By Irene Peter Atolo
My shareholder-activist friend always asks anyone he sees at the venue of an Annual General Meeting (AGM), where he owns equity interest: Se aje ere? (Did we make a profit?) If the answer is in the affirmative, my friend would dance and if it is negative his mien told a sad story.
Today’s topic covers the importance of a profit or loss statement to investors and other stakeholders.
This statement was previously known as the trading profit and loss account, which is part of the components of financial statements of an entity. It is prepared to determine the performance of an entity. It is divided into two statements which include:
(a) Statement of Profit or Loss
(b) Statement of Other Comprehensive Income.
These two statements can be combined or separated.
There are two main elements that make up this statement:
The conceptual framework defines income as 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. It is different from revenue or gain. Revenue and gain are subsets of income. Revenue is an income derived from the ordinary course of business. This implies that all revenues are incomes but not all incomes are revenues. Gains also refer to income derived from the disposal of non-current assets. Gains can also be derived from unrealised profit such as revaluation of marketable securities or revaluation surplus of a non-current asset.
Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
Income and expenses can be presented in different ways in the statement of profit or loss and other comprehensive income to provide information relevant for economic decision making.
For example, income and expenses that relate to continuing operations are distinguished from the results of discontinued operations. This part will be discussed later.
As earlier mentioned, a statement of profit or loss and other comprehensive income is divided into two. I enumerate them below:
STATEMENT OF PROFIT OR LOSS
This statement comprises of the trading account and the profit or loss account.
A trading account is prepared to determine the gross profit or loss of an entity. It is the difference between sales revenue and the cost of sales.
Gross Profit or Loss: This is defined as the profit or loss made before deducting the operating expenses of the entity.
Profit or Loss Statement:
This is the Statement that is prepared to determine the net profit or net loss of an entity. It is the difference between the gross income (gross profit plus other income) of an entity and the total operating expenses incurred in the same accounting period.
Net Profit or Loss
This is the profit or loss made after deducting all operating expenses of the entity. This is referred to as Profit before tax.
Statement of Other Comprehensive Income
This statement is used to account for activities that are not the trading activities of the entity. Examples of these activities are profit on revaluation of non-current assets, gains or losses on foreign currency transactions; re-measurement of assets and liabilities under employee defined benefit plan; and gain or gains and losses from investments in equity instruments designated at fair value through other comprehensive income.
Let me now discuss the individual items in the statement of profit or loss and other comprehensive income.
1. Revenue: This was previously known as sales. Revenue as defined above is income arising from the course of the ordinary activities of an entity. The recognition and measurement of revenue were before now treated according to the provisions of IAS 18 (Revenue) and IAS 11 (Construction Contract) but these standards have been repealed by IFRS 15 (Revenue from Contracts with Customers). It is therefore important to discuss the provision of IFRS 15 as it relates to revenue recognition.
IFRS 15 is based on a core principle that entities should recognise revenue in a manner that depicts the transfer of goods or services to customers and at an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services.
Applying this core principle involves following a five-step model as follows:
Step 1: Identify the contract(s) with the customer
Step 2: Identify the separate performance obligations
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to the performance obligation
Step 5: Recognise revenue when or as an entity satisfies performance obligations.
2. Cost of sales: In applying the matching concept, the revenues generated within a period are matched with the associated direct costs used in generating such revenue. Therefore, the cost of sales is a direct cost associated with the revenue generated to arrive at the gross profit or loss. These costs include:
(a) Opening inventory cost: This was previously known as opening stock. These are goods that were left unsold in the previous accounting year-end. These are now brought forward to be sold in the current period. There are only two reasons why opening inventory may not be available.
This includes the first year of trading with no closing inventory. The reporting entity would have sold all the goods in the preceding year.
(b) Purchases: This simply means goods bought for resale. Within the reporting period, an entity may purchase goods intended for sale. This will be added to the opening inventory of the entity.
(c) Other direct costs: These include the cost of carriage inwards, wages, and other direct expenses which must also be added to arrive at the cost of goods available for sale.
