ACTG 6580 Chapters 4 and 5 – Income Statement, Statement of Financial Position, and Statement of Cash Flows

ACTG 6580

Chapters 4 and 5 – Income Statement, Statement of Financial Position, and

Statement of Cash Flows

Components of Financial Statements

• A complete set of financial statements comprises:

– Statement of Profit or Loss and Other Comprehensive Income– Statement of Financial Position– Statement of Changes in Equity– Statement of Cash flows– Notes

(IAS 1 para 10)

General Features of Financial Statements • As per IAS 1, the following considerations must be followed in the

presentation of a financial report:

1. Fair presentation and compliance with IFRSs2. Going concern3. Accrual basis of accounting4. Materiality and aggregation 5. Offsetting6. Frequency of reporting7. Comparative information8. Consistency of presentation

General Features of Financial Statements Fair presentation & compliance with IFRSs (IAS 1 para 15-19)• A set of financial statements are required to present fairly an

entity’s financial performance, financial position and cash flows• Applying IFRSs (with additional disclosures where necessary) is

presumed to result in a fair presentation

Going concern (IAS 1 Para 25)• There is an assumption that all entities adopt the going concern

basis of accounting• Exception applies where management intends to liquidate or

cease trading

Accrual basis of accounting• Except for cash flow information, the financial statements are

required to be presented using the accruals basis of accounting

General Features of Financial StatementsMateriality and aggregation

– Each material class of similar items must be presented separately– Items of a dissimilar nature or function must be presented separately,

unless they are immaterial(IAS 1 para 7)

Offsetting– Assets & liabilities and income & expenses are not to be offset, unless

required or permitted by another accounting standard– Offsetting detracts from the ability of the users to understand the

entity’s transactions– Offsetting is appropriate when netting any income with related

expenses arising from the same transaction

(IAS 1 para 32, 34-35)

Frequency of Reporting

• Financial statements should normally be presented at least annually.

• An entity which presents statements for a different period must disclose the reasons and state that its statements are not comparative.

General Features of Financial Statements

Comparative information• Comparative information for the immediately preceding reporting period

must be disclosed for all amounts(IAS 1 para 38)

Consistency of presentation• Financial information must be consistently presented from one period to

the next unless:

– There has been a significant change in the entity’s operations– A change in presentation or classification will provide more relevant

information– An IFRS requires a change in presentation

(IAS 1 para 45)

Statement of Profit or Loss & Other Comprehensive Income

• A prime source of information about an entity’s performance

• Income, expenses and other comprehensive income are included

• Total comprehensive income has two components: 1. Profit or loss (P&L)2. Other comprehensive income (OCI)

• Can be provided in one statement or two separate statements

INCOME includes both revenues and gains.

Revenues - ordinary activities of a company

Gains - may or may not arise from ordinary activities.

FORMAT OF THE INCOME STATEMENT

Elements of the Income Statement

Revenue Accounts Sales revenue Fee revenue Interest revenue Dividend revenue Rent revenue

Gain Accounts Gains on the sale of long-term

assets Unrealized gains on trading

securities.

LO 2

Expense Accounts Cost of goods sold Depreciation expense Interest expense Rent expense Salary expense

EXPENSES include both expenses and losses.

Expenses - ordinary activities of a company

Losses - may or may not arise from ordinary activities.

Loss Accounts Losses on restructuring

charges Losses on the sale of long-

term assets Unrealized losses on trading

securities.

FORMAT OF THE INCOME STATEMENT

Elements of the Income Statement

LO 2

Cost of materials used

Direct labor incurred

Delivery expense

Advertising expense

Function

Expense Classification

Nature

INCOME FROM OPERATIONS

Employee benefits

Depreciation expense

Amortization expense

LO 4

Cost of goods sold

Selling expenses

Administrative

expenses

Function

Expense Classification

Nature

INCOME FROM OPERATIONS

LO 4

The minimum information to be presented on the income statement as defined by IAS 1.82:

► Revenue

► Finance costs

► Share of profit or loss of associates and joint ventures accounted for using the equity method

► A single amount comprising the total of:

► The post-tax profit or loss of discontinued operations

► The post-tax gain or loss recognized on the measurement of fair value less costs to sell or on the disposal of assets or disposal group(s) constituting the discontinued operations

► Tax expense

► Profit or loss

Minimum Information

Discontinued Operations

A component of an entity that either has been disposed of, or

is classified as held-for-sale, and:

1. Represents a major line of business or geographical area of

operations, or

2. Is part of a single, co-coordinated plan to dispose of a

major line of business or geographical area of operations,

or

3. Is a subsidiary acquired exclusively with a view to resell.

INCOME STATEMENT REPORTING

LO 5

Companies report as discontinued operations

1. (in a separate income statement category) the gain or loss

from disposal of a component of a business.

