5
Statements of Profit or Loss and Other Comprehensive Income, and Changes in Equity

  1. Introduction
  2. Future Developments
  3. Scope
  4. Definitions of Terms
    1. Elements of Financial Statements
    2. Other Terminology
  5. Concepts of Income
  6. Recognition and Measurement
      1. Income
      2. Expenses
      3. Gains and losses
  7. Statement of Profit or Loss and Other Comprehensive Income
  8. Presentation in the Profit or Loss Section
      1. Statement Title
      2. Reporting Period
      3. Comparative Information
      4. Classification of Expenses
      5. Aggregating items
      6. Offsetting Items of Revenue and Expense
  9. Other Comprehensive Income
    1. Reclassification Adjustments: An Example
  10. Statement of Changes in Equity
  11. US GAAP Comparison

Introduction

The IASB's conceptual framework emphasises the importance of information about the performance of an entity, which is useful to assess potential changes in the economic resources that are likely to be controlled in the future, predict future cash flows and form judgements about the effectiveness with which the entity might employ additional resources. For a period of time from mid-2004, the IASB and the FASB collaboratively pursued projects on Financial Statement Presentation (originally entitled Performance Reporting), which resulted in fundamental changes to the format and content of what is commonly referred to as the income statement (or the profit or loss account). This joint effort was bifurcated. The first phase of the project addressed what constituted a complete set of financial statements and a requirement to present comparative financial statements (absent from US GAAP), and culminated in the issuance of revised IAS 1 in 2007, effective in 2009.

IAS 1, Presentation of Financial Statements, as revised in 2007, brings IAS 1 largely into line with the US standard—Statement of Financial Accounting Standards 130 (FAS 130), Reporting Comprehensive Income. The standard requires all non-owner changes in equity (i.e., comprehensive income items) to be presented either in one statement of comprehensive income or else in two statements, a separate income statement and a statement of comprehensive income. Components of comprehensive income are not permitted to be presented in the statement of changes in equity as a combined statement of income and comprehensive income became mandatory (or at least preferable); this represented a triumph of the all-inclusive concept of performance reporting. While this approach has been officially endorsed by world standard setters for many decades, in fact many standards issued over the years have deviated from adherence to this principle. While IAS 1 encourages the presentation of comprehensive income in a single statement, with net income being an intermediate caption, it remains acceptable to instead report in a two-statement format, with a separate income statement and a separate statement of comprehensive income. The statement of comprehensive income will report all non-owner changes in equity separately from owner changes in equity (investments by or distributions to owners).

IAS 1 in its current incarnation thus marks a notable return to an all-inclusive concept of performance reporting, which had been eroded in recent decades as items such as gains and losses on financial instruments measured at fair value through other comprehensive income and defined benefit plan actuarial gains or losses became reportable directly in the equity section of the statement of financial position—a practice which generated understandable confusion regarding the contents of the reporting entity's “real” results of operations.

Concepts of performance and measures of income have changed over the years, and current reporting still largely focuses on realised income and expense. However, unrealised gains and losses also reflect real economic transactions and events and are of great interest to decision makers. Under current IFRS, some of these unrealised gains and losses are recognised, while others are unrecognised. Both the financial reporting entities themselves and the financial analyst community go to great lengths to identify those elements within reported income which are likely to continue into the future, since expected earnings and cash flows of future periods are the main drivers of share prices.

IFRS rules for the presentation of income are based on a so-called “mixed attribute model.” They therefore reflect a mixture of traditional realised income reporting, accompanied by fair value measures applied to unrealised gains and losses meeting certain criteria. So, for example, financial instruments are accounted for differently from plant assets. Moreover, unrealised gains and losses arising from the translation of the foreign currency-denominated financial statements of foreign subsidiaries do not flow through the income statement. IAS 1 requires that all owner changes in equity should be reported separately from non-owner changes (deriving from performance) in a separate statement of changes in equity.

The traditional income statement has been known by many titles. IFRS refer now to this statement as the statement of profit or loss, which reports all items entering into the determination of periodic earnings, but excluding other comprehensive income items which are reported in the other comprehensive income section of the statement of profit or loss and other comprehensive income.

For many years, the income statement had been widely perceived by investors, creditors, management and other interested parties as the single most important part of an entity's basic financial statements. In fact, beginning in the mid-twentieth century, accounting theory development was largely driven by the desire to present a meaningful income statement, even to the extent that the balance sheet sometimes became the repository for balances of various accounts, such as deferred charges and credits, which could scarcely meet any reasonable definitions of assets or liabilities. This was done largely to serve the needs of investors, who are commonly thought to use the past income of a business as the most important input to their predictions of entities' future earnings and cash flows, which in turn form the basis for their estimates of future share prices and dividends.

