Limitations of an Income Statement
Although the income statement provides useful information, companies must consider their limitations. To obtain a better idea of a company's financial position, managers review an income statement along with other financial statements.
No Cash Transactions
When companies use the accrual method, the income statement does not show cash inflows and outflows.
Inflows: The revenue section of the income statement reflect invoices sent out for payment but not paid.
Outflows: The expenses section of the income statement reflects bills received but not paid.
Estimations
Estimation in an income statement can reflect depreciation expenses. The estimation can make a difference in the expense recognition of certain items.
A coffee company purchases a $50,000 machine. Instead of recognizing the entire amount as an expense, the company recognizes the machine as an asset and calculates depreciation expense using lifetime and salvage value.
The lifetime of the machine is 10 years, and the machine has no salvage value afterward. The estimated depreciation expense is $5,000 a year ($50,000 / 10 years).
Missing Important Information
A company cannot objectively measure certain items, such as customer loyalty and employee morale, so the income statement does not show these items.
