E4-20A (Learning Objective 4: Reporting by expenses by function and nature) Poto
ID: 2489171 • Letter: E
Question
E4-20A (Learning Objective 4: Reporting by expenses by function and nature) Potomac's accountant has just prepared an analysis of its expenses for the year, by nature and by functions. The company earned service revenue totaling $450,000 during the year. Prepare Potomac's income statement using analysis of expenses by nature. Prepare Potomac's income statement using analysis of expenses by function. Looking at your answers to part 1 and 2 above, which one do you prefer as a user of financial statements?Explanation / Answer
An income statement by nature method is the one in which expenses are disclosed according to their nature such as depreciation, transports costs, rent expense, wages and salaries etc. There is no reallocation of these expenses to different functions of the entity (i.e. cost of goods sold, selling costs, administrative costs and other expenses).
This method of disclosure of expenses is used in single step income statement and it is usually employed by small businesses due to its simplicity. However there is drawback in this method that it cannot be used to calculate gross profit within the income statement.
n income statement by function is the one in which expenses are disclosed according to their functions such are cost of goods sold, selling expenses, administrative expenses, other expenses/losses etc. This method allows us to calculate gross profit and operating profit within the income statement and therefore it is usually used in the multi-step format of income statement. Most large and medium sized businesses use the function method of expense disclosure.
The use of function method to disclose expenses still requires us to disclose the individual expenses by nature method under each function either on the face of the income statement or in the notes to the income statement.
income statement by function is a better representation of profit and losses as it helps in determining the gross profit, operating profit. It also segregates the expense which further helps in better understanding.
Sales 450,000 Expenses Wages and salaries 139,000 Depeciation 19,000 Advertising expenses 30,000 Motor vehicle expense 70,000 Utilities expense 28,900 Interest expense 7,300 tax expense 3,400 Total expense (297,600) Net income 152,400Related Questions
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