3.8 Chapter Summary

LO 1: Describe statement of income, the statement of comprehensive income, and the statement of changes in equity, and their role in accounting and business.

The statement of income reports on company performance over the reporting period in terms of net income. The statement of comprehensive income is a concept only used by IFRS companies that reports on other gains and losses not already reported in net income. The statement of changes in equity (IFRS) reports on what changes took place in each of the equity accounts for the reporting period. For ASPE, this statement is a much simpler statement of retained earnings. Together, these statements enable the company stakeholders such as management, investors, and creditors to assess the financial health of the company and its ability to generate profits and repay debt. Each accounting standard (IFRS and ASPE) has minimum reporting requirements, which were discussed in this chapter.

LO 2: Identify the factors that influence what is reported in the statement of income, the statement of comprehensive income, and the statement of changes in equity.

The accounting standards require that all statements are reported on an accrual basis over a specific period of time (periodicity assumption) so that anything relevant to decision making is included (full disclosure principle). To ensure this, various adjusting entries are recorded to make certain that the accounting records are up to date, and an accounting fiscal year-end date is carefully chosen. Accrual entries include any revenues earned but not yet recorded, whether paid or not (revenue recognition principle), and any expenses where goods and services have been received but not yet recorded, whether paid or not (matching principle). Other adjusting entries include prepayment items (prepaid expenses and unearned revenues), the estimate for bad debt expense, depreciation and amortization of depreciable assets, unrealized gains and losses of certain assets, and any impairment or write-down entries, if required. Also considered are subsequent events that occur after the year-end date and whether to include them in the financial statements or in the notes to the financial statements. Changes in accounting estimates (prospective treatment with restatement), correcting accounting errors (retrospective treatment with restatement), and changes in accounting policy (retrospective treatment) can all affect the financial statements.

LO 3: Identify the core financial statements and explain how they interconnect together.

The core financial statements interconnect to complete an overall picture of a company’s performance over the reporting period (income statement) as well as its current financial state (SFP/BS). Starting with performance, the net income from the statement of income becomes the first amount reported on the statement of comprehensive income. Added to that is other comprehensive income (OCI), which reports any gains or losses not already reported in net income (IFRS only). Net income and OCI each flow to the statement of changes in equity, which reports on all the items that have affected the equity accounts during the reporting period. Together, these three financial statements are used to assess the company performance for the reporting period. The statement of cash flows reconciles cash and cash equivalent opening balances at the beginning of the reporting period to the closing balances at the end of the period. These changes are broken down into sources of cash inflows and outflows. Cash inflows could be from customers, issuing debt, or issuing share capital, while cash outflows could be from payments to suppliers, to employees, the purchase of assets, the payment of debt, any retirement of share capital, or the payment of dividends. These activities are separated and reported into the operating, investing, and financing section. The net amount of change represents the total change between the opening cash and cash equivalent balance to the closing cash and cash equivalent balance. The SFP/BS completes the set of core financial statements. It provides a snapshot at the end of the reporting period, such as month-end or year- end, and identifies the company resources (assets) and the claims to these resources (liabilities). The remaining net assets belong to the various classes of shareholders. The ending cash and cash equivalent balance of the statement of cash flow must reconcile to the cash and cash equivalent balances in the SFP/BS, and the statement of changes in equity totals must reconcile to the SFP/BS equity section, so that all the statements fit together into a single reconciled network of financial information.

There are differences between IFRS and ASPE reporting standards. For APSE, the statement of income is quite similar but without the requirement for comparative years’ data and earnings per share reporting. Comprehensive income is not a concept used by ASPE so there is no requirement for a statement of comprehensive income. ASPE companies report any changes in retained earnings through the statement of retained earnings, which is a much simpler statement that reports only the changes in the retained earnings account compared to the statement of changes in equity (IFRS), which reports the changes for all equity accounts.

LO 4: Describe the various formats used for the statement of income and the statement of comprehensive income, and identify the various reporting requirements for companies following IFRS and ASPE.

The purpose of the statement of income is to identify the revenues and expenses that comprise a company’s net income. A comprehensive income statement, required by IFRS, identifies any gains and losses not already included in the statement of income. Together, these statements enable management, creditors, and investors to assess a company’s financial performance for the reporting period. Comparing current with past performance, stakeholders can use these statements to predict future earnings and profitability. Since accounting is accrual-based, uncertainty exists in terms of the accuracy and reliability of the data used in the estimates. Net income (earnings) that can be attributable to sustainable ongoing core business activities are higher quality earnings than artificial numbers generated from applying accounting processes, determining various estimates, or gains and losses from non-operating business activities. The lower the quality of earnings, the less reliance will be placed on them by investors and creditors.

The statement of income can be a simple single-step or a more complex multiple-step format. Either one has its advantages and disadvantages. No matter which format is used, certain mandatory reporting requirements for both IFRS and ASPE exist, such as separate reporting for continuing operations and discontinued operations. To be reported as a discontinued operation, the business component must meet the definition of a cash-generating unit and a formal plan to dispose of the business component must exist.

Companies can choose to report operating expenses by nature (type of expense) or by function (which department incurred the expense). However, if expenses by function is used, additional reporting of certain line items by nature is still required for both IFRS and ASPE companies such as inventory expensed, depreciation, amortization, finance costs, inventory write-downs, and income taxes to name a few. IFRS companies can choose to keep the statement of income separate from the statement of comprehensive income or combine them into a single statement: the statement of income and comprehensive income. For IFRS companies, the earnings per share are reporting requirements.

LO 5: Describe the various formats used to report the changes in equity for IFRS and ASPE companies, and identify the reporting requirements.

For ASPE companies the various sources of change occurring during the reporting period for retained earnings is reported, while for IFRS companies changes to each of the equity accounts is identified, usually in a worksheet style with each account assigned to a column. One important aspect to either statement is the retrospective reporting for changes in accounting policies or corrections of errors from prior periods. The opening balance for retained earnings is restated by the amount of the change or error, net of tax, with the tax amount disclosed. Other line items for these statements include net income or loss and dividends declared. For IFRS companies reporting will also include any changes to the share capital accounts and accumulated other comprehensive income (resulting from OCI items recorded in the reporting period).

LO 6: Identify and describe the types of analysis techniques that can be used for income and equity statements.

Analysis of the financial statements is critical to decision making and to properly assess the overall financial health of a company. Analysis transforms the data into meaningful information for management, investors, creditors, and other company stakeholders. By evaluating the financial data, trends can be identified which can be used to predict the company’s future performance. Some techniques used on financial statements include horizontal analysis that compares data from multiple years, vertical analysis that ex- presses certain subtotals (gross profit) as a percentage of a total amount (sales), and ratio analysis that highlights important relationships between data.