10 Income Statement & Cash Flow Statement

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<ul><li><p>*Income Statement &amp;Cash Flow Statement</p><p>Prof. Dr Safdar A. Butt</p></li><li><p>*ImportanceTax authorities (direct and indirect taxes)Shareholders:DividendsReservesShare valueCreditors (Companys ability to service debts)Employees &amp; Managers (bonuses, etc.)</p></li><li><p>*Contents ofIncome StatementSegments of Income StatementTrading AccountSales, Cost of Sales, Stocks.Profit &amp; Loss AccountAll other incomes and expensesProfit &amp; Loss Appropriation AccountUse of available profits: dividend, transfer to reserves, retained earnings carried forward.</p></li><li><p>Trading AccountSales Revenue, net of returns.Opening StockPurchases, net of returnsClosing StockCost of Goods SoldGross Profit</p><p>*</p></li><li><p>*Revenues: SalesEssentially covered under Chap 8.Sales during the last few daysInvoiced but not delivered by year-endDelivered but not invoiced by year-endReturns during the first few days of the next month</p></li><li><p>Net PurchasesAlready covered in Chapter 7.Check invoices booked in the last few days of the financial year, and first few days of the next financial year.Goods received but not booked.Invoices booked but goods not received.*</p></li><li><p>StocksOpening Stock (from previous balance sheet)Closing StockGenerally not available from financial ledger.See if any separate stock records are keptPerpetual inventory &amp; Continuous stock takingYear end Physical Stock TakingValuation of closing stock</p><p>*</p></li><li><p>*Closing InventoryFinished goodsWork in ProcessSpares and suppliesRaw material</p></li><li><p>Auditor &amp; YE StocktakingStudy the procedure of stock takingAttend the exercise be observant and count a few items personally.Get completed stock sheets.Check castingsCheck Valuation SheetsCheck valuation basis and computationUsing ratios, relate the approx value to COGS.Certificate of valuation from a competent authorityCheck provisions for dead stock.</p><p>*</p></li><li><p>Stock Cut OffProcedure to ensure that only true closing stock is included as closing stockItems included in the closing stock are included in purchasesItems included in the closing stock are NOT included in the sales (awaiting delivery).If stock taking date and YE differ, re-compute the real closing stock after excluding transactions of in-between period.*</p></li><li><p>*Revenue: Other IncomesAlready covered in Chapter 9Pay particular attention to income booked during the last few days of the year, or first few days of the next year.Vouch in detail the accruals for income earned but not yet received, or provision for unearned income. </p></li><li><p>*ExpensesEssentially covered under Chapters 6 &amp; 9.However attention should be paid to accrued and prepaid expenses booked at the end of the year as these are often used to manipulate profit figures.The main test, from the Income Statement point of view, is reasonableness of each expense in light of historical and other records.</p></li><li><p>*Cut Off TestEnsure that only the income earned in the year has been booked.Ensure that all the income earned in the year has been booked.Ensure that only the expenses incurred in the year are debited to P&amp;L Account.Ensure that all the expenses incurred in the year are debited to P&amp;L Account.</p></li><li><p>*Appropriation of ProfitsUn-appropriated profit brought forwardWrite off of intangible assetsTransfers to or from ReservesProposed DividendsUn-appropriated profit carried forward</p></li><li><p>*Authority to appropriate profitOnly shareholders can appropriate profit; directors can only recommend a plan to shareholders.Technically, Profit and Loss Appropriation Account is finalized only after Annual General Body Meeting of shareholders.</p></li><li><p>*Write Off of Intangible AssetsWrite off of Goodwill, preliminary expenses and such other intangible assets does not relate to any particular years operations; hence it is debited not to income statement, but to Profit and Loss Appropriation Account.The auditor should check in detail the journal vouchers for these write offs, in particular the authority which is generally in the form of Board Resolution.Cross check to balances in Balance Sheet</p></li><li><p>*Transfers to and from ReservesCheck the authority, i.e. resolution of Board of Directors.Reasonableness of amounts transferred.Legal requirements relating to transfersScrutinize in detail transfer out of reserves back into P&amp;L Appropriation AccountCross check to balances shown in the Balance Sheet</p></li><li><p>*Proposed DividendsCheck the authority, i.e. the resolution of Board of Directors.Reasonableness of amount declared as dividendCross check to current liabilities in Balacne Sheet.</p></li><li><p>*Interim DividendDeclared and paid during the year.Check authorityCheck actual paymentCash Book / bank statementCheck treatment of unclaimed dividends</p></li><li><p>*Legal RequirementsStudy all relevant laws before auditing the Income Statement, e.g.Dividend can only be declared out of available profits.Capital reserves cannot be used for paying dividends.Certain reserves have to be created and maintained at certain levels by law.</p></li><li><p>*Relation to Balance SheetOpening balance on P&amp;LA Account comes from last years balance sheetMovement in reserves is reflected in both P&amp;L Account and balance sheet.Proposed dividends are shown as current liability in the balance sheet.Closing balance is shown in year-end balance sheet.</p></li><li><p>Cash Flow StatementAll entries come from Income Statement or through computing differences in opening and closing balance sheet figures.Auditor should re-draw the Cash Flow Statement effectively, i.e. checking off each item of the CFS.Arithmetical check of CFS.Reasonableness of each entry.*</p></li><li><p>*Thank you</p><p>Dr Safdar A Butt</p></li></ul>

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