The structure of the Income Statement (DRE)

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The Income Statement (DRE) is a fundamental analysis tool that provides financial information about the financial health and operational performance of a company. It is an accounting representation of revenue, costs, expenses and net income over a period of time.

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In managing the scarce resources available in the company, management may or may not be efficient. The success of this management will be measured by comparing the result for the period (obtained from the Income Statement) with the amount applied to Assets and/or with the capital invested by the owners (Equity).

The result for the period may show a profit or loss.

Profit / loss is a very broad terminology. We will find several types of profit in the Income Statement. They are:

1. Gross operating profit, or simply, Gross Profit

2. Net operating profit, or simply, Operating Profit

3. Profit Before Income Tax

4. Profit After Income Tax

5. Net profit

Let's take a deeper look at the structure of the Income Statement and comment on each topic:

Income Statement Structure
Income Statement Structure

Gross Revenue

Gross Revenue consists of the sale of products and by-products (in industry), goods (in commerce), and service provision (service provider company), including all taxes charged to the buyer and not excluding returns of goods (or products) and allowances granted for goods (or services) that do not match the order.

Deductions from Gross Revenue

Allowances and Returns

The objective of reporting aspects such as returns or allowances, etc. in Gross Revenue is that the external user of the Financial Statements will have access to this data (in the deductions item), which, without a doubt, are valuable indicators of the efficiency of the production and sales departments.

We will not only assess whether the amount of returns and allowances is high, but also its percentage evolution over time.

Taxes on Gross Revenue

Regarding taxes, in many cases, the selling company or service provider is merely a depositary of the taxes charged to the buyer. After the deadline has passed, it will pay them to the government. The main taxes on sales are:

  • IPI (Tax on Industrialized Products).
  • ICMS (Tax on Circulation of Goods and Services).
  • ISS (Service Tax)
  • Export Tax
  • Social Integration Program (PIS)
  • Cofins

Allowances and Deductions

By deductions, we should understand adjustments to Gross Revenue itself:

Canceled Sales (Return)

These are goods that do not match the order (price, quality, damage, etc...) whose buyer, feeling harmed, makes a partial or total return of the goods.

This occurs after the sale (after the invoice is issued).

Allowances

Often, in a situation where there will be a return, the seller proposes an allowance in the price to compensate the buyer for the loss.

This occurs after the sale (after the invoice is issued).

And commercial discounts?

Commercial discounts (such as offering a 10% cash discount) occur before the sale and before the invoice is issued. It is more appropriate for invoices to show the price already with the discount.

Net Revenue

It is the difference between Gross Revenue and the deductions from Gross Revenue discussed above:

\[ \text{Net Revenue} = \text{Sales + Services Rendered - Allowances - Taxes} \]

Gross Profit

It is the difference between the Sale of Goods and the Cost of these Goods Sold, without considering administrative, sales, or financial expenses.

In short, we subtract from Net Revenue how much the goods, product, or service cost to be made available to the consumer, disregarding administrative, financial, and sales expenses.

Deductions from Gross Profit

After Gross Profit, Operating Expenses are removed.

Operating expenses are those necessary to sell products, administer the company, and finance operations. In short, they are all expenses that contribute to maintaining the company's operating activity.

Sales Expenses

They range from the promotion of the product to its delivery to the consumer (marketing and distribution).

These are expenses with sales department personnel, sales commissions, advertising, publicity, estimated losses on trade notes receivable arising from installment sales (allowance for doubtful accounts), etc.

Administrative Expenses

These are necessary to administer the company. Generally speaking, they are office expenses aimed at directing or managing the company.

Examples include: administrative fees, salaries and social charges of administrative personnel, office rent, office supplies, office insurance, depreciation of furniture and fixtures, newspaper subscriptions, etc.

Financial Expenses

These are the remuneration of third-party capital, such as: interest paid or incurred, bank fees, discounts granted, late-payment interest paid, etc.

