Benefit & Limitation of Income Statement

The income statement is an integral part of financial statement which is very beneficiary and helpful for determining for net income or ne loss. Income statement also helps the user of accounting specially the external users such as investors and creditors. The users of income statement basically focus or use the information of income statement for several reasons. Such as:

  • Previous record or operational performance of any economic entity could be valued through income statement. Expenses and revenues are the prime element of income statement. The users can evaluate the current status of expenses and revenues of any company and can compare their operational function or performance with other competitor’s financial position.
  • The future performances of any entity could be valued or predicted through income statement as income statement work as a tool for forecasting future performance. Information about past performance is also very helpful since it helps to determine important development of the company that may continue and effect on future performance. For example, Microsoft has been growing steadily for last few decades. Their past performance indicates better result in future. But past performance do not always shows the better future in business.
  • Users not only evaluate past performance or predict future performance they also predict the risks that could be unsafe for company’s operational activities through income statement. Suppose income statement is beneficiary for evaluating the risk or uncertainty of achieving future cash flows as the information presented in the income statement shows the relationships among the elements of income statement of revenues, expenses, gains, and losses. It also can suggest the level of achieving a particular level of cash flows in the future in order to void the risks. For example, external users like investors and creditors keep apart the operating performance of ABC Company other nonrecurring sources of income. The company generates revenues and cash through its operational activities of business. That’s why the users mainly focus in ongoing operations of business for forecasting future performance than nonrecurring activities and events.

The usefulness of income statement are numerous but there are certain limitations of income statement which are related with the operational activities of any entity. Net income or net loss is an important element of income statement which reflects the assumptions of operational performance which can be either negative or positive. Therefore the users of income statement need to be responsive to certain limitations which are associated with its information. Some of these limitations include:

  • 1. Sometimes companies exclude those items from the income statement which items are difficult to measure properly. This exclusion of items may prove as a barrier to identify certain items from the determination of income because these items can possibly affect the company’s performance. This limitation of income statement leads a company not to record unrealized gains and losses on certain investment securities in income when there is a doubt that it will ever recognize the changes in value. Now a day’s brand recognition, customer service, and product quality of some larger and eminent companies lead them to experience growth in value of their product but identifying and reporting these types of values still are not considered as important items.
  • 2. Different companies use different accounting method according to their operational activities. So Income numbers of companies could be affected in different manner according to the accounting methods employed. Suppose one company use straight-line depreciation to depreciate its assets, when another chooses the accelerated basis method. If all other factors of both companies are the same, then the later company may experience lower income comparing to the first company.
  • 3. Income measurement of any economic entity also based on judgment of individual or business. Such as two entities has same plant assets ,now an entity estimate the useful life of an asset to be 15 years while another entity  estimate the useful life of an asset to be 10 years. Some companies also may predict optimistic estimates of future warranty costs and bad debt write-offs, which lead them to experience lower expense and higher income.

The above described limitations of the income statement can decrease the usefulness of its information to the users for predicting the quantity, performance, and uncertainty of future cash flows.