The Income Statement by Binam Ghimire 1 Learning

The Income Statement by Binam Ghimire 1

Learning Objectives 1. Gross Profit and the Trading Performance 2. Net Profit 3. The Recognition of Items in the Income Statement 4. IAS 1 Presentation of the Income Statement 5. Analysis of Performance

Introduction q As we have previously stated: q. Performance is the ability of an enterprise to earn a profit on the resources that have been invested in it. q. The IFRS Framework states that information about performance is primarily provided in an Income Statement q Let’s start by looking at a very simple example…

Income Statement of F Clothes UK for the year ending 31 st December 20 xx. Sales 160, 000 Less Cost of Goods Sold Opening Inventory 15, 000 + Purchases 75, 000 90, 000 less Closing Inventory 10, 000 80, 000 Gross Profit 80, 000 Less Expenses Wages 50, 000 Admin Expenses 12, 000 Rent 10, 000 Electricity 3, 000 Gas 2, 000 77, 000 Net Profit 3, 000

Performance Evaluation q they are able to sell goods profitably q their Gross Margin is 50%, i. e. Gross Profit as a percentage of Sales: Gross Profit X 100 = 80, 000 x 100 = 50% Sales 160, 000 q indicating that what they bought for £ 80, they were able to sell for £ 160, a 100% mark up. q Not bad, they either buy well or sell well, which is what the Gross Margin and Gross Profit examine - the companies trading performance

q the business generate a Net Profit, let us say a profit after all expenses, of £ 3, 000 and a Net Margin of 1. 875%: Net Profit x 100 = 3, 000 x 100 = 1. 875% Sales 160, 000 q Clearly expenses and in particular Wages eat up most of the trading (Gross) profit. q Whether 1. 875% is good or bad depends the previous years performance, the type of business and who is receiving the wages !

Income Statement Definitions q Income. q. Income is 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. q Expense. q. Expenses are 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.

Income q The definition of income encompasses both revenue and gains. q Revenue arises in the course of the ordinary activities of an enterprise and is referred to by a variety of different names including: qsales, qfees, qinterest, qdividends, qroyalties and qrent. q Gains represent other items that meet the definition of income and may, or may not, arise in the course of the ordinary activities of an enterprise. q. Gains represent increases in economic benefits and as such are no different in nature from revenue. Hence, they are not regarded as constituting a separate element in the IASC Framework.

Expenses q The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the enterprise. q Expenses that arise in the course of the ordinary activities of the enterprise include, for example, cost of sales, wages and depreciation. q They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, property, plant and equipment. q Losses represent other items that meet the definition of expenses and may, or may not, arise in the course of the ordinary activities of the enterprise. Losses represent decreases in economic benefits and as such they are no different in nature from other expenses. Hence, they are not regarded as a separate element in this Framework.

Recognition of the Elements of Financial Statements Income q when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. q this means, that recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities (for example, the net increase in assets arising on a sale of goods or services or the decrease in liabilities arising from the waiver of a debt payable).

Recognition of the Elements of Financial Statements Expenses q when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. q this means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets (for example, the accrual of employee entitlements or the depreciation of equipment).

IAS 1 Presentation of Financial Statements The Income Statement q q q q q Minimum Income Statement Items (a) revenue; (b) finance costs; (c) share of the profit or loss of associates and joint ventures accounted for using the equity method; (d) a single amount comprising the total of (i) the post-tax profit or loss of discontinued operations and (ii) the post-tax gain or loss recognised on the disposal of the assets or disposal group(s) constituting the discontinued operation; and; (e) tax expense; and (f) profit or loss. (i) profit or loss attributable to minority interest; and (ii) profit or loss attributable to equity holders of the parent.

IAS 1 Presentation of Financial Statements q Additional line items may be needed to fairly present the enterprise's results of operations q Extraordinary Items q No items may be presented on the face of the income statement or in the notes as "extraordinary items". q If Material. . q Certain items must be disclosed either on the face of the income statement or in the notes, if material, including: (a) write-downs of inventories to net realisable value or of property, plant and equipment to recoverable amount, as well as reversals of such write-downs; (b) restructurings of the activities of an entity and reversals of any provisions for the costs of restructuring; (c) disposals of items of property, plant and equipment; (d) disposals of investments; (e) discontinuing operations; (f) litigation settlements; and (g) other reversals of provisions

IAS 1 Presentation of Financial Statements q Expenses should be analysed either by nature (raw materials, staffing costs, depreciation, etc. ) or by function (cost of sales, selling, administrative, etc. ) either on the face of the income statement or in the notes. q If an enterprise categorises by function, additional information on the nature of expenses -- at a minimum depreciation, amortisation, and staff costs -- must be disclosed.

