FINANCIAL REPORTING AND ANALYSIS Unit -3 Session:6 RVS Institute of Management Studies & Research FINANCIAL REPORTING AND ANALYSIS Unit -3 Session:6

CONTENTS Understanding Income Statements: Introduction Depreciation and Amortization Revenue Recognition Expenses Recognition.

Income Statement - Introduction Profits are a measure of a company’s well being and perceived value addition by the customer. The Profit & Loss account is a report card of the financial performance of the firm, for a particular period (and not as on a particular day) Profit & Loss Account is also known as P&L statement or Income statement. The word Earnings and Profits are also used interchangeably.

Introduction Profit and Loss account gives an idea about what has transpired during the year, in terms of business activities. It is one of the linking points for the 2 Balance sheets – at the beginning of the year and at the end of the year.

Different Views of Profits Based on the requirement of people working in a company or analyzing it, various views of profits are available. These can be calculated from a basic income statement by moving from top to the bottom. Sales are known as topline since they are at the top of an income statement. Profits are known as bottom line since they appear as the last line in the Income statement.

Format of Income Statement

Different Views of Profit Gross Profit is useful for a specific product unit head, since they are looking at maximizing the profit from the product sold. EBITDA is useful at a CEO level, since they are trying to maximize the benefits out of the company’s operations. EBIT is useful as an indicator for lenders, since they want to evaluate the company’s ability to repay interest. The tax department and government are concerned about the Profit Before Taxes. Finally, shareholders are concerned about the Net Profit numbers.

EBT EBIT EBITDA Check Yourself! Gross Profit minus Other operating expenses EBT A EBIT B EBITDA C

EBT EBIT EBITDA Check Yourself! Gross Profit minus Other operating expenses EBT A EBIT B EBITDA C

Check Yourself! EBT minus Tax Net Profit A EBIT B EBITDA C

Check Yourself! EBT minus Tax Net Profit A EBIT B EBITDA C

Sample Income Statement- Ashok Leyland

Each Line Item in Income Statement

Income Statement Headers Gross Sales - Revenue from sale of products or services Excise Duty / Service Tax - Tax Paid to the government on production or sale of services Other Income - Income from sources other than the normal operations of business - Such as income from investments Raw Material - The Raw material used for manufacturing the products Staff Cost - Payments made to staff Other Expenditure - Ancillary expenses - electricity, marketing etc Total Expenses - Sum of all of the above EBITDA - Profits generated from the normal course of business. This is given by sales minus expenses. Note that this excludes other income since that is not income generated by normal operations of business

Income Statement Headers Depreciation - Any fixed Asset purchased is not written off as an expense in the same year. The capital expenditure is assumed to be divided over its life. Only the value which goes away in one year is accounted as an expense in the P&L account. Interest - Interest paid on loans the company has raised PBT - Profits Before Tax ( EBITDA + Other Income - Depreciation - Interest) Tax - Corporate Tax  Profits - Net profit available for distribution to shareholder

Depreciation Refers to gradual consumption of a long term resource or asset. This gradual consumption is captured by reducing the accounting value of the resource in each period. The Balance sheet shows a reduction in the value of the asset Let’s say a truck is purchased in year 2010 for Rs10 lacs. We assume the truck can be useful for the next 10 years, after which, it will have to be replaced. The reason could be wear and tear or obsolescence of the model

Depreciation This is pure accounting treatment and need not indicate actual sale of the truck in any year. Actual outflow of cash took place in year 1, but is accounted for over 10 years. Remember – Depreciation is a notional expense.

Amortization Depreciation for Intangible assets is known as Amortisation. For Example, if a telecom company bids for a license for 10 years, and pays Rs 4000 crore, then every year, it will write off Rs 400 crore. This is known as amortization.

Revenue Recognition Revenue recognition can occur independently of cash movements—for example, in the case of the sale of goods and services on credit or receipt of cash in advance of providing goods and services A fundamental principle of accrual accounting is that revenue is recognized (reported on the income statement) in the period in which it is earned. Specific Situations – Revenue Recognition Long Term Contracts Instalment Sales Barter Transactions Accrual accounting - records revenues and expenses when they are incurred, regardless of when cash is exchanged

Expense Recognition The Fundamental principle is that a company recognizes expenses in the period in which it consumes (i.e., uses up) the economic benefits associated with the expenditure. Matching principle: Costs are matched with revenues. As with revenue recognition, expense recognition can occur independently of cash movements. Inventory and cost of goods sold or Plant, property, and equipment and depreciation

Self Test Gradual consumption of a long term resource or asset. Depreciation A company recognizes expenses in the period in which it consumes the economic benefits associated with the expenditure. Expense Recognition Any decrease in Intangible asset is known as Amortization A fundamental principle of accrual accounting is that revenue is recognized in the period in which it is earned Revenue Recognition Inventory is an example for________ recognition Expense Long term contract is an example for_________ recognition Revenue

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