2. The results of operations of a component that has been or

will be disposed of separately from continuing operations.

3. The effects of discontinued operations net of tax as a

separate category, after continuing operations.

INCOME STATEMENT REPORTING

Discontinued Operations

LO 5

Total loss on discontinued operations 800,000

Illustration: Multiplex Inc., a highly diversified company, decides to discontinue its electronics division. During the current year, the electronics division lost £300,000 (net of tax). Multiplex sold the division at the end of the year at a loss of £500,000 (net of tax).Income from continuing operations £20,000,000

Discontinued operations:

Loss from operations, net of tax 300,000

Loss on disposal, net of tax 500,000

Net income £19,200,000ILLUSTRATION 4-11Income Statement Presentation of Discontinued Operations

DISCONTINUED OPERATIONS

LO 5

Income Statement Presentation Extraordinary items

IFRS

► Prohibits extraordinary items, but major revenue and expense items are disclosed in the income statement or notes.

US GAAP

► Extraordinary items are reported separately on the income statement.

Convergence

► In January, 2015, the FASB issued an ASU, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. This eliminates the concept of extraordinary items from GAAP; therefore, no items would be presented or disclosed as an extraordinary item. This would converge presentation with IFRS. This is effective for periods beginning after December 15, 2015.


Other Comprehensive Income (OCI)

• OCI comprises items of income and expense that are not recognized in profit or loss

• Components of OCI comprise:• Changes in a revaluation surplus• Actuarial gains and losses on defined benefit plans• Gains and losses arising from the translation of financial statements

of foreign operations• Gains and losses on remeasuring available-for-sale financial assets• The effective portion of gains and losses on hedging instruments in

a cash flow hedge

Statement of Income and Statement of Comprehensive Income Presentation

IFRS► For fiscal years beginning July 1, 2012 (with early adoption permitted),

IFRS requires the presentation of items in OCI that ultimately may be reclassified into net income to be presented separately from those that will not be reclassified into net income. The tax effect must be shown separately, either by individual item or in aggregate.

► Reclassification adjustments do not arise on changes in revaluation surplus recognized in accordance with IAS 16 (Property, Plant and Equipment) or on actuarial gains and losses on defined benefit plans recognized in accordance with paragraph 93A of IAS 19 (Employee Benefits).

US GAAP► Generally, US GAAP

considers all items recorded in OCI as subject to reclassification into net income and, therefore, no separate presentation groupings are required.

IFRS and US GAAP require comprehensive income to be presented in one statement of comprehensive income or in two separate consecutive statements comprising of a separate statement of income and a statement of comprehensive income.

Classification of Other Comprehensive Income Items

Example 1:

Treadstone International’s controller, Hans Burke, called you yesterday inquiring about the differences for classification of various items in OCI that might be encountered when his company changes from US GAAP to IFRS next year. Hans emailed you a list of potential transactions. Hans would like you to prepare a draft statement of other comprehensive income based on IFRS. The tax rate for all items in OCI is 30%.

2014 2013

Cash flow hedges $ 40 $ (90)

Foreign currency exchange differences 670 550

Available for sale gains 170 64

Defined benefit plan actuarial (losses) / gains (60) 80

Revaluation of property 300 –

Classification of Other Comprehensive Income Items

Example 1 solution (IFRS):

2014 2013

Other comprehensive income:

Items that will not be subsequently reclassified to profit or loss:

Revaluation of property $300

Defined benefit plan actuarial (losses)/gains (60) $ 80

Income tax (72) (24)

168 56

Items that may be reclassified subsequently to profit or loss:

Cash flow hedges 40 (90)

Foreign currency exchange differences 670 550

Available for sale gains 170 64

Income tax (264) (157)

616 367

Other comprehensive income, net of tax $784 $423


• To enhance understandability of the statement IAS 1 requires separate disclosure of the nature and amount of certain material income and expense items including:– Inventory and PPE write-downs– Cost of restructuring– Disposals of PPE & other investments– Profit/(losses) re discontinuing operations – Litigation settlements– Reversals of provisions

• Such disclosures can be made either in the statement or in the notes

Statement of Financial Position• Summarizes the elements directly related to the

measurement of financial position

• Provides the basic information for evaluating an entity’s capital structure and analyzing its liquidity, solvency and financial flexibility

• Provides a basis for computing rates of return

Statement of Financial Position Classifications

• No prescribed format in IAS 1, but assets and liabilities to be classified on basis of: – Current/non-current OR– In order of their liquidity – Whichever is more relevant

• Assets are classified as current or non-current depending on whether they are expected to be sold, consumed or realized as part of the normal operating cycle within 12 months of balance date

Generally any monies available “on demand.”

