Thorough and accurate financial records are critical to an organization’s long-term success. Understanding the financial health of a company can help leaders make wise decisions and plan for the future effectively. Using simple, organized accounting methods can help save time and energy when reviewing statements. In this article, we discuss what line item accounting is, what to include in line item accounting, above and below the line items and an example of line item accounting in practice.
PAGE CONTENTS
What is line item accounting?
Line item accounting is an accounting practice that segments each category of income and expenses into separate areas, or lines, on a balance sheet. Each line item represents a distinct type of revenue, expense, asset, liability or equity that may affect the account’s value.
Under each line item, you can also add many sub-line items to further differentiate money earned and money spent by an individual or company. For example, under the administration expenses line item, you might include sub-line items like office supplies, salaries and telecommunications.
Read more: What Is Cost Accounting?
The differences between line item accounting and other accounting methods
Line item accounting is also referred to as a single entry system of accounting. The other primary type of accounting is double-entry accounting. Line item accounting involves tracking transactions with a single entry onto a balance sheet or statement. Accountants or owners calculate profits and losses through one system to arrive at the bottom line or net profit.
A double-entry system requires two entries for each transaction: debit and credit. These are separate accounts and help ensure a company’s books balance out at the end of an accounting period.
Line item accounting differs from double-entry accounting in the following ways:
Business size: Often, small businesses use line item accounting because their finances are less complex, and larger businesses use double-entry systems.
Software requirements: Many accountants can perform line item accounting without complicated programs. Double-entry systems often require special accounting software.
Cost: Line item accounting can be less expensive as business owners may be able to complete this system on their own without hiring additional staff.
What are the benefits of line item accounting?
Using line item accounting helps organize income and expenses. Accountants use this method to present a more accurate and detailed representation of a business’s finances. Keeping categories separate is clearer and more thorough. The breakdown of costs and revenue can help owners, stakeholders and potential investors analyze the health of an organization and plan for the future.
Other benefits include:
Ease of use: Using line items and sub-line items helps readers quickly locate their area of interest and see the nature of expenses in each category. This allows financial professionals and executives to compare and calculate figures from previous statements easily.
Forecasting: Line item accounting provides a highly segmented picture of money allocation, which financial professionals and executives can use to forecast earnings and expenses for the following quarter or year.
What should you include in line item accounting?
You should incorporate all relevant categories of revenue and expenses in line item accounting. These items will vary depending on the nature of your business, but line item accounting often includes categories such as:
Sales revenue: Sales revenue is the amount of money a business earns from its sales.
Gross revenue: Gross revenue is the total amount of money a business earns from all sources before any deductions.
Selling, general and administrative (SG&A) expenses: SG&A expenses related to a business’s operations, such as supplies, manufacturing expenses and facility expenses.
Depreciating expense: A depreciating expense is the amount of depreciation calculated for a long-term asset for each accounting period.
Interest expense: Interest expense refers to the Interest on loans related to the business.
Tax expense: The amount a company pays in state and federal taxes.
Assets: Items that bring money into the business, including cash, prepaid expenses, accounts receivable and inventory.
Liabilities: Items that take money out of the business, including accounts payable, customer prepayments, loans and other expenses.
Shareholders’ equity: Shareholder’s equity may include stocks, securities and other equity items.
Under these line items, you can add the appropriate sub-line items to account for all transactions during a given time period, like a quarter or year. These figures, plus any other relevant income and expenses pertinent to your organization, allow you to determine net income, often referred to as “the bottom line” because it usually appears as the last line on your company’s balance sheet.
What is above the line?
“Above the line” refers to any revenue and income that applies to a company’s normal, day-to-day operations. These transactions occur regularly and relate to the core functions of the business. Accountants factor in above-the-line items when calculating profits and losses for a designated time period.
Some financial professionals also use “above the line” to refer to an organization’s gross profit. They calculate gross profit by subtracting the cost of goods sold (COGS), or typical daily operating expenses, from revenues.
Above-the-line figures are important tools for an organization’s leaders and stakeholders as they create future budgets.
What is below the line?
“Below the line” refers to line items on a statement that do not relate to a business’ typical operations. Below-the-line items can be unusual or unexpected expenses or revenue that occur during a particular accounting period. Accountants do not include these items when calculating general profits and losses for the time period in which they occurred. Below-the-line items appear separately, or below the bottom line, from gross or net profit.
Differentiating these items from normal income and expenses is important to present the most accurate representation of an organization’s financial standing to owners, investors and regulating authorities. Adding a large expense to an accounting period can make the company appear less financially stable whereas having a significant increase in income can misrepresent the success of the company.
Generally, you can classify transactions as below the line if they meet the following criteria:
The expense or revenue is due to an extraordinary or uncommon occurrence unrelated to the company’s primary function
The item may affect the company’s financial image in a positive or negative way
Line item accounting example
Consider a marketing firm that is preparing its annual statement. The company brought in $800,000 in new contracts and renewed contracts with existing customers for $2.5 million. The company also hosted a regional marketing conference and made $200,000 from ticket sales.
The company has normal operating expenses of $1,245,000, which includes salaries, office supplies, facility cleaning and maintenance, rent and utilities. On top of operating expenses, the company pays $60,000 in taxes for the year.
Here is an example of using line item accounting to track revenue and expenses for the marketing firm for a year. Each category has a separate line, which is further segmented into sub-line items. The net profit, or bottom line, is calculated by deducting all expenses from the total gross revenue:
Sales revenue: $3,300,000
New contracts: $800,000
Renewed contracts: $2,500,000
Other revenue: $200,000
Total gross revenue: $3,500,000
Selling, general and administrative (SG&A) expenses: $1,245,000
Non-salary sales expenses: $300,000
Sales salary expenses: $600,000
Administrative expenses: $225,000
Rent and utilities: $75,000
Vendor contracts expenses: $45,000
Tax expenses: $60,000
Corporate tax: $34,000
State tax: $20,000
Miscellaneous tax: $6,000
Annual net profit: $2,195,000
Leave a Reply