Financial expenses must be offset against Financial Income (in accordance with legal provisions), that is, this income will be deducted from those expenses.

Financial income is derived from financial investments, late-payment interest received, discounts obtained, etc.

It may happen that the amount of Financial Income is greater than the Financial Expense. In this case, algebraically, Financial Income will be deducted from other Operating Expenses.

Expenses with Monetary Variations

Brazilian legislation exemplifies exchange rate variations as Monetary Variations.

If a company takes out a loan in foreign currency, for example, 100,000 dollars, at the beginning of the year, when each dollar is quoted at $4.70, its debt corresponds to 470 thousand reais (100,000 times 4.70).

However, with the devaluation of the Real, one dollar may be quoted at $5.40 at the end of the period. Thus, the debt corresponds to 540 thousand reais, resulting in an exchange rate variation of 70 thousand reais.

Other expenses / income

Tax Expenses, losses arising from investments in other companies, etc. In this group, similarly to Financial Expenses vs. Financial Income, we can include other Operating Income of an occasional nature or not, such as: profits from equity interests in other companies, sales of scrap, etc.

Operating Profit

Operating Profit is obtained through the difference between Gross Profit and Operating Expenses. It is the profit resulting from the company's operating activity.

Non-Operating Expenses

Expenses not directly related to the company's business objective are classified as Non-Operating. Examples include: Loss on shares (Capital loss) or losses from frost, hailstorms in agriculture (Extraordinary losses).

Non-Operating Income

Income not directly related to the company's business objective is classified as Non-Operating. Examples include: Profit from shares or sale of fixed assets such as equipment or vehicles (Capital Gain).

Profit Before Income Tax

After removing Non-Operating Expenses and adding Non-Operating Revenues to Operating Profit, we will have Profit Before Income Tax (Lair).

Income Tax Deduction

Income Tax is levied on the Company’s profit.

If, in fiscal year X, we determine a profit of 100 million reais, we will declare and pay to the public treasury (Federal Government) generally 15% on the profit (15% of 100 million = 15 million). It is a portion of Profit channeled to the Government.

[m](It should be noted that the calculation basis for Income Tax is not exactly the profit determined by Accounting, but the profit adjusted to the provisions of Income Tax Legislation, which will be called Taxable Profit.

Additions to Income Tax

Costs, expenses, losses, and any other amounts deducted in determining Profit that, according to Income Tax legislation, are not deductible. Examples: Tax fines, punitive fines paid and recorded as expenses, depreciation above the permitted amount, etc.

Exclusions from Income Tax

Deductions allowed by legislation that have not yet been subtracted. Examples: Losses from previous fiscal years, contributions to employee assistance or pension institutions or funds, etc.

Example

\[\text{Taxable Profit x 15% = Provisions for Income Tax}\]

Let us imagine that a company had Lair of 3 million and adopted 15% as the depreciation basis, rather than 10%, the Income Tax limit. The value of Machinery is 60 million reais. Also, an administrative expense includes a fine of 4 million reais. And in the previous fiscal year there was a loss of 3 million reais.

Thus, additions:

- 3 million reais of profit

- 5% excess Depreciation (5% of 60 million, which equals 3 million)

- Tax Fine of 4 million

Total additions: R$ 10 million

Exclusion:

- Previous Fiscal Year Loss of 3 million.

Taxable profit of 7 million reais. Income tax of 15% of Taxable Profit, therefore 1,050,000 reais.

Profit After Income Tax

After removing Income Tax from Lair, we will have Profit After Income Tax.

In the previous example, there was a profit of 3 million reais, with an income tax provision of 1,050,000 reais. Therefore, its Profit After Income Tax is 1,950,000 reais.

