This is Part 5 of a short series discussing the basics of the income statement. See part 1 for a general overview, part 2 for more info regarding revenue, part 3 for costs of goods sold and part 4 for operating expenses.
So far, we’ve covered all the basics of operational income, from different types of revenue to costs of sales to operating expenses. As we’ve discussed these components, maybe you’ve been stuck on one or two examples that just don’t seem to fit anywhere. For example, an extraordinary loss on an inventory write-off, or interest being imputed on a shareholder loan. Neither of those feel like regular operational expenses, so what are they?
That brings us to the final section of the income statement, other income and expense. This section is located right before net income, and this is a place for final adjustments that don’t really belong anywhere else. This category is broad, and more defined by what it isn’t than what it is.
Are you earning income from a source other than your actual business purpose? Maybe interest income on a money market, or a special government grant deposit that doesn’t feel like it belongs in operating income. These types of income may be more appropriate in “other income”.
Are you incurring a loss from something not really related to your operations? Interest expense on a loan, income tax to a government entity, or maybe even a one-off consulting project could be candidates for other expenses. Other items can go here as well that are closely related to operations, but not regular or expected to be ongoing. To come back to an example mentioned earlier, if a warehouse catches fire and a large amount of inventory is lost, you wouldn’t want to record that adjustment under cost of goods sold, so other extraordinary loss would probably be a good fit.
Dos and Don’ts
Once you get a feel for this account, you’ll see how it can maintain the integrity of operational income while still showing a true net income after everything is accounted for. This is a very useful place for rare or unrelated items that just don’t make sense anywhere else.
That said, you’ll want to avoid the temptation to get carried away with reclassifying things you don’t like into this section. If you’ve hired a consultant that will be an ongoing expense, it does not belong here. If material costs are rising, you shouldn’t just move the premium here to meet an old budget. In other words, don’t start with operating income as a goal and use this section to force things to work.
This concludes the income statement basics. As a reminder, this series is designed for business owners trying to get an initial understanding of the income statement and its components. We hope you learned something valuable.
If you missed the previous installments of this series, you can find them here:
If you have any questions about income statements or need assistance with your income statements, please contact us.