(d) Closing inventory: These are inventories that are left unsold at the current period. They are usually deducted from the cost of goods available for sales to arrive at the cost of sales.
(e) Gross Profit: This is the excess of revenue over the cost of sales. As earlier stated it is the profit made before deducting operational expenses of the business.
A gross loss arises when there is an excess of the cost of sales over revenue generated within a particular period.
(f) Other Income: There are times when entities generate income from other activities that are outside the ordinary course of their businesses. This could include interest, dividends, discounts, rental income, decrease in provisions, etc accruing to the entities. These are to be added to the gross profit or gross loss within the reporting period.
(g) Operating expenses: The operating expenses of an entity are divided into administrative expenses and selling and distribution expenses. They are both deducted to arrive at the profit or loss before interest and taxes. The examples of administrative expenses include salaries, rents, depreciation, increase, electricity, impairments, rates, etc. While some examples of selling and distribution expenses include salesmen commissions, carriage outwards, advertising costs, etc.
(h) Profit Before Interest and Taxes: This is the excess of gross income over the operating expenses of an entity. It could also be a loss before interest and taxes.
(I) Finance Costs: These are financial interest associated with borrowings or liabilities owed by companies. Examples of this include interest on overdraft facilities, finance interest arising from financed lease arrangement, finance interest arising from financial liabilities, etc. All these are generally regarded as finance costs which will be deducted from profit before interest and taxes.
(j) Profit Before Tax: This is the excess of profit before interest and taxes.
(k) Tax: Tax is a distribution of profit to the government of a nation. In Nigeria for instance, an entity is expected to pay 30% as company tax on its profit to the government. Though, this may not be the actual amount to be paid to the tax authority as some adjustments must be made as a result of the different rules that govern financial reports and taxation.
Therefore, taxes which are 30% of the profit before tax are always provisions made during the accounting year-end. This will be deducted from Profit Before Tax to arrive at Profit After Tax.
(L). Profit After Tax: This is the excess of Profit before tax over the tax provision at the end of the financial year. PAT is actually the earnings available to the shareholders of the entity which can either be retained or distributed as dividends to the shareholders or partly retained.
Statement of Other Comprehensive Income
This statement is used to account for activities that are not the trading activities of an entity. Examples of items to be included in this statement are gain or surplus on revaluation of non-current assets, gains or losses on foreign currency exchange, re-measurement of assets and liabilities under employee defined benefit pension plan per IAS 19 and gains or losses on equity instruments designated as fair value through other comprehensive income. These are to be added to the profit after tax to arrive at the total comprehensive income
Statement of Profit or Loss and Other Comprehensive Income Under Discontinued operation.
This aspect is governed by the provisions of IFRS 5.
Before I proceed, it is important to define discontinued operations. IFRS 5 defines discontinued operation as a component of an entity that either has been disposed of or is classified as held for sale and it represents a separate major line of business or geographical area of operation or be a part of a single coordinated plan to dispose of a separate major line of business or is a subsidiary acquired exclusively with a view for resale.
The following must be disclosed for discontinued operations in the presentation of statements of profit or loss.
1. A single amount on the face of the statement of profit or loss comprising the total of the post-tax profit or loss of the discontinued operations and the post-tax gain or loss recognized on the measurement to fair value less costs to sell or on the disposal of the assets or disposal group(s) consisting the discontinued operations.
2. An analysis of this single amount:
(a). The revenue, expenses and the pre-tax profit or loss of discontinued operations
(b). The related income tax expenses
(c) The gain or loss recognised on the measurement to fair value less costs to sell or on the disposal of the assets or disposal group(s) constituting the discontinued operations.
(d) The related income tax expense.
3. The analysis may be presented in the notes or on the face of the statement of profit or loss.
Importance of Statements of profit or loss and other comprehensive income
1. It helps to determine the performance of an entity
2. It aids the presentation and preparation of the statement of cash flow
3. It shows an entity that engages in under trading or over trading in its operations.
4. Financial data here can be further analysed through the use of ratios to make decisions by various users of accounting information.
Frontpage February 3, 2020