Creditors look to the statement of profit or loss for insight into the borrower's ability to generate the future cash flows needed to pay interest and eventually to repay the principal amounts of the obligations. Even in the instance of secured debt, creditors do not look primarily to the statement of financial position (balance sheet), inasmuch as the seizure and liquidation of collateral is never the preferred route to recovery of the lender's investment. Rather, generation of cash flows from operations—which is generally closely correlated to income—is seen as the primary source for debt service.

Management, then, must be concerned with the statement of profit or loss by virtue of the importance placed on it by investors and creditors. In many large corporations, senior management receive substantial bonuses relating either to profit targets or share price performance. Consequently, management sometimes devote considerable efforts to massaging what appears in the income statement, in order to present the most encouraging view of the reporting entity's future prospects. This means that standard setters need to bear in mind the possibilities for abuse afforded by the rules which they impose. Indeed, many of the rules have been imposed in response to previous financial reporting abuses.

The importance placed on income measurement has, as is well known, influenced behaviour by some management personnel, who have sought to manipulate results to, for instance, meet market observers' earnings estimates. The motivation for this improper behaviour is readily understandable when one observes that recent markets have severely punished companies which missed earnings estimates by as little as a penny per share. One very popular vehicle for earnings management has centred around revenue recognition. Historically, certain revenue recognition situations, such as that involving prepaid service revenue, have lacked specific financial reporting rules or have been highly subject to interpretation, opening the door to aggressive accounting by some entities. While in many businesses the revenue earning cycle is simple and straightforward and therefore difficult to manipulate, there are many other situations where it is a matter of interpretation as to when the revenue has actually been earned. Examples have included recognition by lessors of lease income from long-term equipment rental contracts, which were bundled with supplies and maintenance agreements, and accruals of earnings on long-term construction contracts or software development projects having multiple deliverables.

The information provided by the statement of profit or loss, relating to individual items of income and expense, as well as to the relationships between and among these items (such as the amounts reported as gross margin or profit before interest and taxes), facilitates financial analysis, especially that relating to the reporting entity's historical and possible future profitability. Even with the ascendancy of the statement of financial position as the premier financial statement, financial statement users will always devote considerable attention to the statement of profit or loss.

Further to the 2007 revisions to IAS 1, in 2011 and 2012 the IASB made additional amendments. In June 2011, the IASB issued an amendment to IAS 1 titled Presentation of Items of Other Comprehensive Income, which became effective for accounting periods beginning on or after July 1, 2012. The amendment improves the consistency and clarity of items recorded in other comprehensive income. Other comprehensive income is grouped together on the basis of whether or not items are subsequently reclassified to profit or loss. The Board highlighted the importance of presenting profit or loss and other comprehensive income together and with equal prominence. The name of the statement of comprehensive income is changed to statement of profit or loss and other comprehensive income.

In May 2012, the IASB issued “Annual Improvements 2009–2011 cycle,” a collection of amendments to IFRS in response to issues addressed during the 2009–2011 cycle. The IASB became aware of a diversity of views as to the requirements for comparative information when an entity provides individual financial statements beyond the minimum comparative information requirements of IAS 1 and thus issued these amendments to IAS 1 in order to clarify the requirements for comparative information. These amendments became effective for periods beginning on or after January 1, 2013.

Future Developments

The IASB started with a financial statements project to improve the structure and content of the primary financial statements, with a focus on the statement(s) of financial performance.

Scope

This chapter focuses on key income measurement issues and on matters of comprehensive income, statement presentation and disclosure. It also explains and illustrates the presentation of the statement of profit or loss and other comprehensive income and the statement of changes in equity. The chapter incorporates information from the Conceptual Framework for Financial Reporting 2010, IAS 1, and other standards.

Definitions of Terms

Elements of Financial Statements

Expenses. Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurring liabilities that result in decreases in equity, other than those relating to distributions to equity participants. The term expenses is broad enough to include losses as well as normal categories of expenses; thus, IFRS differs from the corresponding US GAAP standard, which deems losses to be a separate and distinct element to be accounted for, denoting decreases in equity from peripheral or incidental transactions.

Income. Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets that result in increases in equity, other than those relating to contributions from equity participants. The IASB's Framework clarifies that this definition of income encompasses both revenue and gains. As with expenses and losses, the corresponding US accounting standard holds that revenues and gains constitute two separate elements of financial reporting, with gains denoting increases in equity from peripheral or incidental transactions.