Cash equivalents - short-term highly liquid investments

that mature within three months or less.

Restrictions or commitments must be disclosed.

Liabilities

Liabilities are current/noncurrent based on settlement

date.

Cash

Current Elements

LO 2

Statement of Financial Position PresentationDebt classification under default for covenant violation

IFRS

► Requires that a lender must waive or modify a debt covenant violation prior to or at the balance sheet date in order for the related debt to be classified as non-current at the balance sheet date.

US GAAP

► Allows debt to retain non-current classification as of the balance sheet date if a lender waives or modifies the related debt covenant violation on or after the balance sheet date but prior to the issuance of the financial statements.

Debt Classification Under Default for Covenant Violation Example

Example 2:

Riley’s Roosters, Inc. (RRI) has a December 31 year-end. As of June 30, 2012, RRI obtains a $100,000 loan from a bank for a new chicken coop facility. The loan is due in 24 months. In December 2012, RRI spends too much of its cash on its holiday party and incurs a debt covenant violation as of December 31, 2012. As a result of the violation, the loan becomes due within 30 days. At this time, RRI asks the bank to waive the violation. RRI tells the bank it will recoup some of the cash by selling the leftover holiday party favors on eBay. On January 5, 2013, the bank agrees to waive the violation. RRI issues its financial statements on January 25, 2013.

► How should this loan be classified (current or non-current) on RRI’s balance sheet as of December 31, 2012 using IFRS and US GAAP?

Debt Classification Under Default for Covenant Violation Example

Solution:

As the bank modified the debt covenant violation subsequent to RRI’s balance sheet date of December 31, 2012 but prior to the financial statement issuance date of January 25, 2013, the debt is classified as current as of the balance sheet date using IFRS but non-current for US GAAP.

Fiscal yearPost-fiscal year and priorto issuance of financials

Balance sheet date

Fiscal yearPost-fiscal year and priorto issuance of financials

IFRS

US GAAP

Example 2 (solution):

► IFRS prohibits deferred tax assets or liabilities to be classified as current.

► US GAAP requires classification as current or non-current based on the nature of the underlying asset or liability.

Deferred Tax Assets and Liabilities

Equity

CLASSIFICATION IN THE STATEMENT

LO 2

Minimum AccountsThe minimum accounts to be presented on the statement of financial position as defined by IAS 1.54 are:

a) Property, plant and equipment

b) Investment property

c) Intangible assets

d) Financial assets (excluding amounts shown under (e), (h) and (i))

e) Investments accounted for using the equity method

f) Biological assets

g) Inventories

h) Trade and other receivables

i) Cash and cash equivalents

j) Total of assets classified as held for sale and assets included in disposal groups classified as held for sale per IFRS 5

The minimum accounts to be presented on the balance sheet as defined by IAS 1.54 (continued):

a) Trade and other payables

b) Provisions

c) Financial liabilities (excluding amounts shown under (a) and (b))

d) Liabilities and assets for current tax per IAS 12

e) Deferred tax liabilities and deferred tax assets per IAS 12

f) Liabilities included in disposal groups classified as held for sale per IFRS 5

g) Minority interest, presented within equity

h) Issued capital and reserves attributable to equity holders of the parent

Minimum Accounts

Statement of Changes in Equity

The following is disclosed in this statement:

• Total comprehensive income for the period attributable to:– Equity holders of parent– Non controlling interests

• For each component of equity– Changes in accounting policies – Corrections of errors required by IAS 8

• For each component of equity a reconciliation between opening and closing balances showing changes resulting from– Profit/(Loss)– OCI– Transactions with equity holders, showing separately distributions to equity

holders

Statement of Changes in Equity

ILLUSTRATION 4-23Statement of Changes in Equity

LO 9

Statement of Cash FlowsSame as US GAAP except:

Cash flow classification

Transaction IFRS US GAAP

Interest paidOperating or financing Operating

Interest receivedOperating or investing Operating

Dividends paidOperating or financing Financing

Dividends received

Operating or investing Operating

Notes • Notes enhance the understandability of the other

statements

• Each item in the statements is cross-referenced to any related information in the notes

• The order of notes is:– Summary of accounting policies – Supporting information for items in statements – Other disclosures:

• Dividends• Company details• Auditor remuneration

Sources Of Estimation Uncertainty

• “an entity shall disclose in notes key assumptions about the future of estimation uncertainty that is material”

(IAS 1 para 125)

• Notes shall include details of:– Their nature– Their carrying amount as at the reporting date

• Examples include:– Future interest rates – Useful lives of non-current assets

Relevant Facts

Following are the key similarities and differences between U.S. GAAP and

IFRS related to the income statement.

