Last week, we examined cost of goods sold and operating expenses. We'll continue our travels down the income statement with a few other expense and income items.
Interest Expense
Companies will often incur debt and subsequently interest expense when they expand the business or fall short of cash. While debt is not always a bad thing (often it's essential in a growing business), when interest expense growth outpaces that of sales and gross profit, it's often a sign of trouble ahead. Interest expense, which equals debt payable plus interest, is generally found just below operating income on the income statement.
Other Expenses
Other expenses is a catchall category for any nonoperating costs or expenses that do not fit neatly into the headings we've already covered.
Deferred Taxes
The income statement presented in a company's quarterly report almost always differs from the income statement that it files with your friend in government, the Internal Revenue Service. The variances are due to gaps in timing that exist between GAAP accounting and accounting for tax purposes. These differences are considered temporary and are expected to converge with time.
Deferred tax liabilities arise when a company pays less tax than due according to GAAP accounting, and deferred tax assets stem from paying more tax than due under the same rules.
Discontinued Operations
When a company decides to sell or abandon a segment of its business, it will experience a gain or loss as a result of that transaction; this amount will appear on the income statement. Since the exact result of the transaction will not be known until the actual disposal date, the company will report expected results based on guidelines for disclosure of likely contingencies. If a loss is expected on disposal, that loss will be reported on the income statement in the same period that the decision was made to sell. If, however, a gain is anticipated, the gain will not appear on the income statement until the fiscal year in which the actual transaction occurs.
Gains or losses that result from operations of a discontinued segment prior to disposal will also appear in a separate category on the income statement. Gains and losses from discontinued operations usually appear after income from continuing operations and are presented as after-tax figures. Gains generally result in higher taxes, while losses often result in tax savings.
Keeping an eye on income from discontinued operations and focusing on income from continuing operations rather than net income will provide a better gauge of future earnings expectations.
Extraordinary Items
Extraordinary items are gains and losses resulting from transactions that take place outside of normal business operations. In order to be classified as an extraordinary item, the event must be both unusual, meaning it is unrelated to typical activities of the company, and nonrecurring. Similar to discontinued operations, extraordinary items appear on the income statement net of income taxes. Examples of extraordinary items could include the early extinguishment of debt or damages incurred from an earthquake.
That's enough for tonight. We'll wrap the income statement next week.
Drip on, Fools!
