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Income Statement &Income Statement &Cash Flow StatementCash Flow Statement

Prof. Dr Safdar A. ButtProf. Dr Safdar A. Butt

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ImportanceImportance Tax authorities (direct and indirect taxes)Tax authorities (direct and indirect taxes) Shareholders:Shareholders:

DividendsDividends ReservesReserves Share valueShare value

Creditors (Company’s ability to service debts)Creditors (Company’s ability to service debts) Employees & Managers (bonuses, etc.)Employees & Managers (bonuses, etc.)

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Contents ofContents ofIncome StatementIncome Statement

Segments of Income StatementSegments of Income Statement Trading AccountTrading Account

Sales, Cost of Sales, Stocks.Sales, Cost of Sales, Stocks. Profit & Loss AccountProfit & Loss Account

All other incomes and expensesAll other incomes and expenses Profit & Loss Appropriation AccountProfit & Loss Appropriation Account

Use of available profits: dividend, transfer to Use of available profits: dividend, transfer to reserves, retained earnings carried forward.reserves, retained earnings carried forward.

Trading AccountTrading Account Sales Revenue, net of returns.Sales Revenue, net of returns. Opening StockOpening Stock Purchases, net of returnsPurchases, net of returns Closing StockClosing Stock Cost of Goods SoldCost of Goods Sold Gross ProfitGross Profit

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Revenues: SalesRevenues: Sales Essentially covered under Chap 8.Essentially covered under Chap 8. Sales during the last few daysSales during the last few days

Invoiced but not delivered by year-endInvoiced but not delivered by year-end Delivered but not invoiced by year-endDelivered but not invoiced by year-end

Returns during the first few days of the next Returns during the first few days of the next monthmonth

Net PurchasesNet Purchases Already covered in Chapter 7.Already covered in Chapter 7. Check invoices booked in the last few days of Check invoices booked in the last few days of

the financial year, and first few days of the the financial year, and first few days of the next financial year.next financial year.

Goods received but not booked.Goods received but not booked. Invoices booked but goods not received.Invoices booked but goods not received.

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StocksStocks Opening Stock (from previous balance sheet)Opening Stock (from previous balance sheet) Closing StockClosing Stock

Generally not available from financial ledger.Generally not available from financial ledger. See if any separate stock records are keptSee if any separate stock records are kept Perpetual inventory & Continuous stock takingPerpetual inventory & Continuous stock taking Year end Physical Stock TakingYear end Physical Stock Taking Valuation of closing stockValuation of closing stock

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Closing InventoryClosing Inventory Finished goodsFinished goods Work in ProcessWork in Process Spares and suppliesSpares and supplies Raw materialRaw material

Auditor & YE StocktakingAuditor & YE Stocktaking Study the procedure of stock takingStudy the procedure of stock taking Attend the exercise be observant and count a few items Attend the exercise be observant and count a few items

personally.personally. Get completed stock sheets.Get completed stock sheets.

Check castingsCheck castings Check Valuation SheetsCheck Valuation Sheets

Check valuation basis and computationCheck valuation basis and computation Using ratios, relate the approx value to COGS.Using ratios, relate the approx value to COGS. Certificate of valuation from a competent authorityCertificate of valuation from a competent authority Check provisions for dead stock.Check provisions for dead stock.

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Stock Cut OffStock Cut Off Procedure to ensure that only true closing stock is Procedure to ensure that only true closing stock is

included as closing stockincluded as closing stock Items included in the closing stock are included in Items included in the closing stock are included in

purchasespurchases Items included in the closing stock are NOT included Items included in the closing stock are NOT included

in the sales (awaiting delivery).in the sales (awaiting delivery). If stock taking date and YE differ, re-compute the If stock taking date and YE differ, re-compute the

real closing stock after excluding transactions of in-real closing stock after excluding transactions of in-between period.between period.

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Revenue: Other IncomesRevenue: Other Incomes Already covered in Chapter 9Already covered in Chapter 9 Pay particular attention to income booked Pay particular attention to income booked

during the last few days of the year, or first during the last few days of the year, or first few days of the next year.few days of the next year.

Vouch in detail the accruals for income earned Vouch in detail the accruals for income earned but not yet received, or provision for unearned but not yet received, or provision for unearned income. income.

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ExpensesExpenses Essentially covered under Chapters 6 & 9.Essentially covered under Chapters 6 & 9. However attention should be paid to accrued However attention should be paid to accrued

and prepaid expenses booked at the end of the and prepaid expenses booked at the end of the year as these are often used to manipulate year as these are often used to manipulate profit figures.profit figures.

The main test, from the Income Statement The main test, from the Income Statement point of view, is reasonableness of each point of view, is reasonableness of each expense in light of historical and other records.expense in light of historical and other records.

