Slide 3.1 Atrill and McLaney, Accounting and Finance for Non-Specialists PowerPoints on the Web, 9...

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Atrill and McLaney, Accounting and Finance for Non-Specialists PowerPoints on the Web, 9th edition © Pearson Education Limited 2015

Chapter 3 MEASURING AND REPORTING

FINANCIAL PERFORMANCE

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LEARNING OUTCOMES

You should be able to:

Prepare an income statement from relevant financial information and interpret the

information that it contains

Discuss the nature and purpose of theincome statement

Explain the main accounting conventions underpinning the income statement

Discuss the main recognition and measurement issues that must be considered

when preparing the income statement

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Property development

13%

Commercial16%

Gate and other match day revenues

33%

Broadcasting31%

Retail6%

Arsenal’s revenue for the year ended 31 May 2013

Figure 3.1 Arsenal’s revenue for the year ended 31 May 2013Source: Based on information in Arsenal Holdings plc, Statement of Accounts and Annual Report 2012/13, p. 44.

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Measuring profit

Total revenue for the periodless

Total expenses incurred in generating that revenue

Profit(or loss) for the period

=

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Relationship between the income statement and the statement of financial position

The above equation can be extended to:

Profit (Loss)

Assets Equity Liabilities+

(−)= +

+ Sales revenue

Expenses Liabilities+−Assets Equity=

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The layout of the income statement

less

equals

less

plus

less

equals

equals

Operating expenses

Interest receivable

Operating profit

Interest payable

Gross profit

Cost of sales

Sales revenue

Profit for the year

Figure 3.2 The layout of the income statement

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Better-Price StoresIncome statement for the year ended 31 October 2014

£

Sales revenue 232,000

Cost of sales 154,000

Gross profit 78,000

Salaries and wages (24,500)

Rent and rates (14,200)

Heat and light (7,500)

Telephone and postage (1,200)

Insurance (1,000)

Motor vehicle running expenses (3,400)

Depreciation – fixtures and fittings (1,000)

Depreciation – motor van (600)

Operating profit 24,600

Interest received from investments 2,000

Interest on borrowings (1,100)

Profit for the year 25,500

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Calculating gross profit for Better-Price Stores

£ £

Sales revenue 232,000

Cost of sales:

Opening inventories 40,000

Goods bought 189,000

Closing inventories (75,000) (154,000)

Gross profit 78,000

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Profit measurement and the recognition of revenue

It is probable that the economic benefits will be received

The amount of revenue can be measured reliably

Basic criteria that must be met before revenue is recognised:

Additional criterion is to be applied where the revenue comes from the sale of goods:

Ownership and control of the items should pass to the buyer

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Accounting for sales commission

Sales commission expense £6,000

Income statement

Statement of financial

position at year

endCash £5,000

Accrual £1,000

Statementof cash flows

Figure 3.3 Accounting for sales commission

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Accounting for rent payable

Rent payable expense £16,000

Statement of financial position at year end

Cash £20,000

Prepaid expense £4,000

Statementof cash flows

Income statement

Figure 3.4 Accounting for rent payable

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Accounting conventions and the income statement

Accruals

Materiality

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Profit measurement and the calculation of depreciation

The useful life of the asset

Residual value (disposal value)

The cost (or fair value) of the asset

To calculate a depreciation charge for a period, four factors have to be considered:

Depreciation methods

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Car

ryin

g a

mo

un

t (£

000)

Asset life (years)

20

40

60

80

0 1 2 3 4

Graph of carrying amount against time using the straight-line method

Figure 3.5 Graph of carrying amount against time using the straight-line method

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Straight-line method – an example

Cost of machine £78,124

Estimated residual value £2,000

Estimated useful life 4 years

Annual depreciation charge = £76,124 4

= £19,031

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Reducing-balance method

P

=

Where:

P = the depreciation percentage

n = the useful life of the asset (in years)

R = the residual value of the asset

C = the cost, or fair value, of the asset

(1− R/C × 100%) n

Deriving the fixed percentage

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Car

ryin

g a

mo

un

t (£

000)

Asset life (years)

20

40

60

80

0 1 2 3 4

Graph of carrying amount against time using the reducing-balance method

Figure 3.6 Graph of carrying amount against time using the reducing-balance method

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The reducing-balance method – an example

£

Cost of machine 78,124

Year 1 depreciation expense (60% of cost) (46,874)

Carrying amount 31,250

Year 2 depreciation expense (60% of carrying amount) (18,750)





Residual value 2,000

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Calculating an annual depreciation expense

Year 1 Year 3Year 2 Year 4

Depreciation DepreciationDepreciationDepreciation

less

Residual value

equals

Cost (fair value)

Depreciable amount

Asset life (Number of years)

Figure 3.7 Calculating the annual depreciation expense

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Last in, first out (LIFO)

Weighted average cost (AVCO)

First in, first out (FIFO)

Common assumptions used are:

Profit measurement and inventory costing methods

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FIFO and LIFO treatment of the inventories in Example 3.8

21,000 tonnesClosing inventories

FIFO

LIFO

20,000 tonnes@ £13 per tonne

10,000 tonnes@ £10 per tonne

9,000 tonnesCost of sales

(inventories used)

21,000 tonnesClosing inventories

9,000 tonnesCost of sales

(inventories used)

Purchases

Figure 3.8 FIFO and LIFO treatment of the inventories in Example 3.8

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Bad debts written off

Increase expenses

Reduce trade receivables

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Uses of the income statement

How effective the business has been in generating wealth

Helps in providing information on:

How the profit was derived

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