CHAPTER FOUR

The Statement of Comprehensive Income

Glossary of Terms

Profit In a broad sense, the difference between revenue and expenses.

Sometimes known as Net Income. There are ‘layers’ of profit, e.g.
Operating Profit, Net profit before/after Tax, Profit attributable to
Ordinary Shareholders, etc.
Income Amount earned either through revenue or other sources.
Revenue The amount receivable from the sale of goods or the provision of
services.
Depreciation The amount charged each year for the usage of depreciable fixed
assets.

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Introduction

The Statement of comprehensive income is a measure of the financial

performance of a business. In other words the statement shows the
difference between revenue (sale of goods or fees charged for services
performed), and expenses incurred. This difference is the profit or loss made
by the business for a specific financial period.

We have already learnt in Chapter 1 that revenue and expense accounts are
part of the owner’s equity in the accounting equation. Any transaction that
increases revenue will increase owner’s equity and any transaction that
increases expenses will decrease owner’s equity.

Definitions

Revenue is defined as
 an increase in economic benefits during an accounting period in the form
of
 increases in assets
 or decreases in liabilities that
 also increases the owner’s equity other than the contributions from the
owner.

For example, the sale of goods to a customer for cash would increase the
asset cash and increase owner’s equity and thus falls under the definition of
income. However, if a client paid R10 000 in advance of the work being done,
the cash asset would be increased but not owner’s equity as the amount paid
is a liability until the work has been done. It does not therefore fall under the
definition of income. When the work has been carried out, the liability will be
reduced and owner’s equity increased. At this point it is income.

Expenses are defined as

 decreases in economic benefits during an accounting period in the form of
 decreases in assets or
 increases in liabilities, that
 result in the decrease in the owner’s equity other than withdrawals by the
owner.

For example, the payment of an expense such as light and water would result
in a decrease in the asset cash, and a decrease in owner’s equity. Also, the
purchase of stationery on credit increases liabilities and decreases owner’s
equity

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Relationship between the Statement of Financial Position and the
statement of comprehensive income

You may have noticed from the above notes and from previous exercises that
every transaction affects the accounting equation in a way that keeps the
accounting equation in balance at all times. If the transaction results in
revenue for the business, it will either increase an asset or decrease a liability
and increase owner’s equity. If the transaction results in an expense, the
opposite will occur.

Thus all transactions affect the Statement of Financial Position including

revenue and expense transactions. For convenience and ease of
understanding, all revenue and expense amounts are shown in a separate
“Statement of comprehensive income” and the resulting profit or loss is shown
in the Statement of Financial Position as single line under the owner’s equity.

The Statement of Financial Position is a statement of the financial position at

a certain date, but the profit or loss figure shown under owner’s equity is the
result of all revenue and expense transactions from the date of the previous
Statement of Financial Position to the date of the present Statement of
Financial Position.

Thus while the Statement of Financial Position is headed “Statement of

Financial Position at 31 December…”, the statement of comprehensive
income is headed “Statement of comprehensive income for the year ended
31 December…”

Format of the statement of comprehensive income

The basic format of the statement of comprehensive income is simply:

R
Revenue 1 500
Less expenses 800
Profit 700

This basic format will vary considerably depending on the type of ownership,
i.e. sole proprietor, partnership, close corporation, or company, and will vary
again according to the type of business conducted by these ownership
entities. Examples of the different types of business forms are:
 Service enterprise where the business provides a service for a fee or
commission.
 Trading enterprise where the business buys goods and on-sells them to its
customers.
 Manufacturer, where the business buys raw materials and converts them
into goods for sale to trading enterprises.
 Financial institutions such as banks and insurance companies.
 Clubs and other non-profit organisations. While these entities may make a
profit or a loss, they are called “non-profit” because the members (who are
the owners) may not participate in a distribution of the profits.
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In these notes we will deal only with the first two types.