Other comprehensive income. Items of income and expense (including reclassification adjustments) that are not recognised in profit or loss as required or permitted by other IFRS. The components of other comprehensive income include (1) changes in revaluation surplus (IAS 16 and 38); (2) actuarial gains and losses on defined benefit plans (IAS 19); (3) translation gains and losses (IAS 21); (4) gains and losses on remeasuring of equity instrument financial assets (IFRS 9); and (5) the effective portion of gains and losses on hedging instruments in a cash flow hedge (IFRS 9).

Profit or loss. The total of income less expenses, excluding the components of other comprehensive income.

Reclassification adjustments. Amounts reclassified to profit or loss in the current period that were recognised in other comprehensive income in the current or preceding periods.

Statement of changes in equity. As prescribed by IAS 1, an entity should present, as a separate financial statement, a statement of changes in equity showing:

  1. Total comprehensive income for the period (reporting separately amounts attributable to owners of the parent and to non-controlling interest);
  2. For each component of equity, the effect of retrospective application or retrospective restatement recognised in accordance with IAS 8;
  3. The amounts of transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners; and
  4. A reconciliation for each component of equity (each class of share capital and each reserve) between the carrying amounts at the beginning and the end of the period, separately disclosing each movement.

Statement of profit or loss and other comprehensive income. The statement of profit or loss and other comprehensive income presents all components of “profit or loss” and “other comprehensive income” in a single statement, with net income being an intermediate caption. IAS 1 alternatively permits the use of a two-statement format, with a separate statement of profit or loss and a separate statement of comprehensive income.

Total comprehensive income. The change in equity (net assets) of an entity during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in net assets during a period, except those resulting from investments by owners and distributions to owners. It comprises all components of “profit or loss” and “other comprehensive income” presented in the statement of comprehensive income.

Other Terminology

Additional comparative information. Narrative and descriptive comparative information in addition to the minimum comparative information required by IFRS.

Component of an entity. In the context of discontinued operations, IFRS 5 currently defines a component of an entity as operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity—a cash-generating unit, or group of cash-generating units.

Discontinued operations. IFRS 5 defines a “discontinued operation” as a component of an enterprise that has been disposed of, or is classified as held-for-sale, and:

  1. Represents a separate major line of business or geographical area of operations;
  2. Is part of a single coordinated disposal plan;
  3. Is a subsidiary acquired exclusively with a view to resale.

Minimum comparative information. Narrative and descriptive information in respect of the preceding period for all amounts reported in the current period's financial statements where it is relevant to an understanding of the current period's financial statements.

Net assets. Net assets are total assets minus total liabilities (which is thus equivalent to owners' equity).

Operating segment. A component of an entity: (1) that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity); (2) whose operating results are regularly reviewed by the entity's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance; and (3) for which discrete financial information is available.

Realisation. The process of converting non-cash resources and rights into money, or more precisely the sale of an asset for cash or claims to cash.

Recognition. The process of formally recording or incorporating in the financial statements of an entity items that meet the definition of an element and satisfy the criteria for recognition.

Concepts of Income

Economists have generally employed a wealth maintenance concept of income. Under this concept, income is the maximum amount that can be consumed during a period and still leave the entity with the same amount of wealth at the end of the period as existed at the beginning. Wealth is determined with reference to the current market values of the net productive assets at the beginning and end of the period. Therefore, the economists' definition of income would fully incorporate market value changes (both increases and decreases in wealth) in the determination of periodic income and this would correspond to measuring assets and liabilities at fair value, with the net of all the changes in net assets equating to comprehensive income.

Accountants, on the other hand, have traditionally defined income by reference to specific transactions which give rise to recognisable elements of revenue and expense during a reporting period. The events which produce reportable items of revenue and expense comprise a subset of economic events which determine economic income. Many changes in the market values of wealth components are deliberately excluded from the measurement of accounting income but are included in the measurement of economic income, although those exclusions have grown fewer as the use of fair values in financial reporting has been more widely embraced in recent years.

This can be seen in IRFS 9, where the changes in market value of some financial instruments are recognised, and in IAS 41, where the change in value of biological assets is recognised even though not realised.

Recognition and Measurement

Income

According to the IASB's conceptual framework:

Income is 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. The definition of income encompasses both revenue and gains, and revenue arises in the course of ordinary activities of an enterprise and is referred to by different names, such as sales, fees, interest, dividends, royalties, and rent.

IFRS 15 is the standard which currently deals with the accounting for revenue. It states that revenue is the gross inflow of economic benefits during the period (excluding transactions with owners). IAS 18 was replaced by IFRS 15 with effect for accounting periods commencing on or after January 1, 2018. IFRS 15 states that revenue is income arising in the course of an entity's ordinary activities.

The measurement basis under IAS 18 is that revenue be measured at the fair value of the consideration received or receivable. In accordance with IFRS 13, Fair Value is defined as

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The historical cost measurement basis involves recognising a completed marketplace transaction, in other words measuring at fair value at initial recognition.

