ACCT1046 Lecture Notes - Lecture 4: Comprehensive Income, Retained Earnings, Share Capital
Module 4 topic 3
The income statement
ā¢ The income statement provides details of the income and expenses of an
organisation.
ā¢ As we learned elsewhere:
ā Income is defined as:
ā¢ 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.
ā¢ We could also say income increases the value of assets or decreases the value of liabilities.
We exclude contributions from owners such as investing capital.
ā Expenses are defined as:
ā¢ 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.
ā¢ We could also say expenses decreases the value of assets or increases the value of
liabilities. We exclude contributions from owners such as withdrawing capital.
ā¢ The difference between income and expenses is a profit or a loss.
ā¢ Profit increases owners equity.
ā¢ Losses decrease owners equity , as:
ā¢ OE end of period = OE beginning of period + (Income ā Expenses) + C - D
ā¢ Profit or loss is a key measure of financial performance, and is a focus of media
interest.
Our four questions
1. Why report?
- Both internal and external users need information about financial performance.
Investors need the information in order to determine such things as likely dividend
payments. Managers need to know profits being generated from activities so as to
determine if various facets of the organisation are viable. Lenders want to know
whether an organisation is likely to be able to repay amounts due. Employees and
unions might be interested in knowing whether it appears that an organisation is
likely to be able to keep paying wages and also if it could pay more to employees.
For many organisations, it is a legal requirement to report profits.
2. To whom are we reporting?
- From the above, we can see that there are many different stakeholders who might
have an interest in an organisationīs profitability ā investors, creditors, employees,
employee unions, customers, government, news media, and so on.
3. What are we reporting?
- We will be reporting various items of income and expense (together with
comparatives for prior periods) which we will discuss shortly.
4. How/where are we reporting?
- For larger organisations, the information will generally be prepared in accordance
with accounting standards and the information will often be provided within an
īannual reportī which also provides a balance sheet (also called a statement of
financial position), a statement of cash flows, a statement of changes in equity,
and supporting notes.
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Module 4 topic 3
The reporting period
ā¢ āProfitā is calculated for a period of time.
ā¢ Even though an organisation might be expected to last indefinitely (it is a āgoing
concernā) financial accounting breaks the life up into discreet (and somewhat artificial)
time periods.
ā¢ This requires various items of income and expense to be allocated to the time periods
which in itself often requires a deal of professional judgement.
ā¢ Organisations typically report their results for a year. They can also do it for six month
periods, or even monthly.
ā¢ In Australia the financial year is typically from July 1 to June 30 whereas in other
countries it is typically January 1 to December 31. Other financial years are allowed.
The use of accrual accounting
ā¢ Financial statements are typically prepared on an āaccruals basisā.
ā¢ This means that income is recognised when it is earned and expenses are
recognised when the expense is incurred ā this is not necessarily the same as when
the related cash movement occurs.
Depreciation
ā¢ Depreciation represents another expense which is recognised in a period that
generally differs from when the underlying asset was acquired (and therefore when the
related cash flow occurred).
Many judgments required
ā¢ The practice of accounting requires many judgements to be made.
ā¢ For example, we just had a question about depreciation. A judgement needed to be
made about its useful life and residual value. Many such judgements need to be made.
ā¢ Also, in measuring income and expenses we need to determine whether the
recognition criteria based on āprobabilityā and āmeasurabilityā have been satisfied
ā¢ In relation to liabilities judgements need to be made about the probability of payment
and in some cases estimates have to be made of the actual obligation.
Accounting rules change over time
ā¢ Apart from professional judgement influencing assets, liabilities, income, and
expenses (and therefore profits), as new accounting standards are issued these can
also impact the profit that is calculated.
ā¢ For example a new accounting standard might be issued that:
ā¢ Prohibits goodwill amortisation (not allowed to write off as expense).
ā¢ Requires research expenditure do be expensed rather than capitalised.
ā¢ Requires us to place a cost on share options provided to managers.
ā¢ Requires us to expense (rather than capitalise) all expenditure on internally generated
intangible assets.
ā¢ The point to be made is that the rules of financial accounting are not static, which
means that it is problematic to compare current period reported profits with previous
year profits ā the ārules of the gameā might have changed.
ā¢ This is a fact that is often ignored by people comparing current year financial
performance with previous yearsā financial performance.
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
The income statement: the income statement provides details of the income and expenses of an organisation, as we learned elsewhere: We exclude contributions from owners such as investing capital. Both internal and external users need information about financial performance. Investors need the information in order to determine such things as likely dividend payments. Managers need to know profits being generated from activities so as to determine if various facets of the organisation are viable. Lenders want to know whether an organisation is likely to be able to repay amounts due. Employees and unions might be interested in knowing whether it appears that an organisation is likely to be able to keep paying wages and also if it could pay more to employees. They can also do it for six month periods, or even monthly. In australia the financial year is typically from july 1 to june 30 whereas in other countries it is typically january 1 to december 31.
