Refer to IFRS conceptual framework for:
- Definitions of Income and Expenses
- Going concern, accrual concept, matching concept realisation, prudence
- Going concern is important for valuation
Income Statement overall purpose – to discuss profit or wealth generated over a period of
time – not enough to inform users of wealth accumulation at a point in time (BS)
If revenue>expense, then profit else loss.
Sales revenue – COGS = Gross profit
We can add additional revenues such as interest received. Other costs such as purchases,
freight etc. are deduced.
Then operating expenses are deducted (also called selling, management and admin
expenses). Overhead may also be used but it is a managerial accounting term
Then we get EBIT Earnings before Interest and Tax.
Depreciation and amortisation are truly non-cash so not considered if EBITA is shown.
Then we do non-operating expense and income (interest for example). These are financial
expenses and income.
Relevant to note that dividends will not feature here. That is after tax.
Tax is deducted finally and you get net profit.
Distribution of profits will be shown in Statement of Equity and NOT under INcome
Statement.
COGS:
- Perpetual inventory is more advanced. Big companies may use tech to monitor
technology and right now it is a bit delayed.
When to recognise revenue? It depends contract to contract. For some businesses where
they do sales on CIF basis for example, it might be at time of delivery. But it can also be
when it is shipped as that is when the goods are not in our control anymore.
Depreciation is not a cash flow and does not mention CFS. It is only mentioned as a
reconciliation in the indirect CFS.
It is usually depreciated over the period when it is expected to generated revenue.
The market value at the time may only be indicative of depreciation amount under net
profit value method of depreciation, but it is not going to determine the depreciation period
by itself – that is determined by the period for which it is expected to generate revenue.
Under straight line method, we will mention accumulated depreciation up till this period.
So in the income statement, we will only show depreciation for that year.
But in the balance sheet, we will mention the cost, indicate accumulated depreciation
which includes this year’s depreciation and arrive at the net book value.
Straight line method does not represent the market value.
Reducing balance method – Fixed percentage rate of depreciation ton written down value
method. We will not have double declining in the exam, we will only have a fixed
percentage for each year under reducing balance.
For assignment, these figures are important:
• Gross profit
• Operating profit (deduct operating expense from gross profit)
• Profit before taxes (after deducting financial expenses
• Net profit (after tax)
IFRS says balance sheet primacy so we want BS to have accurate amounts.
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Tutorial
Treasury shares – Shares issued but not outstanding, bought back
Items such as issue of shares, bonds, re-purchase etc are transactions which do not affect
profits at all and will not show in income statement
Usuually one CFS to be prepared in exam