The two examples below relate to sole proprietors, firstly as a service

enterprise and then as a trading enterprise.

Jon Doe – Quantity Surveyor

Statement of comprehensive income for the year ended 31 December
20x2.
R R
Fee income 165 000
Other income
Interest on call deposits 2 500
167 500
Expenses
Salaries and wages 24 500
Rent 14 200
Electricity and water 7 500
Telephone 1 200
Insurance 1 000
Motor vehicle expenses 3 400
Depreciation
- Office equipment 1 000
- Motor vehicles 600 (53 400)
Net profit 114 100

Conan B – Trading as Construction Dynamics

Statement of comprehensive income for the year ended 28 February
20x3
R R
Revenue/Sales 232 000
Cost of sales (154 000)
Gross profit 78 000
Other income
- Interest on investments 2 000
80 000
Expenses
Salaries and wages 34 500
Rent 12 200
Electricity and water 8 500
Telephone 2 300
Insurance 1 200
Motor vehicle expenses 5 400
Depreciation
- Fixtures & equipment 2 600
- Motor vehicles 1 500 68 200
Net profit 11 800

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Statement of Changes in Equity

The accounting equation states that assets equal liabilities plus owners'
equity. Owners' equity comprises capital contributions by the owners,
withdrawals of capital or profits by the owners, and profits made by the
business, i.e. revenue less expenses.

IAS 1 requires that we should show the changes in a separate financial

statement known as the Statement of Changes in Equity. In the Statement of
Financial Position only the net balance on the owner's equity is shown.

Consideration of certain aspects of the statement of comprehensive

incomes

Sales and cost of sales

A trading enterprise buys goods from a manufacturer or wholesaler and sells

these goods as they are to its customers. It charges the goods at cost plus a
mark-up that will cover expenses and give a profit to the owner. The value
added by the business would be in the form of:
 A convenient location. (Customers don’t have to go to different factories to
buy their groceries, clothes, appliances, etc.)
 Many different types and makes of goods to give customers a wide choice.
 Product knowledge, etc.

Selling price or Sales amount

We start off with the “cost price” of the article bought for resale – in a trading
undertaking.
“Mark-up” is the percent (%) of the “cost” which we add to the “cost” to arrive
at the “selling price”

COST PRICE
Plus MARK UP % of cost
Equals SELLING PRICE

Or

SELLING PRICE
Less GROSS PROFIT % of selling price
Equals COST PRICE

The mark-up is the difference between the selling price and the cost price.
This is the same as gross profit.
Therefore the ‘mark-up” must be the same as the “gross profit”.

The gross profit percentage is the gross profit divided by the selling price
multiplied by 100, often referred to as the “margin”.

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The statement of comprehensive income therefore distinguishes between the
sales of goods at their selling price and the cost of those goods. This may
seem simple enough, but in times of ever-increasing prices, and where goods
are sold at a rapid rate, it is not always easy to know the cost of the goods
that have been sold.

Many stores to-day use technology to assist with this problem. The barcode
seen on most retail goods is scanned at the till and this process accomplishes
a number of tasks:
 Prepares the customer’s till slip showing the goods bought, the price of
each item and the total payable by the customer.
 Calculates the value-added tax.
 Informs the “back-room” computer of the goods sold. The computer then
deducts the quantity of the goods sold from the record for each item and
calculates the cost of these goods. The computer will also reorder goods
when the quantities reach a minimum level.

Thus the cost of sales is recorded each time a sale is made and the total cost
of sales at the end of a financial period is available when the statement of
comprehensive income is prepared. Where such technology is not available,
a more traditional method of calculating the cost of sales must be used.

This involves counting and valuing the goods on hand at the end of a financial
period. Valuation is at cost and this now completes the information (together
with the value of inventory at the beginning of the period, and total purchases
for the period) needed to compute the cost of sales for the accounting period.

