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.

In reporting depreciation expense, a business has an option to use:

• short-life method and load most of the expense over the first few years
• longer-life method and spread the expense evenly over the years.

As depreciation can be a very big expense for some businesses, surely the choice of the method to report it becomes important as well.

Employee pensions and post-retirement benefits.

The GAAP rule on this expense is complex – expected rate of return on the portfolio of funds set aside for these future obligations and other estimates affect the amount of expense recorded. This is a truly tough nut for the reporting.

Quite often the products are sold with expressed or implied warranties and guarantees. These should be estimated as the expense in the same period that the goods are sold.

Other operating expenses may also have timing or estimating considerations.

Earnings before interest and tax (EBIT) measures the sales revenue less all the expenses above this line. It depends on all the decisions made for recording sales revenue and expenses and how the accounting methods are implemented.

Read more in Accounting Income Statement – How to Prepare Income Statement – Part 3

Businesses are to be consistent from year to year about when they record sales. For example, when does an ad agency have to report the sales revenue for a campaign - after the work is completed or after the client approves it or atfre the ads appear in the media or after the billing is complete? You understand the point - these issues should be decided by a company for reporting sales revenue. And surely they must be consistent each year.

The next line in an income statement - the cost of goods sold expense.

There are three methods to report the cost of goods sold expense:

• "first in-first out" (FIFO)
• "last in-last out" (LIFO)
• the average cost method

Other items of the income statement include inventory write-downs.

Inventory should be carefully inspected to determine any losses due to theft, damage and deterioration, and to apply the lower of cost or market (LCM) method. Another important component is made up by bad debts: bad debts are those owed to a business by customers who bought on credit (accounts receivable), but are not going to be paid. It is very important to understand and implement this in real life that the timing of when bad debts are reported is crucial.

Read more in Accounting Income Statement – How to Prepare Income Statement – Part 2