IFRS 15 will require that when (or as) a performance obligation is satisfied, an entity shall recognise as revenue the amount of the transaction price that is allocated to that performance obligation, and goes on to set out detailed requirements for determining the transaction price.

Revenue recognition is discussed in detail in Chapter 20.

Expenses

According to the IASB's conceptual framework:

Expenses are decreases in economic benefits during an accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

Expenses are expired costs, or items that were assets but are no longer assets because they have no future value.

Costs such as materials and direct labour consumed in the manufacturing process are relatively easy to identify with the related revenue elements. These cost elements are included in inventory and expensed as cost of sales when the product is sold and revenue from the sale is recognised. This is associating cause and effect.

Some costs are more closely associated with specific accounting periods. In the absence of a cause and effect relationship, the asset's cost should be allocated to the benefiting accounting periods in a systematic and rational manner. This form of expense recognition involves assumptions about the expected length of benefit and the relationship between benefit and cost of each period. Depreciation of fixed assets, amortisation of intangibles and allocation of rent and insurance are examples of costs which would be recognised by the use of a systematic and rational method.

All other costs are normally expensed in the period in which they are incurred. This would include those costs for which no clear-cut future benefits can be identified, costs that were recorded as assets in prior periods but for which no remaining future benefits can be identified and those other elements of administrative or general expense for which no rational allocation scheme can be devised. The general approach is first to attempt to match costs with the related revenues. Next, a method of systematic and rational allocation should be attempted. If neither of these measurement principles is beneficial, the cost should be immediately expensed.

Gains and Losses

The conceptual framework defines the term expenses broadly enough to include losses. IFRS include no definition of gains and losses that enables them to be separated from income and expenses. Traditionally, gains and losses are thought by accountants to arise from sales and purchases outside the regular business trading of the company, such as on disposals of non-current assets which are no longer required. IAS 1 used to include an extraordinary category for display of items that were clearly distinct from ordinary activities. The IASB removed this category in its 2003 Improvements Project, concluding that these items arose from the normal business risks faced by an entity and that it is the nature or function of a transaction or other event, rather than its frequency, which should determine its presentation within the statement of comprehensive income.

According to the IASB's Framework:

Gains (losses) represent increases (decreases) in economic benefits and as such are no different in nature from revenue (expenses). Hence, they are not regarded as separate elements in IASB's Framework. Characteristics of gains and losses include the following:

  1. Result from peripheral transactions and circumstances that may be beyond entity's control.
  2. May be classified according to sources or as operating and non-operating.

Statement of Profit or Loss and Other Comprehensive Income

IAS 1 states that comprehensive income is the change in the entity's net assets over the course of the reporting period arising from non-owner sources. An entity has the option of presenting comprehensive income in a period either in one statement (the single-statement approach) or in two statements (the two-statement approach). The IASB initially intended to introduce the single-statement approach for the statement of comprehensive income, but during discussions with constituents, many of them were opposed to the concept of a single statement, stating that it could result in undue focus on the “bottom line” of the statement. Consequently, the IASB decided that presentation in a single statement was not as important as its fundamental decision that all non-owner changes in equity should be presented separately from owner changes in equity. However, the IASB prefers a one-statement approach. If an entity presents the components of profit or loss in a separate statement, this separate statement of profit or loss (income statement) forms part of a complete set of financial statements and should be displayed immediately before the statement of comprehensive income.

Although IAS 1 uses the terms “profit or loss,” “other comprehensive income” and “total comprehensive income,” an entity may use other terms to describe the totals, as long as the meaning is clear. For example, an entity may use the term “net income” to describe profit or loss.

Comprehensive income comprises all components of “profit or loss” and of “other comprehensive income.”

An entity has a choice of presenting all components of comprehensive income recognised in a period either:

  1. In a single statement of profit or loss and other comprehensive income, in which all items of income and expense recognised in the period are included (the single-statement approach); or
  2. In two statements (the two-statement approach):
    1. A statement displaying components of profit or loss (separate statement of profit or loss);
    2. A second statement beginning with profit or loss and displaying components of other comprehensive income.

Total comprehensive income for the period reported in a statement of profit or loss and other comprehensive income is the total of all items of income and expense recognised during the period (including the components of profit or loss and other comprehensive income).

Other comprehensive income is the total of income less expenses (including reclassification adjustments) that are not recognised in profit or loss as required or permitted by other IFRS or Interpretations.

