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Ch-04 - Understanding Income Statement

The document discusses key aspects of income statements including: 1) Income statements provide a company's financial results over a period and show net income through revenue minus expenses. 2) They can use a single-step format with revenue and expenses grouped together or a multi-step format showing gross profit, operating profit, and net income. 3) Revenue is recognized according to IFRS guidelines when ownership risks and rewards transfer, measurement is reliable, and economic benefits will likely flow to the entity.

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84 views27 pages

Ch-04 - Understanding Income Statement

The document discusses key aspects of income statements including: 1) Income statements provide a company's financial results over a period and show net income through revenue minus expenses. 2) They can use a single-step format with revenue and expenses grouped together or a multi-step format showing gross profit, operating profit, and net income. 3) Revenue is recognized according to IFRS guidelines when ownership risks and rewards transfer, measurement is reliable, and economic benefits will likely flow to the entity.

Uploaded by

Sadia Rahman
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Understanding Income

Statements
Chapter 04
Introduction
• Income Statement, Profit & Loss Statement,
P&L, Statement of Earnings
• The income statement provides financial results
of ac company's business activities over a period
• Net Income= Revenue – Expenses
• Income Statement is an important input for
valuation models
•
Single step vs. Multi step Format
• Single-step: Revenue less Expenses : all items are
grouped together as revenue or expenses
• Multi-step: Shows detailed presentation including
calculation of gross profit, operating profit & net income
– Gross profit / loss: Revenue – Cost of Good Sold
– Operating profit / loss (EBIT): Gross profit –Other Operating
expenses (like SGA)
– Income from continuing operations: Operating profit - Interest
expense - Income taxes
– Net Income = Income from continuing operations + Earnings/
loss from discontinued operations
Single step vs. Multi step Format
Revenue Recognition
• According to the IFRS, the term "income“ includes revenue and gains
– “Income is defined 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”
– Revenue is recognized in the income statement when:– It is earned– Need not
necessarily be recognized at the time of cash exchange
• IFRS guidelines for revenue recognition:
– 1. Transfer of ownership’s risk and rewards to buyer
– 2. Reliable Measurement of Revenues
– 3. Reliable Measurement of associated costs
– 4. Probable that economic benefits on sale will flow to the entity
• Income is broad concept and includes gains / losses from non operating
activities as well.
Criteria for Revenue Recognition
• Example: Question 1: An electronic goods company allows only its most
valued customers to buy goods on credit in their store. For this, a
background check of those customers is conducted to gauge their
credibility. A customer ordered a laptop from the company in August. The
good was shipped and delivered in September. The payment was made in
full by the due date in November. Assuming that the company follows
accrual method of accounting, the most appropriate month in which the
company should recognize the revenue is :A. August B. September C.
November
Solution• Answer: B• Explanation: Since the delivery took place in
September, the ownership “risk” is transferred. Also, there is a good
probability of future flow of economic benefits because the credibility of
the customers has already been tested. Hence, September is the right time
to recognize the revenue.
Revenue Recognition in Special Cases: Long
Term Contracts
Long term Contracts: Revenue recognition methods

• Generally for the entities engaged in construction projects


– Percentage of completion method:– Appropriate when the projects cost and revenue
can be reliably estimated– Amount of revenue to be recognized =Total contract value x
total cost incurred to date / total expected cost of the project– Accordingly, revenue,
expense, and therefore profit, are recognized based on the % completed
– Completed Contract Method:– Used when the outcome of a project cannot be reliably
measured or– The project is short-term– Revenue, expense, and profit are recognized
only when the contract is completed– But, if a loss is expected, the loss must be
recognized immediately (Principal of conservatism)•
• Compared to completed contract method, percentage of completion method:–
– Recognizes revenue early hence it is more aggressive
– Requires estimation of total costs hence subjectivity is involved
– Provides smoother earnings and results in better matching of revenues and expenses
over time
– No impact on Cash flow: cash flows is same under both methods
Earnings Per Share
• EPS is an important metric and must be shown on the face of
the income statement. It depicts the earnings per ordinary
shares. Ordinary shares are subordinate to all other types of
equity. Also known as common stock or common shares.
• EPS = income available to common stockholders/number of
ordinary shares
• What if a company has issued securities which are convertible to
ordinary shares?
– Convertible bonds, Convertible preferred stocks, employee stock
options etc. These securities might be potentially dilutive.
• When a company has securities, which are convertible to
ordinary shares it is said to have a complex capital structure.
• Basic EPS = Net income-preferred
dividend/outstanding common shares

• Or Basic EPS = Net income-preferred


dividend/ Weighted average outstanding
shares
Diluted EPS
• Compute diluted EPS the if-converted method
• Diluted EPS = Net Income/Weighted average
shares + new shares if convertible shares are
convertible

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