Financial Indicators in Income Statements

Introduction

The presentation of income statements differs depending on the method used as well as the purpose of the financial statement. From this perspective, income statements can be organized according to two specific principles that are known as variable costing and absorption costing (Marshall, McManus & Viele 2011). Moreover, statements can also be presented as parts of annual reports for the external use as well as regular reports for the internal use by the company’s management (Weygandt, Kimmel & Kieso 2015). These income statements are usually used by managers for measuring the company’s performance under certain conditions and with references to changes in provided reports.

Thus, reports that are based on using the principles of variable costing and absorption costing differ in their structure and in the nature of materials and costs that are taken into account in order to complete the report and analysis (Noreen, Brewer & Garrison 2011). As a result, it is possible to expect the organization of the efficiently structured reports or income statements that address managers’ goals and reflect the company’s needs. However, the proposed approaches cannot be discussed as fitting all contexts and situations, and more improvements can be required. It is important to note that these methods of organizing the financial statement can reflect the actual performance of the company inadequately (Weygandt, Kimmel & Kieso 2015). From this point, it is possible to conclude that additional research on factors or indicators that can be included in income statements in order to improve the performance assessment and auditing procedures is necessary.

Problem Statement

The motivation behind this research is the necessity to identify specific factors and indicators that can be used in income statements in order to reflect the performance of companies in the most appropriate manner. The problem is in the fact that standards regarding the presentation of income statements differ, and this aspect is directly related to disparities in the presentation of statements based on variable costing and absorption costing methods. Auditing procedures that are applied to the analysis of these financial statements aim at finding possible errors and frauds, and they are not focused on explaining the company’s performance and profitability (Haskin 2010; Tsamenyi, Sahadev & Qiao 2011). As a result, the situation creates the additional challenges for completing auditing procedures and providing the assessments for shareholders. Currently, shareholders can experience problems with evaluating the performance of the company with references to the provided statements because various approaches can be used in order to administer the report. It is important to note that auditors can issue unqualified reports and that the shareholders can have wrong assumptions regarding the company’s performance (Garrison et al. 2010; Yalcin 2012). These inaccuracies can lead to wrong interpretations and the use of ineffective measures in order to overcome problems related to the company’s performance.

The lack of factors or indicators in financial statements does not allow for overcoming the problem of the ineffective auditing and analysis of differences in income statements based on variable or absorption costing. Therefore, shareholders can be misled and misinformed regarding the real situation in the company (Gupta, Pevzner & Seethamraju 2010). In this context, the provision of new factors or indicators may add to the financial statements, and it will be possible to improve the auditing procedure without affecting changes in accounting standards. The improvements for the income statements that are proposed in a form of adding specific financial factors or indicators can become an appropriate response to the problem of ineffective assessments and wrong conclusions.

The Aim of Research

The aim of the research is to identify factors or indicators that can be added to income statements and auditing reports without leading to changes in the auditing standards according to which variable and absorption income statements are organized. In addition, it is necessary to determine indicators that will be useful to overcome the gap in the auditors’ approach to analyzing two types of statements as well as in the shareholders’ understanding of the company’s performance.

Research Questions

The research questions that should be answered in this study are the following ones:

1. What is the gap between absorption and variable methods of organizing income statements?
2. Who can profiteer this gap, and how it is possible in relation to completing auditing procedures and analyzing the company’s performance?
3. What conditions are associated with deepening the gap? What can be done in order to eliminate the gap?
4. What are the benefits of eliminating the determined gap? Who will gain these benefits?
5. What indicators can be added to income statements and auditing reports in order to address the gap? How can these indicators influence the auditing procedures and the shareholders’ understanding of the company’s performance?

These research questions are related to the aim of the study, and they are intended to be used to guide the research and discuss the aspects of the identified problem in detail.

Relevant Literature

Accountants and auditors are inclined to use both absorption and variable methods of organizing income statements in their work. Researchers support the focus on using both traditional and recent approaches to documenting the firm’s income (Angelakis, Theriou & Floropoulos 2010). This approach creates the additional challenges for analyzing the factors that can influence the changes in the company’s performance because of differences in the treatment of fixed overhead costs (Haskin 2010; Tsamenyi, Sahadev & Qiao 2011). According to Hasan (2015), companies can use both types of statements during different stages of their development, and the choice depends on the benefits of this or that approach. The possibility of using both approaches creates the additional barrier not only for auditors, who are focused on identifying frauds, but also for shareholders, who need to receive the most credible information regarding the company’s performance and profitability. According to Ruiz-de-Arbulo-Lopez, Fortuny-Santos, and Cuatrecasas-Arbos (2013), manufacturers often need additional information in order to support their conclusions regarding the business’s performance. The disparities in statements that are organized according to two different methods can affect the overall quality of the performance evaluation.

