Income Statement &

Cash Flow Statement

Prof. Dr Safdar A. Butt

Importance

Tax authorities (direct and indirect taxes)

Shareholders:

Dividends
Reserves
Share value

Creditors (Companys ability to service debts)

Employees & Managers (bonuses, etc.)
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Contents of
Income Statement

Segments of Income Statement

Trading Account

Profit & Loss Account

Sales, Cost of Sales, Stocks.

All other incomes and expenses

Profit & Loss Appropriation Account

Use of available profits: dividend, transfer to

reserves, retained earnings carried forward.
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Trading Account

Sales Revenue, net of returns.

Opening Stock
Purchases, net of returns
Closing Stock
Cost of Goods Sold
Gross Profit

Revenues: Sales

Essentially covered under Chap 8.

Sales during the last few days

Invoiced but not delivered by year-end

Delivered but not invoiced by year-end

Returns during the first few days of the next

month

Net Purchases

Already 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.

Stocks

Opening Stock (from previous balance sheet)

Closing Stock

Generally not available from financial ledger.

See if any separate stock records are kept
Perpetual inventory & Continuous stock taking
Year end Physical Stock Taking
Valuation of closing stock

Closing Inventory

Finished goods
Work in Process
Spares and supplies
Raw material

Auditor & YE Stocktaking

Study the procedure of stock taking

Attend the exercise be observant and count a few
items personally.
Get completed stock sheets.

Check castings

Check Valuation Sheets

Check valuation basis and computation

Using ratios, relate the approx value to COGS.
Certificate of valuation from a competent authority
Check provisions for dead stock.
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Stock Cut Off

Procedure to ensure that only true closing stock is

included as closing stock
Items included in the closing stock are included in
purchases
Items 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 inbetween period.
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Revenue: Other Incomes

Already covered in Chapter 9

Pay 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.

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Expenses

Essentially covered under Chapters 6 & 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.
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Cut Off Test

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

Un-appropriated profit brought forward

Write off of intangible assets
Transfers to or from Reserves
Proposed Dividends
Un-appropriated profit carried forward

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Authority to appropriate profit

Only 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.

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Write Off of Intangible Assets

Write 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
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Transfers to and from Reserves

Check the authority, i.e. resolution of Board of

Directors.
Reasonableness of amounts transferred.
Legal requirements relating to transfers
Scrutinize in detail transfer out of reserves
back into P&L Appropriation Account
Cross check to balances shown in the Balance
Sheet
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Proposed Dividends

Check the authority, i.e. the resolution of

Board of Directors.
Reasonableness of amount declared as
dividend
Cross check to current liabilities in Balacne
Sheet.

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Interim Dividend

Declared and paid during the year.

Check authority
Check actual payment

Cash Book / bank statement

Check treatment of unclaimed dividends

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Legal Requirements

Study 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.
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Relation to Balance Sheet

Opening balance on P&LA Account comes

from last years balance sheet
Movement in reserves is reflected in both P&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.
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Cash Flow Statement

All 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.
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Thank you
Dr Safdar A Butt

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