Session 5 and 6.pdf

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

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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

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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

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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

Documents

Session 5 and 6.pdf