17-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Chapter 17 The income statement

17-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Learning objectives Understand how profit is calculated and how the profit of an organisation should be disclosed in the financial statements of a reporting entity Appreciate that the determination of the profits for a given period is heavily dependent upon both professional judgment and on the particular accounting model that has been adopted Understand that an entity is required to produce both an income statement and a statement of changes in equity and appreciate that both of these statements need to be read in order to appreciate more fully the various income and expenses earned or incurred in a particular financial period

17-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Learning objectives (cont.) Understand how to account for prior period errors Understand how to account for changes in accounting estimates Appreciate that while profit provides an indication of the financial performance of an organisation, it does not reveal much about the social performance of a reporting entity

17-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Introduction to the income statement Income (according to the AASB Framework) is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity other than those relating to contributions from equity participants

17-5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Introduction to the income statement (cont.) Revenues (AASB Framework) –are a class of income relating typically to an entity’s ordinary activities Gains (AASB Framework) –are a class of income that need not relate to an entity’s ordinary activities

17-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Introduction to the income statement (cont.) Expenses (AASB Framework) are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity other than those relating to distributions to equity participants Profit = Income less Expenses

17-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Introduction to the income statement (cont.) The AASB Framework sets the following recognition criteria –it must be probable that any future economic benefit will flow to or from the entity; and –the item must have a cost or value that can be measured reliably Determination of income, revenues and expenses depends on the measurement models adopted –currently we have a ‘mixed approach’, as various valuation approaches are used

17-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Introduction to the income statement (cont.) There is often disagreement about how certain expenses should be measured –for example, the options provided to managers Without any specific rules about a particular type of expense, different entities will record different expenses, with implications for profit AASB 2 ‘Share Based Payment’ has diminished the discretion that may be exercised regarding placing a cost on share options

17-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Introduction to the income statement (cont.) Where professional judgment is used, an entity should disclose assumptions made and the basis of those assumptions Different accountants might determine different levels of profits, but they can still be true and fair –if they provide all relevant information and comply with applicable accounting standards

17-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Introduction to the income statement (cont.) All discretion relating to some expenses has been removed –for example, all research expenditure is to be written off as incurred –the problem is that readers of financial reports cannot differentiate between entities Firms might have agreements in place relying on reported profits –for example, dividend constraints, management bonus agreements and interest-coverage clauses Timing of recognition of income or expenses can be important to managers

17-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Profit and loss disclosure Format for income statement prescribed in AASB 101 ‘Presentation of Financial Statements’ Some expenses and revenues are adjusted directly against equity –for example, prior period errors (AASB 108)

17-12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Income statement (AASB 101) Includes all items of income and expense unless an Australian Accounting Standard requires otherwise On face of income statement –revenue –finance costs –share of profit or loss of associates and joint ventures –tax expense –post-tax profit or loss of discontinued operations –profit or loss

17-13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Income statement (AASB 101) (cont.) Also on face of income statement –profit or loss attributable to minority interest; and –profit or loss attributable to equity holders of the parent Additional line items, headings and subtotals may be included

17-14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Income statement (AASB 101) (cont.) Entities may choose a presentation format based on either –the nature of expenses incurred; or –the function of expenses within the entity Entities must select the most relevant and reliable format Extraordinary items are not to be disclosed –this represents a departure from the former AASB 1018

17-15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Income statement (AASB 101) (cont.) The nature and amount of material items of income and expenses must be separately disclosed, for example –write-downs of inventories or property, plant and equipment –restructuring of entities’ activities –disposals of items of property, plant and equipment –disposals of investments –discontinued operations –litigation settlements –other reversals of provisions

17-16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Statement of changes in equity Discloses information about direct adjustments to equity On the face of the statement –profit or loss for the period –each item and total of income and expense required to be recognised directly in equity –total income and expense for the period –for each equity component, effects of changes in accounting policies and corrections of errors

17-17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Statement of changes in equity (cont.) Either on the face of the statement or in the notes –amounts of transactions with equity holders acting in their capacity as equity holders –balance of retained earnings at beginning and end of period with changes –reconciliation between carrying amount of each class of contributed equity and reserve at beginning and end of the period, separately disclosing each change

17-18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Other disclosure issues Prior period errors – what are they? Prior period errors are omissions from, and misstatements in, the entity’s financial report for one or more prior periods arising from a failure to use, or misuse of, reliable information that (a) was available when the financial reports for those periods were authorised for issue; and (b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of the financial report. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud (par. 5, AASB 108) –to be adjusted against opening retained earnings, restating comparative information (AASB 108) –therefore prior errors will not appear in the income statement other than as adjustments to comparatives –this represents a departure from the ‘old’ AASB 1018, which required errors to be corrected in the period in which they were detected

17-19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Other disclosure issues (cont.) Changes in accounting estimates (AASB 108) –estimates made of bad debts, inventory obsolescence, etc –estimates need revision if circumstances change or new information or more experience is obtained –if the change in estimate affects current period only  Recognise in period of change –If change affects current and future periods  Recognise in period of change and future periods

17-20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Other disclosure issues (cont.) Other disclosure requirements in AASB 101 are –the amount of dividends (either on face of income statement, in the statement of changes in equity, or in the notes) –payments to auditors for audit and non-audit services The are also a variety of other required expense and income disclosures stipulated in other accounting standards

17-21 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Other disclosure issues (cont.) AASB 118 ‘Revenue’ requires the disclosure of –accounting policies applied for revenue recognition –revenue from the sale of goods, rendering of services, interest, royalties and dividends –revenue from exchanges of goods or services

17-22 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Profit as a guide to an organisation’s success Profit is a measure of financial performance Non-financial issues are not included directly in the calculation of financial profit or loss –for example, social and environmental performance Media do not typically mention accounting methods used to calculate profit or loss Entities can be very successful financially, but be causing extensive damage to the environment

17-23 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Profit as a guide to an organisation’s success (cont.) Numerous reasons why traditional financial accounting ignores environmental and social impacts –for example, based on model emphasising property rights and market transactions Interests of investors might be put above the interests of other stakeholders Financial performance indicators are not comprehensive in regards to total organisational performance

17-24 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Summary The chapter considers how to construct an income statement and a statement of changes in equity Profits are influenced directly by the asset and liability measurement rules applied Format of statements governed by AASB 101 Statement of changes in equity provides a reasonably comprehensive picture of financial performance Profit calculations typically ignore social costs and benefits