Example q Let’s examine Exhibit 2. 2 q What does it show ?

q Before we leave this session take a look at the Income Statement of Tesco what does it show ? q Calculate their Gross Margin & Net Margin

q Gross Margin Gross Profit X 100 = 8. 3% Sales q Net Margin (after Tax) Net Profit X 100 = 4. 4% Sales q Good or Bad ? 5, 060 x 100 = 60, 931 2, 671 x 100 = 60, 931

Summary q Performance is the ability of an enterprise to earn a profit on the resources that have been invested in it. q The IFRS Framework states that information about performance is primarily provided in an Income Statement q The Performance can (in part) be analysed with reference to the Gross and Net Margin BUT these differ depending upon the nature of the business q In fact, the whole financial statement can differ as we shall now see…

Common Size Statements Income Statement Company 1 2 3 4 5 6 7 8 9 10 11 12 13 Profit Statement Sales Revenue Service & Other revenue Total Revenue 100% Cost of goods Sold Operating Expenses Research & Development Interest Tax Total Expenses Net Income 100% 97. 8 16. 2 100% % % 2. 2 83. 8 100% % % 100% 100% 96. 4 % 58. 9 % 33. 0 % 69. 2 % 20. 2 % 57. 2 % 29. 7 % 0. 9% 0. 8% 1. 3% 3. 2% 3. 6% 5. 3% 97. 7 95. 1 % % 2. 3 4. 9% % 93. 9 % 6. 1 % 93. 0 % 7. 0 % 16. 9 % 33. 3 % 12. 5 % 11. 9 % 74. 6 % 25. 4 % 12. 2 % 67. 8 % 78. 9 % 1. 8% 83. 9 % 16. 1 100% % 100% 85. 9 % 61. 4 % 11. 8 % 78. 1 % 11. 7 % 1. 9% 3. 0% 4. 2% 6. 7% 7. 0% 4. 8% 8. 0% 1. 2% 88. 5 % 11. 5 % 87. 8 % 12. 2 % 93. 7 % 6. 3 % 85. 4 97. 7 % % 14. 6 2. 3% % 100 % 23. 7 % 53. 1 % 77. 9 % 30. 0 % 100% 17. 6 47. 5 % % 1. 5. % 8. 1% 78. 3 97. 0 % % 21. 7 3. 0% % 85. 6 % 14. 4 %

Common Size Statements Balance Sheet Balance 1 2 3 4 5 6 7 8 9 10 11 Sheet Fixed 3. 5 9. 1 40. 1 41. 9 23. 1 60. 0 123. 9 125. 8 136. 1 21. 1 23. 8 Assets Stock 17. 2 22. 4 13. 0 3. 4 22. 6 2. 1 1. 9 0. 6 5. 1 Debtors 12. 7 0. 4 1. 2 8. 3 9. 0 15. 9 0. 9 12. 3 4. 2 111. 7 21. 2 Cash & 9. 3 2. 3 10. 0 0. 3 61. 0 25. 8 4. 1 0. 4 2. 5 18. 8 181. Securities 1 Other 2. 2 2. 3 3. 7 17. 9 4. 9 10. 5 4. 9 9. 3 19. 1 25. 6 11. 0 Assets Total 27. 7 31. 5 77. 4 81. 8 101. 4 134. 8 135. 9 149. 9 162. 5 182. 3 239. Assets 1 Current 8. 0 10. 5 26. 1 23. 3 15. 0 32. 4 9. 6 32. 5 14. 9 135. 5 21. 3 Liabilities Long 9. 1 4. 8 27. 4 39. 4 32. 5 47. 1 6. 5 Term Debt Other 0. 6 2. 6 13. 3 17. 3 8. 2 44. 1 13. 8 24. 8 Liabilities Sharehold 19. 7 20. 4 39. 6 40. 4 86. 4 37. 7 58. 7 40. 8 84. 7 15. 5 217. er Equity 8 27. 7 31. 5 77. 4 81. 8 101. 4 134. 8 135. 9 149. 9 162. 5 182. 3 239. 1 12 13 118. 8 15. 5 3. 6 520. 0 528. 6 273. 4 57. 1 397. 8 101. 3 1121. 1 984. 5 238. 4 44. 2 10 58. 1 82. 5 397. 8 1121. 1

q q q q Kelly Services Lands End Toys. RUs Hershey Foods Corp Microsoft Walt Disney Circus Burlington. Mc. Donalds Ford Motor Company Biogen Tele-communications J. P. Morgan 1 2 3 4 5 6 7 8 9 10 11 12 13