholders of Volkswagen, of which €703 million is attributable to ordinary shareholders and €257 million is attributable to preferred shareholders. The €703 million attributable to ordinary shareholders divided by the weighted-average number of ordinary shares of 295 million shares equals basic earnings per share for 2009 of €2.38. Similar detail is provided in the notes for each of the earnings per share numbers.
An analyst examining the income statement might note that Volkswagen was profitable in both years. The company’s profitability declined substantially in 2009, primarily because of lower sales and reduced gross profit. This was not unexpected given the global financial and economic crisis in that year. A better understanding of Volkswagen’s profitability could likely be gained by examining income statements over a longer time period. The analyst might formulate questions related to profitability, such as the following:
Is the change in revenue related to an increase in units sold, an increase in prices, or some combination?
If the company has multiple business segments (for example, Volkswagen’s segments include passenger cars, light commercial vehicles, and financial services, among others), how are the segments’ revenue and profits changing?
How does the company compare with other companies in the industry?
Answering such questions requires the analyst to gather, analyze, and interpret information from a number of sources, including, but not limited to, the income statement.
Comprehensive income includes all items that impact owners’ equity but are not the result of transactions with shareowners. Some of these items are included in the calculation of net income, and some are included in other comprehensive income (OCI). Under IFRS, when comprehensive income is presented in two statements, the statement of comprehensive income begins with the profit or loss from the income statement and then presents the components of other comprehensive income. Although US generally accepted accounting principles (US GAAP) indicate a preference for this type of presentation when a single statement of comprehensive income is not presented, they permit companies to present the components of other comprehensive income in the statement of changes in equity.5
Exhibit 6 presents the statement of comprehensive income of the Volkswagen Group from its Annual Report 2009.Exhibit 6. Statement of Comprehensive Income of the Volkswagen Group for the Period 1 January to 31 December
|Profit after tax||911||4,688|
|Exchange differences on translating foreign operations:|
|Fair value changes recognized in other comprehensive income||917||–1,445|
|Transferred to profit or loss||57|
|Cash flow hedges:|
|Fair value changes recognized in other comprehensive income||683||1,054|
|Transferred to profit or loss||–908||–1,427|
|Available-for-sale financial assets (marketable securities):|
|Fair value changes recognized in other comprehensive income||200||–330|
|Transferred to profit or loss||71||100|
|Share of profits and losses of equity-accounted investments recognized directly in equity, after tax||30||–188|
|Other comprehensive income||406||–1,901|
|Total comprehensive income||1,317||2,787|
|Of which attributable to|
|Shareholders of Volkswagen AG||1,138||3,310|
Exhibit 6 shows that other comprehensive income, although smaller in absolute terms than profit after tax (net income), had a significant effect on total comprehensive income. In 2009, other comprehensive income represented approximately 31 percent of total comprehensive income and was approximately 45 percent of the size of profit after tax (net income). In 2008, other comprehensive income was negative (a loss) and was approximately 41 percent of the size of profit after tax (net income) in absolute terms. The statement of comprehensive income will be discussed in greater detail in a later reading. The next section briefly describes the statement of changes in equity.