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8/14/2019 Session 5 and 6.pdf
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Corporate Financial Reporting
Session- 5
IIMC-PGP-2013: Prof. Arpita Ghosh
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Learning Goals - Income Statement
Revenue Vs Gains, Expenses Vs Losses
Expenditure and Expense
Product cost and Period Cost
Income Statement DRL, Infosys
Earning Per Share
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Revenue: Economic resources earned from Core Activities, Increases Equity
1. Recognise when Earning process is complete
Completion of performance: when goods/ services have been provided Persuasive evidence of order exists , Price is fixed or determinable
2. Collectability is reasonably assured - How much revenue to be recognized?
Recognize only to the extent, to which ultimate collection from customer isreasonably assured
IFRS: When significant risks & rewards of ownership of the goods have been passed Amount of revenue and expected associated costs can be measured reliably
Chapter C2 (p180)
Gains :
Increases in Equity resulting from peripheral or incidental transactions (i.e. other thanthose which generate revenue or are new contribution by owners)
Might be beyond entitys control
Described by the source (Gain on sale of equipment), Measured at Netamounts, Realizability
Gains unlike revenues do not arise out of core operations and therefore are
expected to be non-recurring
Revenues and Gains
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Expenses and Losses
Expenses:
Resources consumed or used in the process of generating revenue
Relates to core operations of the entity
Decreases Equity (not by way of distribution to owners)
Losses:
Results from peripheral or incidental transactions (i.e. other than those generatingexpenses for earning revenue or distribution to owners)
Decreases Equity
Source, Net Amount, Recognized when Loss is evident (lost a lawsuit andcompensation is payable)
Includes Non-reciprocal transactions like loss by fire
Net Income = (Revenues + Gains) (Expenses + Losses)
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Cost: is a monetary measurement of resources consumed for some purpose
Expenditure : Cost of all goods and services acquired during the year
Results in decrease in assets (Cash) or increase in liability(on credit - A/P) associatedwith cost incurrence
Apply Matching Principle, the associated cost is either an asset or an expense
If cost benefits future periods Asset In BS (Capital expenditure)
Otherwise Expense in IS (Revenue expenditure)
Expense: is an item of cost applicable to current accounting period, benefits have expired
What is the effect on Owners Equity (OE) ?
If Asset: OE remains unaffected; If Expense: OE reduces What happens if you recognized an asset as an expense & Matching Principle
violated ?
Overstatement of Expenses, Understatement of Assets and Shareholders Equity
Are Cost, Expenditure and Expense same ?
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Capital and Revenue Expenditure
Two companies C and E started with cash and equity share capital of Rs 1000
Capitalize Rs 900; SLM Dep, UL=3, RV=0 Expense Rs 900 in year 1
C EYear 1 2 3 Year 1 2 3
Revenue 1500 1500 1500 Revenue 1500 1500 1500
Cash Exp 500 500 500 Cash Ex 1400 500 500
Depn 300 300 300 Depn 0 0 0
PBT 700 700 700 PBT 100 1000 1000
Tax @30% 210 210 210 30 300 300PAT 490 490 490 70 700 700
Retained
Earnings 490 980 1470
Retained
Earnings 70 770 1470
Share Capital 1000 1000 1000 1000 1000 1000
Shareholders'Equity 1490 1980 2470 1070 1770 2470
Asset -Net
BlockBegin 900 600 300
Asset -
Net Block 0 0 0
Asset -Net
Block -
Closing 600 300 0 6
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A cost is an expense for the year in case of either of the three situations:
1. It has cause and effect relationship with revenues for the year
Direct Matching : Cost of goods sold, commission to sales person
2. It relates to the activities for the accounting period which might have no directcause and effect relation with sales volume for the period
Office Salary, Other Administrative Expenses, Advertising Expense, TrainingExpense
Association with revenue can only be broadly or indirectly determined (likesystematic and rational allocation of cost of Plant bought during the currentor previous periods)
3. Even if cant be associated with operations of a period, it can be an expense if
It cant be associated with future revenues and therefore is recognised inthe immediate period (like inventory assessed obsolete)
There is no future economic benefits from it to meet asset recognitioncriteria (like Amount spent on research, Loss out of fire)
Recognition of Expense
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Product costs
Are connected with production of goods
Includes Material cost, Labour cost and other costs incurred to convert the RMinto Finished Goods
Also called Inventoriable Cost
Added to Inventory (assets) till the products are sold
Charged to IS as and when goods are sold (Matching Principle)
Cause and Effect relation with Sales, Important for ascertaining Gross Profits Do not have an impact on income until the product has been sold
Period Costs
Are costs associated with a given accounting period which are expenses in theperiod in which they are incurred
Can not be traced to any revenue transaction during the period, No Cause & Effectrelationship with Revenues
General costs of being in the business like General and Administrative Expenses
What if there is difference of opinion in classifying a cost like Production Administrationas Period cost or Product cost ?