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Cut Off TestCut Off Test Ensure that only the income earned in the year Ensure that only the income earned in the year

has been booked.has been booked. Ensure that all the income earned in the year Ensure that all the income earned in the year

has been booked.has been booked. Ensure that only the expenses incurred in the Ensure that only the expenses incurred in the

year are debited to P&L Account.year are debited to P&L Account. Ensure that all the expenses incurred in the Ensure that all the expenses incurred in the

year are debited to P&L Account.year are debited to P&L Account.

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Appropriation of ProfitsAppropriation of Profits Un-appropriated profit brought forwardUn-appropriated profit brought forward Write off of intangible assetsWrite off of intangible assets Transfers to or from ReservesTransfers to or from Reserves Proposed DividendsProposed Dividends Un-appropriated profit carried forwardUn-appropriated profit carried forward

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Authority to appropriate profitAuthority to appropriate profit Only shareholders can appropriate profit; Only shareholders can appropriate profit;

directors can only recommend a plan to directors can only recommend a plan to shareholders.shareholders.

Technically, Profit and Loss Appropriation Technically, Profit and Loss Appropriation Account is finalized only after Annual General Account is finalized only after Annual General Body Meeting of shareholders.Body Meeting of shareholders.

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Write Off of Intangible AssetsWrite Off of Intangible Assets Write off of Goodwill, preliminary expenses and such Write off of Goodwill, preliminary expenses and such

other intangible assets does not relate to any other intangible assets does not relate to any particular year’s operations; hence it is debited not to particular year’s operations; hence it is debited not to income statement, but to Profit and Loss income statement, but to Profit and Loss Appropriation Account.Appropriation Account.

The auditor should check in detail the journal The auditor should check in detail the journal vouchers for these write offs, in particular the vouchers for these write offs, in particular the authority which is generally in the form of Board authority which is generally in the form of Board Resolution.Resolution.

Cross check to balances in Balance SheetCross check to balances in Balance Sheet

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Transfers to and from ReservesTransfers to and from Reserves Check the authority, i.e. resolution of Board of Check the authority, i.e. resolution of Board of

Directors.Directors. Reasonableness of amounts transferred.Reasonableness of amounts transferred. Legal requirements relating to transfersLegal requirements relating to transfers Scrutinize in detail transfer out of reserves Scrutinize in detail transfer out of reserves

back into P&L Appropriation Accountback into P&L Appropriation Account Cross check to balances shown in the Balance Cross check to balances shown in the Balance

SheetSheet

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Proposed DividendsProposed Dividends Check the authority, i.e. the resolution of Check the authority, i.e. the resolution of

Board of Directors.Board of Directors. Reasonableness of amount declared as Reasonableness of amount declared as

dividenddividend Cross check to current liabilities in Balacne Cross check to current liabilities in Balacne

Sheet.Sheet.

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Interim DividendInterim Dividend Declared and paid during the year.Declared and paid during the year. Check authorityCheck authority Check actual paymentCheck actual payment

Cash Book / bank statementCash Book / bank statement Check treatment of unclaimed dividendsCheck treatment of unclaimed dividends

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Legal RequirementsLegal Requirements Study all relevant laws before auditing the Study all relevant laws before auditing the

Income Statement, e.g.Income Statement, e.g. Dividend can only be declared out of available Dividend can only be declared out of available

profits.profits. Capital reserves cannot be used for paying Capital reserves cannot be used for paying

dividends.dividends. Certain reserves have to be created and Certain reserves have to be created and

maintained at certain levels by law.maintained at certain levels by law.

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Relation to Balance SheetRelation to Balance Sheet Opening balance on P&LA Account comes Opening balance on P&LA Account comes

from last year’s balance sheetfrom last year’s balance sheet Movement in reserves is reflected in both P&L Movement in reserves is reflected in both P&L

Account and balance sheet.Account and balance sheet. Proposed dividends are shown as current Proposed dividends are shown as current

liability in the balance sheet.liability in the balance sheet. Closing balance is shown in year-end balance Closing balance is shown in year-end balance

sheet.sheet.

Cash Flow StatementCash Flow Statement All entries come from Income Statement or All entries come from Income Statement or

through computing differences in opening and through computing differences in opening and closing balance sheet figures.closing balance sheet figures.

Auditor should re-draw the Cash Flow Auditor should re-draw the Cash Flow Statement effectively, i.e. checking off each Statement effectively, i.e. checking off each item of the CFS.item of the CFS.

Arithmetical check of CFS.Arithmetical check of CFS. Reasonableness of each entry.Reasonableness of each entry.

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Thank youThank you

Dr Safdar A ButtDr Safdar A Butt