However, researchers also agree that different accounting and cost systems have various advantages and disadvantages that should be taken into account while referring to the correctness or suitability of the proposed income statements (Fisher & Krumwiede 2012). The management and accountants decide what accounting practices to use for the purpose of reflecting and measuring the company’s performance, and there is no single opinion regarding the benefits of this or that practice (Drury 2013; Yalcin 2012). The variety of approaches to conducting the overhead analysis makes shareholders, accountants, and auditors think about the additional ways of improving the procedures (Agbejule & Huusko 2011). In their work, Zimmerman and Yahya-Zadeh (2011) discuss the use of accounting and its principles for making business decisions, and in this context, the analysis of approaches to improving the income statements is regarded as a necessary option. In his turn, Weiss (2010) concentrates on the impact of statements’ structure on the auditing procedures and further forecasting for the company. The data on costs and materials that are reflected in income statements can be supported with other information. This idea is presented in the works by Angelakis, Theriou, and Floropoulos (2010) and Gupta, Pevzner, and Seethamraju (2010) in the form of notes on the quality and adaptation of the absorption and variable costing methods. Still, researchers do not concentrate on this problem, and they do not discuss the possible variants to overcome the difficulties in using these statements and reports.

The analysis of the literature demonstrates that income statements based on the absorption and variable costing methods can be used by managers, accountants, auditors, and shareholders for different purposes (Agbejule & Huusko 2011; Tsamenyi, Sahadev & Qiao 2011; Yalcin 2012). However, the current versions of these statements can be improved in order to provide users with an opportunity to receive the accurate interpretation of the data. Furthermore, it is important to pay attention to the fact that the existing literature does not provide a discussion of the changes that can be used in practice in order to contribute to the auditing procedures and shareholders’ analysis without influencing the auditing standards (Hasan 2015; Ruiz-de-Arbulo-Lopez, Fortuny-Santos & Cuatrecasas-Arbos 2013). In spite of the fact that the use of absorption and variable methods for organizing the financial statements in order to measure the company’s performance is discussed in the literature in detail, there are still gaps in determining what factors can improve the use of these methods for accounting and auditing. Therefore, additional research is required in this field.

Methodology and Data Collection

For this study, the mixed methods approach will be used because of the necessity to conduct the complex analysis of the data and provide the relevant conclusions. Both qualitative and quantitative data should be collected for further analysis in order to study the problem, address the research aim, and provide specific and detailed answers to the research questions (Marshall, McManus & Viele 2011; Weygandt, Kimmel & Kieso 2015). The qualitative methodology is intended to be used in order to examine how companies from different industries can address the problem of the gap in absorption and variable income statements. In order to collect the corporate data that are appropriate for the study, it is relevant to use the case study as the qualitative method. The focus is on collecting the corporate data that are related to the use of absorption and variable income statements and the associated auditing procedures. The data on the history of identified frauds in companies should also be gathered during the data collection procedure in order to support the conclusions regarding the effectiveness of the used methods.

In order to come to a conclusion about the indicators that can be added to the income statements, it is also necessary to collect the numerical data regarding the company’s performance, possible drawbacks in reporting, and problems in applying absorption and variable income statements (Tsamenyi, Sahadev & Qiao 2011). These specific data will also include the expectations regarding the use of additional indicators that can be collected with the help of the questionnaire based on the Likert scale in order to determine what gaps and challenges should be addressed and what factors are preferred. The use of the Likert scale is appropriate for studies when it is necessary to transform the information that is qualitative in its nature into the numerical data (Agbejule & Huusko 2011; Noreen, Brewer & Garrison 2011). While using this quantitative methodology, the focus should be on analyzing gaps in approaches and possible indicators with references to the numerical representations (scores) of these aspects’ effects on the shareholders’ understanding of the problem. Much attention should be paid to the data analysis with the focus on the frequency distribution. It is important to note that the frequency distribution will be helpful to determine indicators that are preferable from the managers and accountants’ viewpoints. The use of these methods will provide the researcher with an opportunity to determine the tendencies of using statements based on absorption and variable costing methods in companies and to identify the factors that are distinguished by accountants and auditors as relevant to be added to statements.

Outcomes

It is expected that the research will demonstrate what specific factors or indicators can be added to income statements and auditing reports that are organized according to the variable costing and absorption costing methods. It will be possible to add these indicators to income statements without violating the auditing standards. Furthermore, the determined indicators will be effective for overcoming the gap in the auditors’ approach to analyzing the discussed statements. In addition, the proposed indicators will be referred to by shareholders for the better understanding of the company’s performance. The need for determining such factors is supported with references to the examined literature, and it is intended that the research will demonstrate that managers and accountants in different companies also expect the addition of new factors to financial statements and reports.