The components of other comprehensive income comprise:

  1. Changes in revaluation surplus (see IAS 16, Property, Plant and Equipment, and IAS 38, Intangible Assets);
  2. Remeasurements of defined benefit plans (see IAS 19, Employee Benefits);
  3. Gains and losses arising from translating the financial statements of foreign operations (see IAS 21, The Effects of Changes in Foreign Exchange Rates);
  4. Gains and losses on remeasuring equity instrument financial assets (see IFRS 9, Financial Instruments);
  5. The effective portion of gains and losses on hedging instruments in a cash flow hedge (see IAS 39, Financial Instruments: Recognition and Measurement).

The statement of profit or loss and other comprehensive income must in addition to the information given in the profit and loss and other comprehensive income sections disclose the following totals:

  1. Profit or loss;
  2. Total other comprehensive income;
  3. Comprehensive income for the year (total of 1. and 2.)

IAS 1 stipulates that, in addition to items required by other IFRS, the profit and loss section of the statement of profit or loss and other comprehensive income must include line items which present the following amounts for the period (if they are pertinent to the entity's operations for the period in question):

  1. Revenue;
  2. Finance costs;
  3. Share of the profit or loss of associates and joint ventures accounted for by the equity method;
  4. Tax expense;
  5. A single amount for the total of discontinued operations.

In addition, an entity should disclose the following items on the face of the statement of profit or loss and other comprehensive income as allocations:

  1. Profit or loss for the period attributable to:
    1. Non-controlling interest; and
    2. Owners of the parent.
  2. Total comprehensive income for the period attributable to:
    1. Non-controlling interest; and
    2. Owners of the parent.

Items 1–5 listed above and disclosure of profit or loss attributable to non-controlling interest and owners of the parent (listed in 1.) can be presented on the face of a separate statement of profit or loss (income statement).

The foregoing items represent the barest minimum of acceptable detail in the statement of comprehensive income: the standard states that additional line items, headings and subtotals should be presented on the face of the statement when this is relevant to an understanding of the entity's financial performance. This requirement cannot be dealt with by incorporating the items into the notes to the financial statements. When items of income or expense are material, disclosures segregating their nature and amount are required in the statement of comprehensive income or in the notes.

Presentation in the Profit or Loss Section

In accordance with IAS 1, if an entity presents the components of profit or loss in a separate statement of profit or loss, this separate statement should be displayed immediately before the statement of comprehensive income. The following also needs to be disclosed:

Statement Title

The legal name of the entity must be used to identify the financial statements and the correct title used to distinguish the statement from other information presented in the annual report.

Reporting Period

The period covered by the statement of profit or loss must be clearly identified, such as “Year ended December 31, 2017” or “Six months ended September 30, 2017.” Income statements are normally presented annually (i.e., for a period of 12 months or a year). However, in some jurisdictions they may be required at quarterly or six-monthly intervals, and in exceptional circumstances (such as a newly acquired subsidiary aligning its accounting dates with those of its new parent), companies may need to prepare a statement of profit or loss for periods in excess of one year or for shorter periods as well. IAS 1 requires that when financial statements are presented for periods other than a year, the following additional disclosures should be made:

  1. The reason for presenting the statement of profit or loss (and other financial statements, such as the statement of cash flows, statement of changes in equity and notes) for a period other than one year; and
  2. The fact that the comparative information presented (in the statement of profit or loss, statement of changes in equity, statement of cash flows and notes) is not entirely comparable.

Entities whose operations form a natural cycle may have a reporting period that ends on a specific day of the week (e.g., the last Friday of the month). Certain entities (typically retail enterprises) may prepare income statements for a fiscal period of 52 or 53 weeks instead of a year (thus, to always end on a day such as Sunday, on which no business is transacted, so that inventory may be taken). These entities should clearly state that the income statement has been presented, for instance, “for the fifty-two-week period ended March 25, 2016.” IAS 1 notes that it is unlikely that financial statements presented in this way would be materially different from those which would be presented for a full year.

In order that the presentation and classification of items in the statement of profit or loss be consistent from period to period, items of income and expenses should be uniform with respect to both appearance and categories from one time period through to the next. If a decision is made to change classification schemes, the comparative prior period financial statements should be restated to conform and thus to maintain comparability between the two periods being presented together. Disclosure must be made of this reclassification, since the earlier period financial statements being presented currently will differ in appearance from those nominally same statements presented in the earlier year.

Comparative Information

The issue of the “Annual Improvements 2009–2011 cycle” in May 2012 clarified the requirements for comparative information. These requirements state that, as a minimum, comparative figures regarding the previous reporting period should be included. The requirements apply for both the profit or loss section and the other comprehensive income section.