Profit Sharing and Contributions with Profit after Income Tax

After calculating Profit After Income Tax, we will make the following deductions:

  • Debentures: companies may request loans from the general public, paying periodic interest and granting regular amortizations. To do so, they will issue long-term securities with guarantees: these are debentures.
  • Profit sharing for Employees and Administrators: This is a supplement to the compensation of employees and Administrators. Normally, a percentage of profit is defined in the Articles of Association or articles of organization.
  • Beneficiary Shares: Normally, they are granted to people who have played a relevant role in the direction of the company. They are negotiable securities without nominal value that the company may create at any time. The holders of these securities will be entitled to share in annual profits.
  • Contributions to employee assistance or pension institutions or Funds. These are donations to the establishment of foundations with the purpose of assisting their staff, to private pension plans, in order to supplement retirement, etc.

Example:

Profit After Income Tax: 1,000,000

(-) Debenture Participation (1,000,000 x 10%): (100,000)

Profit at the moment: 900,000

(-) Employee Participation (900,000 x 10%): (90,000)

Profit at the moment: 810,000

(-) Administration Participation (810,000 x 10%): (81,000)

Profit at the moment: 729,000

Net Profit

After profit sharing and contributions are deducted from the result, what remains will be net profit.

The owners decide the portion of profit that will be retained in the company and the part that will be distributed to the owners of capital (dividends).

Excel Spreadsheet for Simulations

This link contains a spreadsheet for simulations of a meal-box businesslink outside website. Make a copy of this spreadsheet and change the values as you prefer.

Exercises

1) (Instituto Consulplan - 2023 - City Hall of Orlândia - SP - Accountant) Regarding the Balance Sheet and the Income Statement, mark V for true statements and F for false statements.

( ) A company has Current Assets of R$ 1,200.00 and Total Assets of R$ 4,000.00. Knowing that merchandise for resale was acquired in the amount of R$ 800.00 to be paid on credit, the value of Current Assets and the value of Total Equity became, respectively, R$ 2,000.00 and R$ 4,800.00.

( ) A company has Assets of R$ 2,500.00 and Liabilities of R$ 1,700.00. Knowing that a machine worth R$ 1,000.00 was purchased in cash, the company’s Equity will be R$ 800.00.

( ) A company reported Net Sales Revenue of R$ 11,500.00 and Gross Profit of R$ 5,700.00; therefore, the value of Cost of Goods Sold corresponds to R$ 5,800.00.

( ) A company reported Net Sales Revenue of R$ 8,000.00, Taxes Levied on Sales of R$ 1,800.00, and Canceled Sales of R$ 200.00; therefore, Gross Sales Revenue corresponds to R$ 10,000.00.

The correct sequence is:

A) F, F, F, F.

B) F, V, F, V.

C) V, F, V, F.

D) V, V, V, V.

2) (CONSULPAM - 2023 - TCM-PA - External Control Technician) The financial statements are the structured representation of the entity’s equity, financial position, and performance. Financial statements in the public sector must provide useful information to support decision-making and the rendering of accounts and accountability of the entity regarding the resources entrusted to it. Regarding this topic, select the CORRECT alternative.

A) Because the information contained in the financial statements is relevant, it is likely to satisfy all the objectives specifically described with regard to entities whose main objective is not to generate profit.

B) It is not the role of financial statements to provide useful information in assessing the entity’s ability to finance its activities and meet its obligations and commitments.

C) Financial statements, as a rule, do not have a predictive or prospective function.

D) Supplementary information, including non-financial statements, may be presented together with the financial statements in order to provide a more comprehensive view of the entity’s activities during the period.

3) (FUNDEPES - 2023 - Municipality of Marechal Deodoro - AL - Accountant) Company ABC acquired, in cash, on 3/1/2023, 50 computers for R$ 6,000.00 each. On 3/5/2023, it sold, in cash, 50% of the inventory for R$ 400,000.00. On 3/10/2023, a customer of this company returned one computer. Regarding this hypothetical situation, disregarding any taxation and considering that the company had no initial inventory and that there were also no other transactions besides these, mark the correct alternative.