The computation of cost of sales is thus as follows:

R
Value of inventory at beginning of period 40 000
Purchases during period 189 000
Cost of goods available for sale 229 000
Value of inventory at end of period (75 000)
Cost of sales 154 000

The valuation of inventory at the end of an accounting period is a

controversial subject and there are a number of methods that can be used.
Changing the valuation of inventory is one of the simplest means of
manipulating the final net profit. Taking the example above, if the closing
inventory is valued at R80 000 (same quantity of goods), the cost of sales
would be R149 000 and the gross and net profits increased by R5 000.

IAS 2 deals with the valuation of inventory, and the concepts of comparability
and consistency require a business to maintain the same method of valuation
from year to year. If a business does change its method of valuation, it should
state that fact and the effect of the change in financial statements.

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Other considerations in the computation of cost of sales

Purchases include all the costs incurred to get the goods into the shop or
warehouse, i.e. invoice price, transport costs, landing charges, insurance,
taxes and duties. All costs associated with the goods after they have been
received are treated as operating expenses. For example, wages and
salaries of store personnel, fire insurance, shelving, rent of warehouse, etc.

Cash discounts and trade discounts are deducted from the cost price of the
goods purchased and only the net amount is recorded in the accounting
records.

Methods of valuation of closing inventory include (amongst others)

 First in, first out,
 Last in, first out (may not be used)
 Average cost.

First in, first out (FIFO) assumes for valuation purposes that the first goods to
arrive in the warehouse or shop are the first to be sold. Last in, first out
(LIFO) assumes that the last goods to arrive are the first to be sold. Average
cost averages the cost of an item each time a purchase is made. The
following example shows how this works in practice.

On 1 March a retail store had 20 containers of pool chlorine on hand (opening

stock) at a cost of R18 each. During the first week of March the following
purchases were made:
Date Quantity Cost per unit
2 48 20
3 30 22
4 15 24
6 10 25

On 7 March, 60 units were sold.

Calculate the closing inventory and the cost of sales using the following
methods:
a) FIFO
b) LIFO
c) Average cost

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FIFO – first in first out

Sales (at cost)

Date Units Unit cost Total Units Unit cost Total
R R R R
Opening stock
1
Purchases
2
3
4
6
7
Available for sale

R
Opening inventory
Purchases
Cost of goods available for sale
Closing inventory (8 @ R20 + 30 @ R22 + 15 @ R24 + 10
@ R25)
Cost of sales

LIFO - last in first out (not used)

Sales (at cost)
Date Units Unit cost Total Units Unit cost Total
R R R R
Opening stock
1 20 18 360
Purchases
2 48 20 960
3 30 22 660
4 15 24 360
6 10 25 250
7 10 25 250
15 24 360
30 22 660
5 20 100
123 2 590 60 1 370

R
Opening inventory 360
Purchases (2 590-360) 2 230
Cost of goods available for sale 2 590
Closing inventory (43 @ R20 + 20 @ R18) (1 220)
Cost of sales 1 370

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Average cost

Sales (at cost)

Date Units Unit cost Total Units Unit cost Total
R R R R
Opening stock
1
Purchases
2
3
4
6

R
Opening inventory
Purchases (
Cost of goods available for sale
Closing inventory (123 – 60 @ R21.06)
Cost of sales

You will notice that the cost of sales is highest under LIFO and lowest under
FIFO. Average cost is between these two. The choice of method will
therefore have a material effect on both the gross and net profit of a trading
business. This will tend to even out over a number of years, which is why it is
important that trading entities do not change methods without full disclosure.
It must also be mentioned that LIFO is not allowed under both South African
and International statements of generally accepted accounting practice. It is
shown here for illustrative purposes only.