Classification of Expenses

An example of the income statement (profit or loss) classification by the “nature of expense” method is shown below:

Exemplum Reporting PLC
Statement of Profit or Loss
For the Year Ended 31 December 20XX
(classification of expense by nature)
€ €
Revenue X
Other income X
Changes in inventories of finished goods and work in progress X
Work performed by the entity and capitalised X
Raw material and consumables used X
Employee benefits expense X
Depreciation and amortisation expense X
Impairment of property, plant and equipment X
Other expenses X
Total expenses X
Operating profit X

An example of the income statement (profit or loss) classification by the “function of expense” method is as follows:

Statement of Profit or Loss
For the Year Ended 31 December 20XX
(classification of expense by function)
€
Revenue X
Cost of sales X
Gross profit X
Other income X
Distribution costs X
Administrative expenses X
Other expenses X
Operating profit X

Under the “function of expense” method an entity should report, at a minimum, its cost of sales separately from other expenses. This method can provide more relevant information to the users of the financial statements than the classification under the “nature of expense” method, but allocating costs to functions may require arbitrary allocations based on judgement.

IAS 1 furthermore stipulates that if a reporting entity discloses expenses by function, it must also provide information on the nature of the expenses, including depreciation and amortisation and staff costs (salaries and wages). The standard does not provide detailed guidance on this requirement, but entities need only provide a note indicating the nature of the allocations made to comply with the requirement.

IFRS 5 governs the presentation and disclosures pertaining to discontinued operations. This is discussed later in this chapter.

While IAS 1 does not require the inclusion of subsidiary schedules to support major captions in the statement of income, it is commonly found that detailed schedules of line items are included in full sets of financial statements. These will be illustrated in the following section to provide a more expansive discussion of the meaning of certain major sections of the statement of income.

Companies typically show their regular trading operations first and then present any items to which they wish to direct users' attention.

  1. Sales or other operating revenues are charges to customers for the goods and/or services provided to them during the period. This section of the statement of income should include information about discounts, allowances and returns to determine net sales or net revenues.
  2. Cost of goods sold is the cost of the inventory items sold during the period. In the case of a merchandising entity, net purchases (purchases less discounts, returns and allowances plus freight-in) are added to the beginning inventory to obtain the cost of goods available for sale. From the cost of goods available-for-sale amount, the ending inventory is deducted to compute cost of goods sold.

    A manufacturing enterprise computes the cost of goods sold in a slightly different way. Cost of goods manufactured would be added to the beginning inventory to arrive at cost of goods available for sale. The ending finished goods inventory is then deducted from the cost of goods available for sale to determine the cost of goods sold. Cost of goods manufactured is computed by adding to raw materials on hand at the beginning of the period the raw materials purchased during the period and all other costs of production, such as labour and direct overhead, thereby yielding the cost of goods placed in production during the period. When adjusted for changes in work in process during the period and for raw materials on hand at the end of the period, this results in the cost of goods produced.

  3. Operating expenses are primary recurring costs associated with central operations, other than cost of goods sold, which are incurred to generate sales. Operating expenses are normally classified into the following two categories:
    1. Distribution costs (or selling expenses);
    2. General and administrative expenses.

    Distribution costs are those expenses related directly to the entity's efforts to generate sales (e.g., sales salaries, commissions, advertising, delivery expenses, depreciation of store furniture and equipment, and store supplies). General and administrative expenses are expenses related to the general administration of the company's operations (e.g., officers and office salaries, office supplies, depreciation of office furniture and fixtures, telephone, postage, accounting and legal services, and business licences and fees).

  4. Other revenues and expenses are incidental revenues and expenses not related to the central operations of the company (e.g., rental income from letting parts of premises not needed for company operations).
  5. Separate disclosure items are items which are of such size, nature or incidence that their disclosure becomes important in order to explain the performance of the enterprise for the period. Examples of items that, if material, would require such disclosure are as follows:
    1. Write-down of inventories to net realisable value, or of property, plant and equipment to recoverable amounts, and subsequent reversals of such write-downs;
    2. Costs of restructuring the activities of an enterprise and any subsequent reversals of such provisions;
    3. Costs of litigation settlements;
    4. Other reversals of provisions.
  6. Income tax expense. The total of taxes payable and deferred taxation adjustments for the period covered by the income statement.
  7. Discontinued operations. IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, was issued by the IASB as part of its convergence programme with US GAAP.

IFRS 5 created a new “held-for-sale” category of asset into which assets, or “disposal groups” of assets and liabilities that are to be sold, are classified. Such assets or groups of assets are to be valued at the lower of carrying value and fair value less selling costs. Any resulting write-down appears, net of tax, as part of the caption “discontinued operations” in the statement of income.

The other component of this line is the post-tax profit or loss on discontinued operations. A discontinued operation is defined as a component of an entity that has either been disposed of, or has been classified as held-for-sale. It must also:

  • Be a separate major line of business or geographical area of operations;
  • Be a part of a single coordinated plan for disposal; or
  • Be a subsidiary acquired exclusively with a view to resale.

