Above-the-Line

Definition

Above-the-line is a term used in accounting to denote entries listed above a horizontal line on a company’s profit and loss account (also known as income statement). These entries include all normal revenue, expenses, and operating activities. The line separates the company’s normal operating profit (or loss) from the entries reflecting how the profit is distributed, such as taxes, interest expense, and dividends.

Examples

Sales Revenue: The total income generated from the sale of goods and services before any costs or expenses are deducted.
Cost of Goods Sold (COGS): The direct costs attributable to the production of goods sold by a company.
Operating Expenses: Regular expenses necessary for the day-to-day functioning of the business, such as salaries, rent, and utilities.
Gross Profit: The difference between sales revenue and the cost of goods sold.
Selling, General and Administrative Expenses (SG&A): Costs not directly tied to the production of goods or services, including salaries for staff not involved in production and advertising expenses.

Frequently Asked Questions (FAQs)

What is the difference between above-the-line and below-the-line items?

Above-the-line items reflect a company’s normal, ongoing business activities. In contrast, below-the-line items include non-operating activities like interest, taxes, or extraordinary items that are outside the usual course of business.

How did FRS 3 change the treatment of exceptional and extraordinary items?

FRS 3, introduced in October 1992, redefined extraordinary items as exceptional and required them to be shown above the line. This aimed to standardize reporting practices and reduce the manipulation of earnings figures.

Why is it important to distinguish between above-the-line and below-the-line items?

Distinguishing these items helps stakeholders understand the core operating performance of a company and separate it from financial activities or one-time events.

Yes, under current UK accounting practices, exceptional items are shown above the line and included in the calculation of EPS, affecting the perceived profitability of the company.

Are extraordinary items ever included in above-the-line entries?

Under current standards, most items that were previously classified as extraordinary are now treated as exceptional and included above the line.

Below-the-Line: Items found below the horizontal line separating operating profit and distribution of profits, including interest expenses and taxes.
Profit and Loss Account: A financial statement outlining a company’s revenues, costs, and expenses during a specific period.
Earnings per Share (EPS): A financial ratio indicating the profitability of a company allocated to each outstanding share.
Exceptional Items: Significant transactions that are part of ordinary business activities but are non-recurring.
Extraordinary Items: Previously defined as non-recurring transactions outside the normal scope of business, but now generally classified as exceptional.

Online Resources

Suggested Books for Further Studies

Financial Accounting Theory by William R. Scott
Accounting Made Simple: Accounting Explained in 100 Pages or Less by Mike Piper
Financial Statement Analysis and Security Valuation by Stephen H. Penman
Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
Principles of Accounting by Belverd E. Needles and Marian Powers

Accounting Basics: “Above-the-Line” Fundamentals Quiz

### What does the term above-the-line refer to in accounting? - [x] Entries listed above a horizontal line on the profit and loss statement. - [ ] Entries related to off-balance sheet activities. - [ ] Entries indicating non-operational events. - [ ] Breakdown of distribution of profits. > **Explanation:** Above-the-line refers to the items listed above the horizontal line that separates operating profits and the profit distribution entries on the profit and loss statement. ### How are typical operating expenses categorized in a profit and loss account? - [ ] Below-the-line - [x] Above-the-line - [ ] As extraordinary items - [ ] As capital expenses > **Explanation:** Operating expenses are considered above-the-line costs as they are part of normal business operations and are listed before the calculation of net profit. ### Which of the following would NOT be considered an above-the-line item? - [x] Interest expenses - [ ] Sales revenue - [ ] Cost of Goods Sold (COGS) - [ ] Operating expenses > **Explanation:** Interest expenses are typically considered below-the-line items as they relate to financing rather than core business operations. ### Before the introduction of FRS 3, how were extraordinary items handled? - [ ] They were included above-the-line. - [ ] They were excluded from financial statements. - [x] They were shown below-the-line. - [ ] They affected gross profit calculation. > **Explanation:** Prior to FRS 3, extraordinary items were typically shown below-the-line, separating them from ordinary activities. ### What significant change did FRS 3 bring about in financial reporting? - [ ] Defined all extraordinary items as dismissible. - [x] Redefined extraordinary items as exceptional and included them above-the-line. - [ ] Eliminated the concept of exceptional items. - [ ] Changed the gross profit calculation method. > **Explanation:** FRS 3 redefined extraordinary items as exceptional and included them above-the-line to improve reporting transparency. ### Why are above-the-line items significant for stakeholders? - [ ] They reflect changes in capital structure. - [ ] They depict non-recurring business events. - [x] They give insight into core operating performance. - [ ] They indicate how profits are distributed. > **Explanation:** Above-the-line items are crucial as they provide a clear view of the company’s core operating performance, separate from non-recurring or financial activities. ### What typically constitutes the majority of above-the-line entries? - [x] Revenue and operating expenses - [ ] Personnel changes - [ ] Dividend payments - [ ] Net interest expenses > **Explanation:** The majority of above-the-line entries will consist of revenue and operating expenses as these represent the primary business activities. ### How does above-the-line differ from below-the-line in profit allocation? - [ ] Above-the-line excludes any profit allocation. - [ ] There is no difference; both include profit allocations. - [ ] Above-the-line only includes tax provisions. - [x] Above-the-line reflects the business earnings before profit allocation. > **Explanation:** Above-the-line items reflect earnings before any profit allocation or specific financial adjustments, which are addressed below the line. ### How did the previous treatment of extraordinary items potentially mislead investors? - [ ] It exaggerated core operational income. - [ ] It was too transparent. - [x] It allowed manipulation of earnings per share. - [ ] It affected dividend calculations unfavorably. > **Explanation:** The treatment of extraordinary items allowed manipulation of earnings per share by selectively classifying gains and losses to influence financial perceptions. ### Which of the following is a typical above-the-line accounting entry for a business? - [x] Sales revenue. - [ ] Dividends paid. - [ ] Tax refunds. - [ ] Treasury stock activities. > **Explanation:** Sales revenue is a quintessential above-the-line entry as it arises from everyday business operations.

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