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Periodic system

The general ledger accounts used in this system are

 The inventory account – which reflects the value of the stock when
stock is physically counted and valued using one of the methods
explained already ( FIFO or average cost)
 The purchases account – to record the cost price of the goods
purchased for resale
 Separate accounts to record the cost of getting the goods to the point
of sale – eg carriage on purchases, import duties, freight costs,
insurance on goods being transported etc
 Sales account

Cost of sales is calculated as follows:

Opening stock
Add purchases
Add additional costs
= cost of goods available for sale
Less closing stock
= cost of sales

Gross profit = sales less cost of sales.

Perpetual system

The general ledger accounts used in this system are

 Trading stock the cost price of stock purchased plus all additional costs
are recorded directly into this account.( a debit to the Trading stock
account) When goods are sold the cost price of the goods sold is
subtracted from this account ( a credit to the trading stock account)
 Cost of sales reflects the cost of the goods sold
 Sales

Physical stock counts are done to verify whether the stock on hand agrees
with the accounting records, if there is a difference this stock deficit is shown
as an additional amount added to the cost of the goods sold ( cost of sales).
There are exceptions as when there is a fire – this could be shown as a
separate expense item in the statement of comprehensive income and there
would be additional explanatory notes.

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Summary of entries using perpetual and periodic inventory systems, adapted
(Kolitz and Quinn)
Transaction Perpetual Periodic

Purchase of goods for Dr Trading stock Dr Purchases

cash Cr Bank Cr Bank
Purchases of goods on
credit
Return of goods Dr Bank Dr Bank
purchased for cash Cr Trading stock Cr Purchases
Return of goods
purchased on credit
Other cost paid in cash Dr Trading stock Dr Transport on
eg transport Cr Bank purchases
Cr Bank
Sale of goods on credit Dr Accounts Receivable Dr Accounts Receivable
Cr Sales Cr Sales

Recording cost of sales And At the end of the period

Dr Cost of Sales
Cr Trading stock
Sale of goods for cash Dr Bank Dr Bank
Cr Sales Cr Sales

Recording cost of sales And At the end of the period*

Dr Cost of Sales
Cr Trading stock
Return of goods sold on Dr Sales returns Dr Sales returns
credit Cr Accounts Receivable Cr Accounts Receivable

Reversal of cost of Dr Trading Stock Taken into account at the

goods sold Cr Cost of Sales end of the period*

 This is done using the calculation given on the previous page

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When to recognise revenue and expenses in the preparation of the
Statement of comprehensive income

We learnt in Chapter 1 about the accrual system and the importance of time in
the preparation of financial statements. This is particularly important in the
preparation of the Statement of comprehensive income.

Revenue is recognised as income when the service has been performed or

the goods have been sold to the customer and the amount for the service or
goods is due and payable by the customer. It is not necessary for the cash to
be paid, but the sale must be legally enforceable.

Expenses are recognised in the accounting period in which they are incurred.
Like revenue, expenses do not have to be paid for to be recognised. In fact
expenses paid in advance may not be recognised in an accounting period if
the expenses have not been used up by the end of the period. For example,
rent of R1 200 may be paid to cover the next six months. If the financial year
ends after two months only R400 will be recognised as an expense in the
current financial period and the balance of R800 will be shown as an asset in
the Statement of Financial Position. This conforms to the accrual convention
whereby revenue and expenses are matched in the same accounting period.

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Determining the cost of an asset

The general rule is that all costs to get the asset into a position where it may
be used as a productive asset are included in the original cost. In the case of
a machine this includes site preparation, transport to the site, installation,
testing, and other charges such as insurance in transit, landing charges and
legal fees.

In the case of a motor vehicle, extra charges such as alloy wheels, air-
conditioning and radio-tape would be part of the capital cost, but items such
as the first annual licence fee and the first tank of petrol would be treated as
expenses even if included on the dealer’s invoice.

Expenditure on a fixed asset during its life falls into two categories:
 Expenditure to improve the performance of the asset or to increase its
useful life. In some cases it may also result in a revised estimate of the
residual value.
 Expenditure to maintain the asset.