The two elements of the single line in the statement of income have to be analysed in the notes, breaking down the related income tax expense between the two, as well as showing the components of revenue, expense and pre-tax profit of the discontinued items.

For the asset or disposal group to be classified as held-for-sale, and its related earnings to be classified as discontinued, IFRS 5 says that the sale must be highly probable, the asset must be saleable in its current condition, and the sale price must be reasonable in relation to its fair value. The appropriate level of management in the group must be committed to a plan to sell the asset and an active programme must have been embarked upon. Sale should be expected within one year of classification and the standard sets out stringent conditions for any extension of this, which are based on elements outside the control of the entity.

Where an operation meets the criteria for classification as discontinued, but will be abandoned within one year rather than be sold, it should also be included in discontinued operations. Assets or disposal groups categorised as held-for-sale are not depreciated further.

Aggregating Items

Aggregation of items should not serve to conceal significant information, as would the netting of revenues against expenses, or the combining of other elements, which are individually of interest to readers, such as bad debts and depreciation. The categories “other” or “miscellaneous expense” should contain, at most, an immaterial total amount of aggregated, individually insignificant elements. Once this total approaches, for example, 10% of total expenses (or whatever the relevant materiality threshold may be), some other aggregations, together with appropriate explanatory titles, should be selected.

Information is material if its omission, misstatement or non-disclosure could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item judged in the particular circumstances of its omission (according to IASB's Framework). But it is often forgotten that materiality is also linked with understandability and the level of precision with which the financial statements are to be presented. For instance, the financial statements are often rendered more understandable by rounding information to the nearest thousand currency units (e.g., euros). This serves to alleviate the danger of loading the financial statements with unnecessary detail. However, it should be borne in mind that the use of the level of precision which makes presentation possible in the nearest thousands of currency units is acceptable only as long as the threshold of materiality is not surpassed.

Offsetting Items of Revenue and Expense

Materiality also plays a role in the matter of allowing or disallowing the offsetting of items of income and expense. IAS 1 addresses this issue and prescribes rules in this area. According to IAS 1, assets and liabilities or income and expenses may not be offset against each other, unless required or permitted by an IFRS. Usually, when more than one event occurs in a given reporting period, losses and gains on disposal of non-current assets or foreign exchange gains and losses are seen reported on a net basis, due to the fact that they are not material individually (compared to other items in the income statement). However, if they were material individually, they would need to be disclosed separately according to the requirements of IAS 1.

However, the reduction of accounts receivable by the allowance for expected credit losses, or of property, plant and equipment by the accumulated depreciation, are acts that reduce these assets by the appropriate valuation amounts and are not in fact the offsetting of assets and liabilities.

Views differ as to the treatment of disposal gains and losses arising from the routine replacement of non-current assets. Some experts believe that these should be separately disclosed as a disposal transaction, whereas others point out that if the depreciation schedule is estimated correctly, there should be no disposal gain or loss. Consequently, any difference between carrying value and disposal proceeds is akin to an adjustment to previous depreciation, and should logically flow through the income statement in the same caption where the depreciation was originally reported. Here again, the issue comes down to one of materiality: does it affect users' ability to make economic decisions?

IAS 1 further clarifies that when items of income or expense are offset, the entity should nevertheless consider, based on materiality, the need to disclose the gross amounts in the notes to the financial statements. The standard gives the following examples of transactions that are incidental to the main revenue-generating activities of an enterprise and whose results when presented by offsetting or reporting on a net basis, such as netting any gains with related expenses, reflect the substance of the transaction:

  1. Gains or losses on the disposal of non-current assets, including investments and operating assets, are reported by deducting from the proceeds on disposal the carrying amounts of the asset and related selling expenses;
  2. Expenditure related to a provision that is reimbursed under a contractual arrangement with a third party may be netted against the related reimbursement.

Other Comprehensive Income

Under IAS 1, “other comprehensive income” (OCI) includes items of income and expense (including reclassification adjustments) that are not recognised in profit or loss as may be required or permitted by other IFRS. The components of OCI include (1) changes in revaluation surplus (IAS 16 and IAS 38); (2) actuarial gains and losses on defined benefit plans (IAS 19); (3) translation gains and losses of foreign operations (IAS 21); (4) gains and losses on remeasuring equity investment financial assets (IFRS 9); and (5) the effective portion of gains and losses on hedging instruments in a cash flow hedge (IFRS 9).

The above items and an entity's share of other comprehensive income of any associate must be classified between those that:

  1. Will not be reclassified subsequently to profit or loss; and
  2. Will be reclassified subsequently to profit or loss.

