The interest expense line is a basic equation.
Unlike the previously mentioned, the accounting for income tax expense can come down to using different accounting methods. The hypothetical amount of taxable income, if the accounting methods used were used in the tax return is calculated. Then the income tax based on this hypothetical taxable income is calculated. This becomes the income tax expense reported in the income statement. A reconciliation of the two different income tax amounts is then provided in a footnote on the income statement.
Net income is like earnings before interest and tax (EBIT). It can vary depending on which accounting methods are used to report sales revenue and expenses. Profit smoothing can be used to manipulate earnings. Profit smoothing crosses the line from choosing acceptable accounting methods from the list of GAAP into the gray area of earnings management that involves accounting manipulation.
Managers and business owners have to be involved in the decisions about which accounting methods are used to measure profit and how those methods are actually implemented. That is why it is critical for manager in a company be thoroughly familiar with how the company’s financial statements are prepared.
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