CHAPTER 6
THE INCOME STATEMENT
The Economic Consequences of Financial
Reporting
• Financial reporting has economic consequences including:
1 Financial information can affect the distribution of wealth among
investors. More informed investors, or investors employing security
analysts, may be able to increase their wealth at the expense of less
informed investors.
2 Financial information can affect the level of risk accepted by a firm.
As discussed earlier, focusing on short-term, less risky, projects may
have long-term detrimental effects.
3 Financial information can affect the rate of capital formation in the
economy and result in a reallocation of wealth between consumption
and investment within the economy.
4 Financial information can affect how investment is allocated among
firms.
• These economic consequences may have a differential
impact on different user groups and future deliberations of
standards must consider these economic consequences
Elements of the Income Statement
• the primary focus of financial reporting is to
provide information about a company’s
performance
• The income statement reports on
performance and the elements of the income
statement were defined IAS 1 as:
–
–
–
–
Revenues
Gains
Expenses
Losses
IAS1
International Acc. - IASs
4
IAS 1 Presentation of Financial Statements
• This Standard drescribes the basis for presentation of
general purpose financial statements to ensure
comparability both with the entity’s financial
statements of previous periods and with the financial
statements of other entities.
• It sets out overall requirements for the presentation of
financial statements, guidelines for their structure and
minimum requirements for their content.
International Acc. - IASs
5
IAS 1
• A complete set of financial statements comprises:
–
–
–
–
–
(a) a statement of financial position as at the end of the period;
(b) a statement of comprehensive income for the period;
(c) a statement of changes in equity for the period;
(d) a statement of cash flows for the period;
(e) notes, comprising a summary of significant accounting policies and
other explanatory information; and
– (f) a statement of financial position as at the beginning of the earliest
comparative period when an entity applies an accounting policy
retrospectively or makes a retrospective restatement of items in its
financial statements, or when it reclassifies items in its financial
statements.
International Acc. - IASs
6
IAS 1
• IAS 1 requires an entity to present, in a statement of
changes in equity, all owner changes in equity.
• All non-owner changes in equity (i.e. comprehensive
income) are required to be presented in one statement of
comprehensive income or in two statements (a separate
income statement and a statement of comprehensive
income).
• Components of comprehensive income are not permitted
to be presented in the statement of changes in equity.
International Acc. - IASs
7
SFAS No 130 - Reporting
Comprehensive Income
• Original issues:
1 Whether comprehensive income should be
reported?
2 Whether cumulative accounting adjustments
should be included in comprehensive income?
3 How the components of comprehensive income
should be classified for disclosure
4 How comprehensive income should be disclosed
in the financial statements
5 Whether the components of other comprehensive
income should be disclosed before or after their
related tax effects
International Accounting Standards
• International Accounting Standards Committee has:
1 Defined the concepts of performance and income in “Framework
for the Preparation and Presentation of Financial Statements”
2 Discussed the content and format of the income statement in IAS
No. 1, “ Presentation of Financial Statements”
3 Defined the concept of revenue in IAS No. 18, “Revenue.”
4 Described the preferred format for interim financial statements in
IAS No. 34 - “Interim Financial Reporting”
5 Described the preferred format for reporting discontinued
operations in IAS No 35 “Discontinued Operations”
IASC Definitions of Performance
and Income
•Profit is used to measure performance or as
the basis for other measures
•Measurement of income is dependent on the
concept of capital maintenance used by the
enterprise
– Physical capital maintenance
– Financial capital maintenance
IASC Definitions of Performance
and Income
• The IASC definition of income encompasses both
revenue and expenses
• The IASC has not made the distinction between
ordinary and nonordinary operations contained in
SFAC No. 6
• A proposed standard would require a “Statement
of Non-owner Movements in Equity”
• Encourages an analysis of income and expenses
based on their nature or function in the enterprise
IAS No. 1
Presentation of Financial Statements
• Requires an operating/non operating separation
and disclosure of the following components of
income:
Revenue
Results of operating activities
Finance costs
Income from associates and joint ventures
Taxes
Profit or loss from ordinary activities
Extraordinary items
Minority interest
Net profit or loss
• FASB Staff Reaction
IAS No. 8 - Net Profit or Loss for a
Period, Fundamental Errors and Changes
in Accounting Policies
• Defined the concept of net profit and loss
for: normal operations, extraordinary items
and accounting changes in a manner similar
to U. S. GAAP
• Discontinued operations and errors defined
somewhat differently:
– Errors allowed alternate treatment
– Discontinued operations are ordinary unless they
qualify as extraordinary
• FASB Staff Reaction
IAS No. 18 - Revenue
• Revenue should be recognized when:
1 The enterprise has transferred to the buyer the significant risks and
rewards of ownership of goods
2 The enterprise doesn’t retain managerial involvement or control over
the goods sold
3 The amount can be measured reliably
4 It is probable that economic benefits associated with the transaction
will flow to the enterprise
5 The costs associated with the transaction can be measured reliably
• U. S. GAAP does not specifically address the issue of
revenue
• If it did, there would probably be a difference because of
the IASC use of the term probable future economic
benefit
• FASB Staff Reaction
IAS No 34
Interim Financial Reporting
• Does not specify which enterprises should present
interim financial reports - left to be decided by
laws or regulations
• The minimum content of an interim financial
report is a condensed balance sheet, condensed
income statement, condensed cash flow statement,
condensed statement of changes in equity and
explanatory notes.
• Also requires disclosure of unusual events
• FASB Staff Reaction