Product Cost and Period Cost
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Cost of Goods Sold
Raw Material :
Opening RM
+ RM Purchases (net)
+ Freight-in, if any
- Closing RM= Raw Material
Consumed in
production
+ Opening WIP
- Closing WIP
+ Opening FG
= Goods available forSale
- Closing FG
= Cost of GoodsSold (COGS)
Raw MaterialConsumed
= Total Manufacturing Costs
+ Manufacturing Exp
Incl. depreciation on
factory assets
+ Direct Labour Costs
= Cost of goodsmanufactured
Total Manufacturing CostsRaw MaterialConsumed
Conversion Costs
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A condensed income statement
that arrives at net income in a
single step
Subtract total expenses from
total revenues
Two reasons for using the
single-step format:
No profits until total revenues
exceed total expenses.
Format is simpler and easier
to read.
Single-Step Income Statement
Income Statement Presentation
10
Revenues
Net sales $1,248,624
Interest income 5,600
Total revenues $1,254,224
Costs and expenses
Cost of goods sold $815,040
Selling expenses 219,120
General and administrative 138,016
Interest expense 10,524
Total costs and expenses 1,182,700
Income before income taxes $71,524
Income taxes 13,524
Net income $58,000
Earnings per share $2.90
Income Statement
For the Year Ended December 31, 2010
Cruz Corporation
All major categories
of revenues
All major categories
of expenses
Income Tax listed separately
Income Statement Forms : Single Step and Multi-Step
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Infosys Limited
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Presented in a series ofsteps, or subtotals, toarrive at net income
Highlights the components
of net income Separates sources of
operating income fromnon-operating sources
Three important line items:
Gross profit, Income from operations(Operating Income)
Net income.
Income Statement Presentation
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Multiple-Step Income Statement
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Multiple-Step Income Statement: Infosys
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Types of companies and their Operations
Merchandising or Trading Companies Retailer or Wholesaler
Buy and Sell products in the same form in which acquired Merchandise Inventory: Cost of goods acquired but not sold
Manufacturing Companies
Converts raw material and purchased parts into finished goods
Makes and Sells products Three types of Inventories RM, WIP, FG
Service Companies
Do not sell a physical product
Furnishes intangible services rather than tangible products Example: Hotels, Legal firms
Might have some material inventories
like service of the plumber, Job in progress, but no FG
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Multistep Income Statements : Components
Net Sales
Cost of Goods Sold
Step 1: Gross Margin
Operating Expenses
Step 2: Income from Operations
Other Revenues and Expenses
Step 3: Inc. Before Income Taxes
Income Taxes Expense
Step 4: Net Income
minus
minus
minus
equals
equals
equals
equals
plus or minus
Revenues
Operating Expenses
Step 1: Income from Operations
Other Revenues and Expenses
Step 2: Inc. Bef. Income Taxes
Income Taxes Expense
Step 3: Net Income
minus
equals
plus or minus
equals
minus
equals
Service Merchandising/ Manufacturing
Non-Operating
EBT
Income for Share holders and EPS (Basic and Diluted)
Not used in aService business
PAT
Operating
Income
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Gross Sale and Net Sales
Gross sales equal the total cash sales and total credit sales during a given
accounting period Revenue is recorded when earned under Revenue recognition rule Revenue is recognized even though cash may not be collected until the
following accounting period
Net Sales - Amount of sales and trends in net sales over time are used toanalyze a companys progress
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Gross Sales 1,20,000
Less: Taxes, If any (like Excise Duty) 20,000
Less: Sales Returns and Allowances 600Less: Sales Discounts 120
Net Sales 99,280
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Gross Profits
Cost of Goods Sold (COGS) :
Aggregate of cost of purchase or production of units sold and cost incurred tobring them to the location and condition of sales
Matched with Revenues generated during the period, Product Cost
Gross Profits
= Net Sales Cost of Goods Sold
Comparison with past, Industry
Gross Margin : Absolute
Gross Margin/ Net Sales
Shows efficiency of
Pricing, Purchasing
& Manufacturing Process
Can also be improved by Operating Exp
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Cost of Goods Purchased : Merchandising company
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Begin with : Purchase Price * Quantity Purchased
Exclude: Purchase Returns and Purchase Discounts= Net Purchases
Include: Freight in, Taxes (like Customs duty, Road Taxes) Transit Insurance,Handling Charges (Unloading etc)
= Cost of Goods Purchased
Purchases 60,000
Less: Purchase Returns
and Purchase Discounts
800
Add: Freight-In, Taxes, If
any (like Customs Duty),
Handling Charges, Transit
Insurance Premium
5,000
Cost of goods Purchased 64,200
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Companies use either a perpetual inventory system or a periodic inventory system to
account for inventory.
