How To Find Mistakes In The Income Statement

hey guys in today's video i'm going to show you how to find mistakes or errors in a company's income statement so be jumping into my computer here i'm going to show you going through revenue and expenses line by line what are the areas that have the most frequently have accounting errors or misstatements and for example here looking at revenue you have interest income and why would a company show interest income and its operating revenue it makes no sense so we're going to go through this line by line and i'm going to show you all the accounting errors in this income statement this is the topic of this video today so stick around if you're new here welcome welcome my name is bill hannah i'm the financial controller i'm a licensed cpa in the great state of new york and i have over 15 years of experience in the field of finance what i started out at pricewaterhousecoopers as an auditor and then i transitioned out to private industry and then i worked my way up from a financial analyst position all the way up to a corporate controller position which is what i do today and this channel is all about giving you the summary or the juice of my experience over the last decade and a half and i do this here in the youtube channel as well as on my website through blog posts an online course and templates so go ahead and check that out as well all right jumping into the income statement here to try and figure out what's going on so this income statement obviously as you would imagine is broken down into revenue and then expenses and when you look at expenses it's further broken down by coastal goods sold operating expenditure and then here you have non-operating expenses which is going to be depreciation interest expense and income taxes all right so the first thing we're going to do is try and figure out what kind of company is this by looking at the income statement so looking here at the income statement you can see that they have cost of goods sold and that will tell you that this is a manufacturing company right and then within the manufacturing space you can also look further into expenses and figure out what kind of manufacturing is this so you can see here that they have food inventory cogs or food inventory cost of goods sold so this tells you this is a food manufacturing operation all right so keeping that in mind keeping in mind that this is a food manufacturing company let's go through the revenues and expenses and figure out what's wrong with this income statement so the first line here in revenue is gross unit revenue and in january is 61 000 and then it's 37 and then it's eight and then it's 11. so kind of fluctuates a lot throughout the year and normally this would be a sign that this some sort of an accounting error here or misstatement but this is a manufacturing company a food manufacturing company so it relies on receiving precious orders from its distributors to make sales right so this makes sense that it can fluctuate throughout the year if this was a subscription company or a software company this would be a different matter because then you should expect revenue to be sort of steady and not fluctuate up and down so much so in here we think this is fine for interest income now this is a manufacturing company why would it have interest income and its revenue and it makes no sense so this is the first accounting mistake here that this company is recording an interest income in its operating revenue right when is the only case where interest could be an operating revenue is if the company is a bank if this is we're looking at a financial institution interest then if you earn interest that could be a part of revenue right but in this case here it seems that this company is making some kind of interest income from its deposits with the bank and in this case this is a non-operating um item so this should go down in the income statement uh somewhere down here in the non-operating expense income and expenses it shouldn't be up here with revenue so this line here uh interest income is the first mistake and then going through expenses so the first thing we look at here and this is the area where companies make mistakes is look at the gross margin and obviously gross margin is the percentage uh and it's taken basically uh dividing the gross margin or gross profit dividing it by revenue so looking at that number here uh 31 in january and then it's negative 55 in february and this is a sign of something is wrong here right um and then march you got 26 percent 27 so fluctuates uh it gets a little bit more steady toward the end of the year but something is definitely wrong especially in february with a negative 55 in in gross margins so this will definitely mean that something is wrong here with the items that are being recorded in coastal goods sold so you can look at them individually and figure out is if some of them may seem inappropriate or something seems off so with food inventory cogs or food inventory cost of goods sold you see they're recording here a number and it kind of fluctuates so the first thing is try and see if that number uh fluctuates in the same direction as revenue so you can say here you can create a formula and say equals this as a percentage or divided by revenue right so it's 36 percent and then you drag that across and then see where you land so 36 35 31 32 so it's not bad right so this line here is trending nicely with revenue which indicates you know to a certain extent that this company is recording cogs in this line here um at the same direction you take uh packaging you try that you see packaging should trend in a similar direction to revenue and you drag that across and you got six 91 percent in february whoa that makes zero sense so i'm gonna highlight that in red right so here something is up here so in february packaging cogs right boom 35 000 in packaging cogs and this probably means that the company wrote off or you know kind of had some packaging that was obsolete it was no longer using or maybe was lost or destroyed and some kind of issue or fire um so basically 35 000 here of packaging suddenly where each month is like 700 600 suddenly 35 000 in feb uh obviously this is an issue so this is a question that you will have for management all right so so far we said that for coastal goods sold we have food inventory cogs here which seems to be trending with revenue nicely and then packaging cogs has an issue in february whereas suddenly there's a big slug of 35 000 in packaging that you need to figure out why is this recorded all in one shot in february and then the next item is delivery in um so delivery in uh typically delivery end of uh goods or packaging or raw material is part of inventory and thus part of cost of goods sold so here i can see that it's zero each month right and this kind of makes no sense uh so this one here could be a potential problem why is this company has zero of delivery in cogs and then the next item is delivery outcomes now with delivery out unlike delivery in uh delivery out shouldn't be part of cogs right so this is a problem here as well why is the company recording delivery out as part of cogs and this is what's causing the gross margin to fluctuate or the margin percentage to fluctuate so severely because suddenly in feb they have a big amount 9 000 um in in delivery outcogs which shouldn't be recorded in cogs it should be recording down here in operating expenditure so uh to recap uh cogs uh delivering in cogs should be recorded and they have zero here i'm not sure why so this is a potential problem and then you have delivery out delivery out should not be part of cogs delivery out should be down down in operating expenditure