Guest spot: John Burson on income statements (As published in The Zweig Letter August 4, 1997)
TOO MANY CPAs and accountants working for design and environmental firms fail to recognize the unique nature of these industries when they prepare a compiled financial statement for the board of directors or principals. Often, these financial professionals present income statements in a format more appropriate for a retail company than for a design firm.
The direct and reimbursable project-related expenses are sometimes consolidated with the overhead (non-project-related) expenses and presented on the income statement in alphabetical order. This form of account presentation may be appropriate for an income tax return, but not for a financial statement presented to the board of directors. What should a design firm’s compiled financial statement look like?
Exclude bonuses and tax-deductible profit-sharing plan contributions from overhead expenses. A successful design firm reduces its income tax expense and thus its taxable income by paying cash bonuses to principals and employees. The firm may also make a tax-deductible contribution to a qualified profit-sharing plan. These items should not be included with other overhead expenses. Bonuses and contributions should be shown after net profit from operations along with the other non-operating income and expenses.
Show the basic categories needed to determine the key indicators of financial performance. The income Statement should show the basic categories suggested by the American Institute of Architects (AIA) (Washington, DC) in the 1980 book by Robert F. Mattox, “Financial Management for Architects.” These basic categories are developed using the chart of accounts suggested in another book published in 1982 by the AIA, “Standardized Accounting for Architects,” also by Mattox. Most industry-specific accounting software use the standardized chart of accounts for architects. The software produces an income statement classified by categories and subtotals suggested by the AIA. The outside accountant should follow this format when preparing the compiled financial statement for the A/E firm client.
Use net revenue from projects before direct salary expenses, rather than gross revenue. Net revenue is gross revenue minus payments to sub consultants and reimbursable expense. The income statement format shown in “Financial Management for Architects” and used by A/E firm accounting software would be more meaningful if a subtotal for net revenue from projects before direct salary expense were shown.
Focus on net revenue, not total revenue or gross profit. The key indicators of financial performance are based on net project revenue, direct salary expense, overhead, and net profit from operations before bonus and profit-sharing. A percentage analysis of accounts using net revenue as the basis, rather than gross revenue, is more meaningful for the A/E firm. The relative value of the pass-through revenue paid to outside consultants may vary from year to year and firm to firm, so percentage analysis based on net revenue allows firm owners to better compare their results from year to year and firm to firm.