Similarities

• Both U.S. GAAP and IFRS require companies to indicate the amount of net

income attributable to non-controlling interest.

• Both U.S. GAAP and IFRS follow the same presentation guidelines for

discontinued operations, but IFRS defines a discontinued operation more

narrowly. Both standard-setters have indicated a willingness to develop a

similar definition to be used in the joint project on financial statement

presentation.

GLOBAL ACCOUNTING INSIGHTS

Relevant Facts

Similarities

• Both U.S. GAAP and IFRS have items that are recognized in equity as part

of other comprehensive income but do not affect net income. Both U.S.

GAAP and IFRS allow a one statement or two statement approach to

preparing the statement of comprehensive income.

Differences

• Presentation of the income statement under U.S. GAAP follows either a

single-step or multiple-step format. IFRS does not mention a single-step or

multiple-step approach.


Relevant Facts

Differences

• The U.S. SEC requires companies to have a functional presentation of

expenses. Under IFRS, companies must classify expenses by either nature

or function. U.S. GAAP does not have that requirement.

• U.S. GAAP has no minimum information requirements for the income

statement. However, the U.S. SEC rules have more rigorous presentation

requirements. IFRS identifies certain minimum items that should be

presented on the income statement.

• U.S. SEC regulations define many key measures and provide requirements

and limitations on companies reporting non-U.S. GAAP information. IFRS

does not define key measures like income from operations.


Relevant Facts

Differences

• U.S. GAAP does not permit revaluation accounting. Under IFRS,

revaluation of property, plant, and equipment, and intangible assets is

permitted and is reported as other comprehensive income. The effect of this

difference is that application of IFRS results in more transactions affecting

equity but not net income.


About The Numbers

The terminology used in the IFRS literature is sometimes different than what is

used in U.S. GAAP. For example, here are some of the differences.


On the Horizon

The IASB and FASB are working on a project that would rework the structure

of financial statements. One stage of this project will address the issue of how

to classify various items in the income statement. A main goal of this new

approach is to provide information that better represents how businesses are

run. In addition, this approach draws attention away from just one number—

net income.


Relevant Facts

Following are the key similarities and differences between U.S. GAAP and

IFRS related to the statement of financial position.

Similarities

• Both U.S. GAAP and IFRS allow the use of the title “balance sheet” or

“statement of financial position.” IFRS recommends but does not require the

use of the title “statement of financial position” rather than balance sheet.

• Both U.S. GAAP and IFRS require disclosures about (1) accounting policies

followed, (2) judgments that management has made in the process of

applying the entity’s accounting policies, and (3) the key assumptions and

estimation uncertainty that could result in a material adjustment.

Comparative prior period information must be presented and financial

statements must be prepared annually.


Relevant Facts

Similarities

• U.S. GAAP and IFRS require presentation of non-controlling interests in the

equity section of the statement of financial position.

Differences

• U.S. GAAP follows the same guidelines as presented in the chapter for

distinguishing between current and noncurrent assets and liabilities.

However, under U.S. GAAP, public companies must follow U.S. SEC

regulations, which require specific line items. In addition, specific U.S.

GAAP mandates certain forms of reporting for this information. IFRS

requires a classified statement of financial position except in very limited

situations.


Relevant Facts

Differences

• Under U.S. GAAP cash is listed first, but under IFRS it is many times listed

last. That is, under IFRS, current assets are usually listed in the reverse

order of liquidity than under U.S. GAAP.

• Use of the term “reserve” is discouraged in U.S. GAAP, but there is no such

prohibition in IFRS.


About The Numbers

The order of presentation in the statement of financial position differs between

U.S. GAAP and IFRS. As indicated in the following table, U.S. companies

generally present current assets, non-current assets, current and non-current

liabilities, and shareholders’ equity. In addition, within the current asset and

liability classifications, items are presented in order of liquidity.


Homework

• E4-7,P4-4, CA4-6• E5-7, P5-3, CA5-3• DUE THURSDAY, SEPTEMBER 10

Documents

ACTG 6580 Chapters 4 and 5 – Income Statement, Statement of Financial Position, and Statement of Cash Flows