BU1002 Lecture Notes - Lecture 5: Accrual, Financial Statement, Income Statement
14 Jun 2018
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Lecture 5
Purpose and the Importance of Measuring Financial Performance
- The statement of profit or loss reflects accounting return for an entity over a specific
time period
- NET PROFIT (LOSS) = REVENUE – EXPENSES
- But not all value changes result in income expenses that are recognised in the
statement of profit or loss
- While many entities aim for profit maximisation, the importance of sustainable
business practices means that decisions may be made that are not necessarily profit
maximising, but are beneficial for the environment or the community.
- Entities often articulate their governance, environmental and social polocies and
report on their environmental and social performance in additional to their financial
performance. This is referred to as triple bottom line reporting.
Income Measurement
- Definition according to Conceptual Framework (topic 1) incomes encompasses both:
o Revenue arising in the ordinary course of activities (for example, sales, fees,
dividends)
o Gains (for example, gains on disposal of non-current assets, and urealised
gains on revaluing assets)
The reporting Period
- The fiaial stateets assue that a etity is a goig oer ut the life of the
entity is divided into arbitrary reporting periods, also known as accouting peridos
- For external reports, the convention is that the arbitrary reporting is yearly, so the
entity prepares financial statements at the end of each 12 months (not nesessarily a
calendar year)
Models of Accounting: Cash v. Accrual
- Accounting standards require financial statements to be prepared on the basis of
accrual accounting
- Accrual accounting is a system in which transactions and events are recorded in the
periods they occur, rather than in the periods the entity receives of pays the related
cash.
- A cash accounting system would determine profit or loss as the difference between
the cash received in relation to income items and the cash paid for expenses.
Accrual Accounting
Under accrual accounting the following may occur
- Income is recognised without receipt of cash
o What are the 2 sides of the transaction?
- Cash is received, but income is not recognised because the goods on service has not
been provided
o What are the 2 sides of the transaction?
- Expense has been incurred (recognised) without payment of cash
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o What are the 2 sides of the transaction?
- Item is paid, but not recognised as an expense. I.e not used or consumed
o What are the 2 sides of the transaction?
Depreciation
- (amortisation) is the systematic allocation of the cost of tangible (intangible) asset
over its useful life
- It does NOT represent the loss in the assets value during the reporting period
- It does NOT involve cash flows
- Accumulated depreciation represents the total depreciation that has been charged
to the income statement in relation to an asset over the assets lifetime
- To calculate depreciation we need to know:
o Cost
o Useful life
o Residual value
o Depreciation method
Depreciation methods
- Straight Line Depreciation
o Depreciation is charged equally over the life of the asset
o Formula: annual deprecation expense = cost of asset – expected residual
value / assets expected useful life
o Two sides of the equation:
▪ Depreciation Exp = ^ exp and recorded in the income statement
▪ Accumulated depreciation = negative or contra asset, it is recorded in
the Balace Sheet and is deducted from the asset
- Reducing balance / diminishing balance method:
o This method uses a percentage rate to calculate depreciation expense
o Charges a higher expense in early life that decreases as the asset ages
o Formula: annual deprecation expense = carrying amount at beginning of year
x %
- Units of production
o Charges of deprecation on the basis of activity / output
o Formula: annual depreciation expense = cost of asset – expected residual
value / assets expected life based on output
o ^ formula determines a deprecation charge per activity (km travelled) or
output (units produced)
o the annual deprecation expense is determined by multiplying the charge x
activity
Policy Choices, Estimates and Judgements
- GAAP permit choices when transcations are being recorded, and require estimations
by preparers
- The reported profit or loss figure wil be effected by an entitys
o Accounting estimations
o Accounting policy choices i.e method of deprecation used: different methods
for Bills Pizza
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Document Summary
Purpose and the importance of measuring financial performance. The statement of profit or loss reflects accounting return for an entity over a specific time period. Net profit (loss) = revenue expenses. But not all value changes result in income expenses that are recognised in the statement of profit or loss. While many entities aim for profit maximisation, the importance of sustainable business practices means that decisions may be made that are not necessarily profit maximising, but are beneficial for the environment or the community. Entities often articulate their governance, environmental and social polocies and report on their environmental and social performance in additional to their financial performance. This is referred to as triple bottom line reporting. The fi(cid:374)a(cid:374)(cid:272)ial state(cid:373)e(cid:374)ts assu(cid:373)e that a(cid:374) e(cid:374)tity is a (cid:858)goi(cid:374)g (cid:272)o(cid:374)(cid:272)er(cid:374)(cid:859) (cid:271)ut the life of the entity is divided into arbitrary reporting periods, also known as accouting peridos.