A) The cost of goods sold was less than R$ 150,000.00.

B) The ending inventory, on 3/31/2023, was greater than R$ 160,000.00.

C) Since only these transactions occurred in the period, net income was greater than gross profit.

D) Net revenue in the Income Statement will be less than R$ 380,000.00.

E) The accounting for the sales return involves a debit to cash and a credit to the merchandise inventory account.

4) (FUNDEPES - 2023 - Municipality of Marechal Deodoro - AL - Accountant) Regarding the Income Statement, a financial statement required by corporate legislation, mark the correct alternative.

A) The Income Statement must be prepared using the cash basis for revenues and the accrual basis for expenses.

B) Canceled sales and the cost of goods sold represent deductions from gross sales to arrive at net revenue in the Income Statement.

C) The Income Statement is considered a deductive and dynamic financial statement, which presents the entity’s result for a given fiscal year.

D) When obtaining distinct revenues from sales of goods and provision of services, the entity must prepare an Income Statement for each type of activity.

E) In determining the result for the fiscal year, revenues must be matched exclusively with their costs, expenses, and charges disbursed in the period, in accordance with corporate legislation.

5) (CESPE / CEBRASPE - 2006 - Banco da Amazônia - Scientific Technician - Area: Accounting) Judge the next item, based on the data of a given company, presented below.

Unit selling price: $ 15.00

Variable cost per unit: $ 6.00

Fixed cost: $ 600,000

Production: 100,000 units

Sales: 80,000 units

To increase profit by 100%, the company will have to increase sales revenue by at least 16.67%. Right or wrong?

6) ( CESPE / CEBRASPE - 2006 - Banco da Amazônia - Scientific Technician - Area: Accounting) Consider the data of company XYZ in a given period.

Direct material consumed: $ 1,000.00

Direct labor: $ 800.00

Indirect manufacturing cost: $ 600.00

Sales commissions: 10%

Freight on sales: $ 2.00 per unit sold

Quantity produced: 100 units

Quantity sold: 80 units

Net revenue: $ 40.00 per unit

Costing method: absorption

The gross profit for this period corresponds to $ 1,120. Right or Wrong?

7) (UFRRJ - 2023 - UFRRJ - Accounting Technician) A bottled fruit juice producer presented the following information on the selling price and unit variable cost.

Selling price $800.00

Unit variable cost $500.00

Assuming that fixed costs are $1,000,000.00

and sales revenue is $3,000,000.00, the profit will be:

A) $850,000.00

B) $725,000.00

C) $600,000.00

D) $525,000.00

E) $125,000.00

8) Classify each item below as Asset (A), Liability (P), Revenue (R), Expense (D), Cost (C), and Equity (PL):

( ) Bank Current Accounts

( ) Notes Receivable

( ) Loans Payable

( ) Revenue from Product Sales

( ) Share Capital

( ) Inventory of Work-in-Process Products

( ) Interest Income Received

( ) ICMS Payable

( ) Office Supplies Expenses

( ) Electricity in the Production Area

( ) Direct Labor

( ) Vehicles

( ) Suppliers

( ) Rental Income

( ) Statutory Reserve

( ) Factory Insurance

( ) Depreciation of Production Machines

( ) Administrative Telephone Expenses

( ) Land

( ) Advances to Employees

( ) Salaries Payable

( ) Revenue from Provision of Services

( ) FGTS Payable

( ) Furniture and Fixtures

( ) Sales Commission

( ) Packaging Material Consumed in Production

( ) Accumulated Profits

( ) Short-Term Financial Investments

( ) Long-Term Financing

( ) Advertising Expenses

Solution

1) D

2) D

3) A

4) C

5) Right

6) Wrong

7) E

8)

A

A

P

R

PL

A

R

P

D

C

C

A

P

R

PL

C

C

D

A

A

P

R

P

A

D

C

PL

A

P

D

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