BY - KRISH LOHANA
WHAT IS A VERTICAL INCOME STATEMENT?
• In very simple terms, a Vertical Income Statement is a
combination of Manufacturing Account, Trading Account and
Profit & Loss Account. It helps in analysing the performance of
the company i.e., it helps to get the financial position of the
company. Vertical Income Statements are prepared to ascertain
Working Capital, Net Profit Before Tax, Net Profit After Tax,
etc. which is not possible in a Horizontal Statement. A Vertical
Income Statement also helps to easily present the data in front
of Higher Authorities which is not possible in Horizontal
Statements.
WHY IS A VERTICAL INCOME STATEMENT
PREPARED?
• It tracks the Income and Expenses of a Company over a certain
period of time to ascertain the Profit or Loss of that particular
period.
• Vertical Income Statements typically categorizes the Income
and Expenses broadly to make it easier to understand the
financial statements of the firm.
IMPORTANT DEFINITIONS RELATED TO
VERTICAL INCOME STATEMENT
1. OPERATING EXPENSES - These are the expenses which a
business incurs repeatedly in its normal course of business. They
are also known as Revenue Expenditures. For Example - Rent,
Equipments, Discount Allowed, etc. They are further subdivided
into three parts which are Administrative Expenses, Finance
Expenses, Selling and Distribution Expenses.
a. Administrative Expenses- The expenses which are related to the
organisation as a whole are Administrative Expenses. For
example- Depreciation on Furniture, Rent, Salaries to employees,
etc.
b. Finance expenses - These are costs incurred from borrowing or
earning income from financial investments. They are expenses outside
the company's core business. Examples include bank charges, interest
on money borrowed, loan origination fees , etc.
c. Selling & Distribution Expenses - Selling expenses are those
expenses which are incurred to promote sales and service to
customers. Distribution expenses, on the other hand, are those which
are incurred for warehousing and storage, packing for goods sent and
making the goods available for delivery to customers. Ex- Salesman
salary, Advertising and Publicity, etc.
2. NON-OPERATING EXPENSES - These are also known as Capital
Expenses. These are the expenses which are Incurred once in a while
during the course of business. For Example- If a company sells a
building, and it is not in the business of buying and selling real estate,
the sale of the building is a non-operating activity. If the building sold at
a loss, the loss is considered a non-operating expense.
3. OPERATING INCOME- The Income which is repetitive in regular
course of business is called as Operating Income. It is also called as
Recurring or Revenue Income. Examples are- Rent Received, Interest
Received, Commission Received, etc.
4. NON- OPERATING INCOME - The income which are received
once in a while in the ordinary course of business are non- operating
incomes. For example- Interest Incomes.
5. RETAINED EARNINGS/ RETAINED PROFITS
The retained earnings of a corporation is the accumulated net income
of the corporation that is retained by the corporation at a particular
point of time, such as at the end of the reporting period. In simple
terms, Retained Earnings (RE) is the amount of net income left over
for the business after it has paid out dividends to its shareholders.
ACCOUNTING EQUATIONS FOR A VERTICAL INCOME STATEMENT
The Accounting Equations with which Vertical Income Statement
becomes more easier to understand are as follows:1. Net Sales = Gross Sales - Sales Return
2. Cost Of Goods Sold (COGS) = Opening Stock of Material +
Purchases + Carriage/Freight + Octroi + Import Duty - Closing
Stock of Material + Cost of Materials Consumed + Opening
Stock of Finished Goods - Closing Stock of Finished Goods.
3. Cost of Materials Consumed = Direct Wages + Direct Expenses
+ Factory Expenses + Factory Power + Factory Salary + Factory
Rent and Taxes + Depreciation on machinery, factory, etc +
Building patterns , Patents, etc + Opening Work-in-progress Closing Work-in-progress - Sale of Factory Scrap.
4. Overall Cost Of Goods Sold = Manufacturing Expenses +
Direct Factory Expenses
5. Gross Profit = Net Sales - Overall Cost Of Goods Sold
6. Operating Expenses = Administration/Office Expenses +
Selling And Distribution Expenses + Finance Expenses
7. Net Operating Profit Before Interest = Gross Profit/Gross
Margin - Operating Expenses
8. Important Note - Normal Bad Debts are included in Selling &
Distribution Expenses and Abnormal Bad Debts are to be
included in Finance Expenses. We have to write note in every
question stating the type of bad debt and under which head it will
go.
9. Net (Operating) Profit After Interest = Net Operating Profit
Before Interest - Interest Paid / Finance Cost (Dr. side of P&L
A/c).
10. Net Profit Before Tax = Net Profit After Interest + NonOperating Income [Dividend on Shares , Interest on Debentures,
Loans, Profit on Sale of Investment (Credit side of Profit & Loss
Account)] - Non-Operating Expenses [Loss on sale of fixed assets,
investments, Compensation Paid, Penalty Paid, Fictitious Assets
Written Off]
11. Net Profit After Tax = Net Profit Before Tax - Tax
12. Retained Profits/ Retained Earnings = Net Profit After Tax +
Profit And Loss Account Balance b/d - Appropriations (General
Reserve, Reserves and surplus, etc)
With these equations, you will very easily be able to make
vertical income statement .
In the next slide, there is format of Vertical Income Statement
which you can go through and these equations will help in easy
understanding of the format.
After the format, I have also shown a basic solved question
depicting the vertical income statement.
OCTOBER 2008 UNIVERSITY QUESTION (SOLVED)