While determining the factors that can be added to financial statements, the research will be used for identifying the gap or differences between the absorption costing and variable costing methods. In addition, it will be possible to recognize potential profiteers who can use the inaccuracy in reports and statements as well as errors in the auditing procedures. The research will indicate how the identified gap can be covered with references to the specific financial indicators that can be added to statements in order to avoid possible inaccuracies in evaluating the company’s performance and auditors’ assessments. The formulation and discussion of the financial indicators or factors will be helpful for making conclusions regarding the persons who can benefit from overcoming the gap and proposing the procedures to improve the statements. From this perspective, it is possible to state that the main outcome of the research will be the development of financial indicators that can be added to statements organized according to the variable costing and absorption costing methods. These indicators can be used by auditors and shareholders in order to provide the complex and accurate analysis of the company’s performance.

Schedule

The process of working on the research is divided into several stages that are intended to be completed during periods that last from several weeks to several months. It is possible to identify the following stages:

1. Topic identification
   • During this stage, it is important to choose the topic for further research.
2. Preparation of the work plan
   • This stage includes the development of the plan for working on the study.
3. Literature review and research
   • During this stage, it is important to review the prior research on the topic.
4. Identification of the problem
   • Referring to the literature review, it is important to determine the gaps in the research and practice.
5. Formulation of the research questions
   • At this stage, it is necessary to determine the aims of the research and formulate the research questions.
6. Development of the methodology
   • The choice of the methods for the research is based on the determined aims and objectives of the study.
7. Preparation of the research proposal
   • The research proposal aims at presenting the rationale for the future research.
8. Collection of the data
9. Data preparation
   • These stages are associated with collecting and administering the data required for the further analysis. The intention is to collect the qualitative and quantitative data.
10. Data analysis
    • At this stage, the analysis of different types of data is conducted with the help of special data analysis tools.
11. Interpretation and discussion of study results.
    • Interpretation of findings can take several weeks in order to provide the complex discussion of the problem.
12. Preparation of the draft
13. Revision of the draft
14. Preparation of the final report
    • These stages of the work on the proposed research are associated with the preparation of the draft and its further revision in order to complete the final version without errors.

Reference List

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Angelakis, G, Theriou, N & Floropoulos, I 2010, ‘Adoption and benefits of management accounting practices: evidence from Greece and Finland’, Advances in Accounting, vol. 26, no. 1, pp. 87-96.

Drury, C 2013, Management and cost accounting, Springer, New York.

Fisher, J & Krumwiede, K 2012, ‘Product costing systems: finding the right approach’, Journal of Corporate Accounting & Finance, vol. 23, no. 3, pp. 43-51.

Garrison, R, Noreen, E, Brewer, P & McGowan, A 2010, ‘Managerial accounting’, Issues in Accounting Education, vol. 25, no. 4, pp. 792-793.

Gupta, M, Pevzner, M & Seethamraju, C 2010, ‘The implications of absorption cost accounting and production decisions for future firm performance and valuation’, Contemporary Accounting Research, vol. 27, no. 3, pp. 889-922.

Hasan, M 2015, ‘Variable costing and its applications in manufacturing company’, International Scholar Journal of Accounting and Finance, vol. 5, no. 1, pp. 11-23.

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Marshall, D, McManus, W & Viele, D 2011, Accounting, McGraw-Hill Education, New York.

Noreen, E, Brewer, P & Garrison, R 2011, Managerial accounting for managers, McGraw-Hill Education, New York.

Ruiz-de-Arbulo-Lopez, P, Fortuny-Santos, J & Cuatrecasas-Arbos, L 2013, ‘Lean manufacturing: costing the value stream’, Industrial Management & Data Systems, vol. 113, no. 5, pp. 647-668.

Tsamenyi, M, Sahadev, S & Qiao, Z 2011, ‘The relationship between business strategy, management control systems and performance: evidence from China’, Advances in Accounting, vol. 27, no. 1, pp. 193-203.

Weiss, D 2010, ‘Cost behavior and analysts’ earnings forecasts’, The Accounting Review, vol. 85, no. 4, pp. 1441-1471.

Weygandt, J, Kimmel, P & Kieso, D 2015, Financial and managerial accounting, John Wiley & Sons, New York.

Yalcin, S 2012, ‘Adoption and benefits of management accounting practices: an inter-country comparison’, Accounting in Europe, vol. 9, no. 1, pp. 95-110.

Zimmerman, J & Yahya-Zadeh, M 2011, ‘Accounting for decision making and control’, Issues in Accounting Education, vol. 26, no. 1, pp. 258-259.