Merchandising Operations - Flow of Costs and COGS
Ins
Outs
Beginning Inventory + Cost of goods Purchased
= Cost of goods Available for Sale = Cost of goods Sold + Ending Inventory
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Purchases net of Purchase Returns and Discounts 300000
Add: Freight inwards, Transit Insurance , Others like handling
Charges (related to Purchases)
4000
=Cost of goods Purchased 304000
Add: Opening Inventory 10000
= Cost of goods available for sale 314000
Less: Closing Inventory 4000
=Cost of goods sold 310000
Calculation of Cost of goods sold (COGS) - For Merchandising Company
Beginning Inventory Cost of goods Purchased
Cost of Goods Sold Ending Inventory
Cost of Goods
Available for Sale
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Perpetual System
Maintain detailed records of the cost ofeach inventory purchase and sale.
Records continuously show inventorythat should be on hand.
Company determines cost of goods sold
each time a sale occurs. Physical inventory count for verification
of accuracy of records
Traditionally used for merchandise withhigh unit values.
Provides better control over inventories identifies loss
Requires additional clerical work andadditional cost to maintain inventoryrecords.
Periodic System
Do not keep detailed records of thegoods on hand.
No Running account of changes ininventory as and when sales occur
At the end of the accounting period,the ending inventory on hand isdetermined by physical count
and Cost of goods sold is calculatedat that time as follows :
Merchandising Operations - Flow of Costs
Beginning inventory $ 100,000
Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000
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DRL: Flow of Costs and COGS
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Operating Expenses and Income from Operation
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Expenses other than cost of goods sold that are incurred in running a business
Selling Expenses
Cost of storing goods,
preparing goods for sale
Advertising
Promoting sales (Sales Commission)
Freight out expense (FOBDestination)
General & Administrative Expenses
Accounting
Personnel (Salaries)
Credit & CollectionsExpenses related to overall
operations (Stationery, Telephone)
General Occupancy Expenses: Rent,
Utilities, Insurance (To be allocated:
Selling and Gen & Adm Expenses) Operating Income: Gross Profit - Operating Expenses
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Operating Expenses, Operating Income , EBITDA
Operating Expenses : Period Costs
EBITDA = Gross Profit - Operating Expenses (excl. Depreciation) [CASH PROFITS]
Operating Income = EBITDA Depreciation, Amortization, Depletion
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Other Revenues and Expenses: Non- operating Activities
Various revenues, expenses, gains and losses unrelated to companys main line
of operations, Not part of a companys operating activities
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EBIT and EBT
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Earnings Before Interest and Taxes (EBIT)
= Operating Income
+ Other Revenues and Gains
Other Expenses and Losses
Income before income taxes (EBT) = EBIT Interest Expense
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Income before income taxes and Net Income
28
Income before income
taxes
Amount a company has earned from all activities:
operating and non-operatingbefore taking into account
the amount of income taxes it incurred
Net income Bottom line is what remains of the gross margin after
operating expenses are deducted, other revenues and expenses are added or deducted, and income taxes expense are deducted Represents earnings that accrue to stockholders Amount transferred to Retained Earnings from IS
Less
Income taxes expense
Provision for income taxes, represent the expense for
taxes on corporate income
Net income = Income before income taxes Income taxes expense
= EBIT Interest Expense Income taxes expense
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Income
Statement
Presentation
29
Net Profit Margin
= Net Income
Net Sales
Measures the
extent by which
selling price covers
all expenses
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20XX
Total Revenues:
Sales Revenue (Net Sales)
Gross Sales (Price per unit * Units sold)
Less: Taxes, Sales Returns and Discounts
Other Operating Income
Less: Cost of Goods Sold
Raw Material Consumed(opening + Purchases closing)
Direct Labour Cost
Manufacturing Expenses
Adjustment for WIP(Add: Opening WIP Less: closing WIP)
Adjustment for FG
(Add: Opening FG, Less: closing FG)COGS
GROSS PROFIT
Less: Operating Expenses (SG&A) excluding
Depreciation
EBITDA
(operating Profit before Depreciation)
Continuation 20XX
EBITDA
Less: Depreciation, Depletion,
AmortizationOPERATING PROFIT
or Profit from Operations
Add: Other Income (Non-Operating)
(includes Interest Income)
Less:
Other Expenses (Non-Operating)
EBIT
(Earnings Before Interest and Taxes )
Less: Interest Expense
EBT (Earnings Before Tax)
Less: Income Tax
Less: Minority Interest, if any
PAT
(Earnings or Profits After Tax)
or (Net Income or Net Profits)
Less: Dividend to Preference SH
Profits Available to Equity SHs
EPS
Multiple Step Income Statement
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Thank You
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