General purpose financial statements – further consideration of the income statement, the statement of changes in equity, and the statement of cash flow Flashcards
(30 cards)
The income statement
The income statement provides details of the income and
expenses of an organisation.
Income
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.
Expenses
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.
Difference between income and expenses
The difference between income and expenses is profit (or
loss).
• Profit (losses) increases (decreases) owners equity, as:
OE = OE + (Income – Expenses) + C - D
The use of accrual accounting - income statement
Financial statements are typically prepared on an ‘accruals
basis’. This means that income is recognised when it is earned
and expenses are recognised when the expense is
incurred.
Many judgements required in the preparation of the income statement
• Depreciation: judgement on useful life and residual value).
• Income and expenses: judgement based on ‘probability’
and ‘measurability’.
• Revalue PP& E to fair value will increase depreciation
expense, and therefore decrease profits.
Implications of judgements
very unlikely that different accountants would derive the same ‘profits’.
Accounting rules change over time
• New accounting standards can also impact the profit calculation.
• For example a new accounting standard might be issued that:
• prohibits goodwill amortisation.
• Requires research expenditure do be expensed rather than
capitalised.
• The rules of financial accounting are not static.
• it is problematic to compare current period reported profits with
previous year.
• the ‘rules of the game’ might have changed.
The statement of changes in equity
• Equity is the residual interest in the assets of the entity after
deducting its liabilities.
• For a company, equity might be made up of number of
components, for example, JB Hi-Fi includes the following
accounts:
• Contributed equity
• Reserves
• Retained earnings
Income receivable
This arises when an organisation performs a service but has not been paid for it.
Prepayment
Occurs when a payment for a good or service is made in
advance of receiving the good or service.
• Is considered to be an asset as it provides us with a right to
a future economic benefit.
Income received in advance
• An organisation is paid for a good or service in advance.
• For example, a lawn mowing business might be paid 6
months mowing fees in advance of actually doing the
mowing.
• This would be considered to be a liability.
Accrued expenses
• Accrued expenses
• expenses have been incurred but not yet paid.
• examples include: Accrued wages; Accrued electricity;
Accrued interest.
The statement of cash flows
• The purpose of the statement of cash flows is to provide
details of the cash inflows and outflows of an organisation.
• It provides information that is not directly available from the
balance sheet or the income statement.
Purpose of the statement of cash flows
Assists in assessing the ability of the company or economic
entity to:
• generate cash flows
• meet financial commitments
• fund changes in the scope and/or nature of its activities
• obtain external finance
Items that might cause a difference between profits and cash flows include:
• depreciation and amortisation
• increases/decreases in various receivable and payable
accounts, accrued and prepaid expenses etc.
• loss/gain on sale of plant and equipment
The statement of cash flows is divided into three kinds of
activities:
- Operating Activities
- Investing Activities
- Financing Activities
Cash flows from operating activities
The principal revenue-producing activities of the entity and
other activities that are not investing and financing activities.
Cash flows from operating activities include:
• receipts from customers
• payments to suppliers and employees
• cash generated from operations
• interest paid
• income taxes paid
Cash flows from investing activities
The acquisition and/or disposal of long-term and other
investments.
Cash flows from investing activities include:
• purchase of property, plant and equipment
• proceeds from sale of equipment
• dividends received
Cash flows from financing activities
Relating to changing the size and/or composition of the
financial structure of the entity.
Cash flows from financing activities include:
• proceeds from issue of shares
• proceeds from borrowings
• repayment of borrowings
• dividends paid
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.
To whom are we reporting
From the above, we can see that there are many different stakeholders who might have an interest in an organisation’s profitability – investors, creditors, employees, employee unions, customers, government, news media, and so on.
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.
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 ‘annual report’ 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.