The first is considered to be capital expenditure and is added to the cost of

the asset. This will require a recalculation of depreciation taking into account
the remaining years of useful life, the revised cost of the asset, depreciation
charged to date and the estimated residual value. Depreciation already
charged in previous years is not altered; only future depreciation will be
changed.

The second type of expenditure (expenditure to maintain the asset) is

considered to be part of normal operating expenses and is written off in the
statement of comprehensive income during the year the expense was
incurred. Judgement is sometimes required to distinguish between these two
types of expenditure. For example, if a gear lock were fitted to a vehicle two
years after acquisition at a cost of R600, this would probably be written off
immediately as the amount is not material and will not improve the
performance or the life of the vehicle (other than preventing it from being
stolen!)

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Depreciation

Fixed assets (sometimes called ‘non-current assets’) are written off, or

depreciated over their useful lives. This does not apply to land, which for
most businesses is the location rather than the raw land. The value could
therefore fluctuate depending on the value of the surrounding area. We will
deal with changes in the value of land later.

There are four factors to be considered in calculating the annual depreciation

expense of a wasting asset such as motor vehicles, plant, office equipment,
etc.
 Cost of the asset
 Its useful or economic life
 Any residual value at the end of its useful life
 The method of depreciation

There are a number of methods of depreciation that can be employed.

 The straight-line method
 The reducing balance method
 The units of production method, in which the total number of units to
be produced by a machine are estimated at the start of its life. The
annual depreciation is based on the actual units produced during
that year as a proportion of the total estimate.
 The sum of the digits methods. This is a variation of the reducing
balance method.

The method chosen for a particular asset should conform to the nature of the
asset, its use and the likely maintenance expenditure on the asset. For
example, proponents of the reducing balance method maintain that
maintenance costs are usually higher in the latter years of an assets life.
Therefore the higher depreciation in the early years and low maintenance will
be almost the same as the low depreciation and high maintenance in the latter
years.

In these notes we will deal only with the first two methods.

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The straight-line method of depreciation
is calculated by dividing the original cost less any residual value by the
number of years of useful life.

Example: a machine is purchased on 1 January 1999 for R100 000. The

useful life of the machine is five years and the scrap or residual value at the
end of its life is estimated to be R10 000. The year-end is 31 December. The
annual depreciation is thus:
=

This amount is debited to depreciation expense and credited to accumulated

depreciation. No cash is involved. The asset has already been paid for and
now we are accounting for the expense of using the asset. This conforms to
the accrual concept whereby we match the cost of the asset over the periods
in which revenue is earned by the asset. The various methods of depreciation
attempt to do this as accurately as possible depending on the type and nature
of the asset.

The reducing balance method

Calculates the annual depreciation by using a percentage on the cost of the
asset less the accumulated depreciation at the beginning of the year.

Taking the previous example and using a rate of 40%, the depreciation for
each year would be:
R
Cost 100 000
Depreciation year 1 (40 000)
Balance 60 000
Depreciation year 2
Balance
Depreciation year 3
Balance
Depreciation year 4
Balance
Depreciation year 5
Balance

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Example of generic Fixed asset register outline
Details:

Cost price
Date of purchase
Rate of depreciation
Description

Date Current Accumulated Carrying value

depreciation depreciation (CP – Accum
Dep)

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Computing the profit or loss on the sale of a fixed asset

The carrying value of a fixed asset is the difference between its original cost
(plus any capitalised additions) and the accumulated depreciation on that
asset. The difference between this carrying value and the selling price of an
asset is therefore a profit (selling price greater than the carrying value), or a
loss (selling price less than the carrying value). The profit or loss on the sale
of an asset is shown in the statement of comprehensive income under “Other
Income/ expenses”.