all right so to recap so far we found an issue with revenue where the recorded income uh from interest up here in operating revenue where it shouldn't be here and then for uh cogs we found that they recorded a big slug for packaging uh in february and then they have no delivery in and delivery out shouldn't even be here should be down here at operating uh expenditure so now jumping into operating expenditure all right so analyzing operating expenditure the first item is going to be payroll expenses and so the first line is executive where they recorded the salary of this executive as you can see here is steady each month the same amount which seems fine to me and then for operations salaries um here are the numbers monthly 7 500 7 500 but then suddenly here if you look in november the southern uh 25 000 amount and this tells me that this is a number that should have probably been accrued uh throughout the months so this is probably some bonus that they paid so that should have been accrued over the period that it pertains to uh it shouldn't be shouldn't be all recorded in one month here is 25 000. uh but this is not a huge problem because for the full year the the entire year in aggregate it should be fine in terms of presentation it's just a problem when you present it on a monthly basis this should have been broken down on a number of months and then after that we have sales of marketing and this is fine each month they're recording the salary and it's kind of flat or straight line and then technology here's the salary seems to be the same each month which makes sense and then after that you have chef or nutritionist uh so this number here it's it's kind of small like the amount is small but typically a chef the salary for a chef would normally be in cogs right because what goes into the costing of inventory is going to be direct material and direct labor and overhead and this is probably a direct labor if it's a chef who's making the food this usually is a direct labor and should be part of inventory and then when it's sold it becomes part of coastal goods sold so this is a potential problem it's a small dollar amount so i'm not going to focus too much on it and then packaging so this is a salary for the packaging person and this definitely is a direct labor to inventory and so it doesn't belong here it doesn't belong in operating expenditure the packaging item here or the salary should be up here in packaging cogs so this is a mistake here as well packaging is a direct labor and should be part of cogs preparation is the same thing so if you're preparing your inventory or the items you're selling preparation is also cost of cogs so this is definitely also direct labor and shouldn't be here customer service um you know you could argue it's also part of cost of goods sold but i've seen many companies record that in operating expenditure so we're not going to make a big deal out of this one miscellaneous or admin this is fine and cogs illegal there is zero expenses which is kind of odd but not a mistake on in itself payroll taxes you just look at that and see if the amount fluctuates in any strange way and it doesn't which is also strange because you see we have a big slug of 25 000 in salaries here uh so i'd expect maybe the payroll tax to be high in the same months and it's not so not a mistake in itself but definitely something to question um and then after that you have credit card processing costs which is fine in operating expenses uh corporate office rent um an office rent is definitely part of overhead here so it's fine it's not you know shouldn't be in cogs or anything we're fine here office and admin supply cost you see here they're recording small amounts each month so this should be fine um we have admin uh software cost so this the recording here the cost of the software uh that seems to be um okay um and should be part of operating expenditure and then you have tax and legal services um utility expenses professional services um and then you have industrial kitchen rent so this is a rent for the kitchen where they are making the actual product and so this is part of overhead that is directly attributed to inventory and it shouldn't be here this should be part of cost of goods sold so this here should be attributed to the inventory and then becoming part of the actual cogs for the food that's being made so industrial kitchen rent definitely is an overhead that is attributed to inventory and it shouldn't be here in operating expenditure so this one should definitely move up and then you have pallet shelving costs uh this is fine uh 200 that's kind of a flat amount and then you have a refrigeration freezer it's a small amount you can argue that this is part of the inventory um so this should be a part of cogs but also it's it's not a huge amount so it should be fine research and development should be here that's fine marketing cost is also fine so for operating expenditure we found a few issues we found that for salaries for operations uh there is a huge slug in in the months of november 25 000 it should have been accrued throughout the months and then we found some salaries here for chef packaging and preparation that is potentially part of the cost of the inventory and it should be part of cogs and then down here we found that they're recording the rent as an operating expenditure while the industrial kitchen rent is the place where they're making the actual product and should be part of cogs or the costing of the inventory and then therefore part of cogs so this sums up what we found wrong here with operating expenditure all right so jumping here into non-operating expenses and we have depreciation interest and income taxes uh and look at depreciation here uh that should be straight line uh each month so we have 706 706 kind of fluctuates a little bit um and then you have your big slug in october ten thousand dollars so this is something you want to question why is it ten thousand recorded in october that could be the company writing off uh any of his fixed assets uh or it could be an error so definitely something to flag and figure out what's wrong here and then you have interest expenses this is the company recording um some sort of interest expense on a loan that it has um and it's constant each month about 8 000 and change so this makes sense uh you want to see the consistency you don't want to see a big slug all of a sudden in one of these months so this one is consistent and then for income taxes we look here we find kind of zero zero zero so there's nothing recorded in income taxes and then suddenly you have 5000 being recorded in september so that kind of makes you question whether the 5000 should have been accrued throughout the months um and then you got to also figure out you know why did they have income tax liability because if you look down here net income uh you'll have that you'll see that they are in a net loss position so this is a loss so obviously when you have a loss you shouldn't owe income taxes but still that may be some sort of a you know minimum tax that you owe in certain states but you want to question whether that should be spread out throughout the months so that's it for this video i hope you enjoyed it i hope you learned something new from it if you did smash that like button and share this video with someone that you think might learn from it or enjoy it and i'll see you in the next video [Music] you

Channel: The Financial Controller

Views: 59,142

Keywords: how to analyze the income statement, income statement analysis, common mistakes in the income statement, how to find mistakes in the income statement

Id: CESKTk0t42g

Length: 15min 16sec (916 seconds)

Published: Sat Jan 16 2021