Question

The following items are located “below the line” on the income statement for a manufacturing firm:

Select one:

a. Interest expense

b. All of the listed answers

c. None of the listed answers

d. Sales tax or value added tax (VAT) taxes

e. Deferred revenue

Answer 1

Solution: Option(a) is correct i.e interest expense.

The reasons are as follows:

The meaning of “Below the line items” means those items that figure in the income statement below the Gross Profit Entry.

1)Interest Expense is an expense incurred by an organization on the funds that it has borrowed for the purpose of its business.

2) The funds that a business raises could be in the form of long term loans , working capital borrowings , debentures etc i.e secured and unsecured loans both and these  have a cost attached to it and that is a non operating expense for the organization. This interest is a finance expense which comes below the gross profit in the income statement i.e below the line item in the income statement.

3) The interest expense accounted for in the income statement is the interest accrued for the entire current period and not the amount of interest that is paid by the organization.

As far as options (d) Sales tax and VAT and (e) Deferred Revenue are considered the reasons are as stated below:

Sales Tax and VAT taxes:

1)Sales tax and VAT taxes are indirect taxes. These are adjusted in the sales figure to give the net figure in the income statement.

2) These taxes are collected by the organization on behalf of the government i.e they function as an agent by collecting it on behalf of the government and then soon after that they deposit it with the government.

3)These are actually not the expenses of the organization. So when these taxes are collected then the organisation’s cash balance in the balance sheet shows an increase and there is a liability created as “Sales Tax Payable” or “VAT Payable” and when these are deposited with the government shortly the cash and liability account shows the decrease.

4) Therefore these taxes collected are not Revenues of the organization but of the Government.

Deferred Revenue:

1)These are revenues that are not earned by the organisation in the current period.These are unearned revenues or incomes of the organization that is received in advance for the goods to be sold or services to be provided in the future.

2) Since the organization has received it in advance, it has a liability to provide the services or goods in the future. So this item is actually a liability of the organization that finds a place in the balance sheet of the organization and not an item of the income statement itself.

3) So deferred revenues are short term liabilities for the company.