When an asset is purchased, the cost is debited to the asset account in the
general ledger. This will not be an account for the specific asset, but a
general account for all assets in that classification, e.g. Land & Buildings,
Plant & Machinery, Motor Vehicles, etc. Depreciation is charged to a
depreciation expense account and credited to “Accumulated Depreciation” for
the asset classification. Thus the carrying amount for say “Plant & Machinery”
is the difference between Plant & Machinery cost and Plant & Machinery
Accumulated Depreciation.

When a specific asset is sold or scrapped, the original cost is credited to the
asset cost account and debited to an account called “Asset Disposal
Account”. The accumulated depreciation on that asset to the date of disposal
is debited to the Accumulated Depreciation account and credited to the Asset
Disposal Account. At this point the asset disposal account shows the carrying
amount of the asset sold.

The amount received for the sale of the asset is debited to the bank account
and credited to the asset disposal account. The profit or loss on the sale can
now be computed in the asset disposal account; if a profit will be debited to
the disposal account and credited to an account called “Profit or Loss on the
Disposal of Assets”, and vice versa for a loss.

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Example
At 31 December 20x3, Plant & Machinery had a debit balance of R1 550 000
and Plant & Machinery Accumulated Depreciation had a credit balance of
R645 000.
On 31 March 20x4, a variable tracking machine was sold for R9 500.
The original cost of the machine on 1 January 20x0 was R85 000.
Plant & Machinery is depreciated at 20% on the straight-line basis.
The year-end is 31 December.

Calculate the carrying amount of the machine at the date of the sale and the
profit or loss on the sale. Show also the ledger accounts with the relevant
entries to record the disposal.
R
Original cost (1/1/20x0) 85 000
Depreciation to 31 December 20x31
Depreciation from 1 January 20x4 to 31 March 20x42
Carrying amount at 31 March 20x4
Selling price
Loss on sale

Workings:

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Ledger accounts

Plant & Machinery (cost)

Date Details Amount Date Details Amount
31/12/x Balance 1 550 000 31/3/x4 Disposal a/c 85 000
3

P & M Accumulated Depreciation

Date Details Amount Date Details Amount
31/12/x3 Balance 645 000
31/3/ x4 Disposal a/c

Asset Disposal Account

Date Details Amount Date Details Amount
31/3/ x4 P&M 85 000

To summarise

Cost price
Less accumulated deprecation
= Carrying value (book value)

if you compare the selling price with the carrying value:

if the selling price is greater than the carrying value the difference is a profit
if the selling price is less than the carrying value the difference is a loss

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Bad debts

Goods or services sold to a customer ‘on credit’ are debited to the customer’s
account (accounts receivable) and credited to sales. In other words we
account for the revenue on the sale immediately it becomes a valid sale and
an enforceable debt. We assume that the customer will pay within a
reasonable time.

It the customer does not pay the debt and it becomes clear that he is unable
to pay (e.g. the business has gone into liquidation, or the customer has
disappeared), then the debt must be ‘written off’. This is accounted for as an
expense called “Bad Debts”. The journal entry to account for this is simply:

Most retail businesses with thousands of customers, e.g. Edgars Stores,

Woolworths, Ellerine Furnishers, etc. know from experience that a certain
number of their customers will not pay their accounts. This is one of the risks
of business. Although a business may take all the necessary precautions
when opening accounts for customers such as ensuring that the customer is
earning a steady salary, has good references, etc., some bad debts will
always slip through the net. Credit control, which will be dealt with later
treading a line between turning away potentially good business and granting
credit so liberally that bad debts get out of control.

Example

Extract from a trial balance at 28 February 20x1.

Dr. Cr.
R R
Accounts receivable 540 000

Bad debts expense 9 500

Notes
1. Bad debts expense represents bad debts written off during the year.
2. Additional bad debts of R6 500 must be written off.

What will the post-adjustment trial balance in respect of the above three
accounts look like?
Pre-adjustment Adjustments Post-adjustment
Dr. Cr. Dr. Cr. Dr. Cr.
Accounts receivable

Bad debts expense

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