The amount of income tax relating to each component of OCI, including reclassification adjustments, should be disclosed either on the face of the statement of comprehensive income or in the notes.

Components of OCI can be presented in one of two ways:

  1. Net of related tax effects; or
  2. Before related tax effects with one amount shown for the aggregate amount of income tax relating to those components.

Other IFRS specify whether and when amounts previously recognised in OCI are reclassified to profit or loss. The purpose of this requirement is to avoid double-counting of OCI items in total comprehensive income when those items are reclassified to profit or loss in accordance with other IFRS. Under IFRS, some items of OCI are subject to recycling while other items are not (under US GAAP, such items are always recycled). For example, gains realised on the disposal of a foreign operation are included in profit or loss of the current period. These amounts may have been recognised in OCI as unrealised foreign currency translation (CTA) gains in the current or previous periods. Those unrealised gains must be deducted from OCI in the period in which the realised gains are included in profit or loss to avoid double-counting them. In the same manner, for instance, unrealised gains or losses on equity instrument investment financial assets should not include realised gains or losses from the sale of the financial assets during the current period, which are reported in profit or loss. Reclassification adjustments arise, for example, on the following components:

  • On disposal of a foreign operation (IAS 21);
  • On derecognition or transfer of the financial assets (IFRS 9); and
  • When a hedged forecast transaction affects profit or loss (IAS 39).

Reclassification adjustments do not arise on the following components, which are recognised in OCI, but are not reclassified to profit or loss in subsequent periods:

  • On changes in revaluation surplus (IAS 16; IAS 38);
  • On changes in actuarial gains or losses on defined benefit plans (IAS 19).

In accordance with IAS 16 and IAS 38, changes in revaluation surpluses may be transferred to retained earnings in subsequent periods when the asset is sold or when it is derecognised. Actuarial gains and losses are reported in retained earnings in the period during which they are recognised as OCI (IAS 19).

Reclassification Adjustments: An Example

When a financial asset is held in a business model with the objective of collecting the contractual cash flows and selling the financial assets and the cash flows represent solely payments of principal or interest, the financial assets is measured at fair value through other comprehensive income.

When a sale of the financial assets occurs, a reclassification adjustment is necessary to ensure that gains and losses are not double-counted. To illustrate, assume that Exemplum Reporting PLC has the following two financial assets classified at fair value through other comprehensive income (FVTOCI), on which interest is monthly settled as due, in its portfolio at the end of 20XX-1, its first year of operations:

Financial asset Cost Fair value Unrealised holding
gain (loss)
€ € €
Loan A 105,000 125,000 20,000
Loan B 260,000 300,000 40,000
Total value of portfolio 365,000 425,000 60,000
Previous (accumulated) fair value adjustment balance 0
Fair value adjustment (Dr) 60,000

Exemplum Reporting PLC reports net income of €650,000 in 20XX-1 and presents a statement of profit or loss and other comprehensive income as follows:

Exemplum Reporting PLC
Statement of Profit or Loss and Other Comprehensive Income
For the Year Ended 31 December 20XX-1
€
Profit or loss 650,000
Other comprehensive income
Holding gains on financial asset 60,000
Comprehensive income 710,000

During 20XX, Exemplum Reporting PLC sold 50% of Loan B for €150,000 and realised a gain on the sale of €20,000 (150,000–130,000). At the end of 20XX, Exemplum Reporting PLC reports its FVTOCI securities as follows:

Investments Cost Fair value Unrealised holding
gain (loss)
€ € €
Loan A 105,000 130,000 25,000
Loan B 130,000 160,000 30,000
Total value of portfolio 235,000 290,000 55,000
Previous (accumulated) fair value adjustment balance (60,000)
Fair value adjustment (Dr) (5,000)

Exemplum Reporting PLC should report an unrealised holding loss of €(5,000) in comprehensive income in 20XX and a realised gain of €20,000 on the sale of Loan B. Exemplum Reporting PLC reports net profit of €830,000 in 20XX and presents the components of holding gains (losses) as follows:

Exemplum Reporting PLC
Statement of Profit or Loss and Other Comprehensive Income
For the Year Ended 31 December 20XX
€ €
Net income (includes 20,000 realised gain on Loan B) 830,000
Other comprehensive income
Total holding gains (5,000)
Less: Reclassification adjustment for gains previous included in comprehensive income (20,000) (25,000)
Comprehensive income 805,000

In 20XX-1, Exemplum Reporting PLC included the unrealised gain on Loan B in comprehensive income. In 20XX, Exemplum Reporting PLC sold the stock and reported the realised gain on sale in profit, which increased comprehensive income again. To prevent double-counting of this gain of €20,000 on the Exemplum Reporting PLC makes a reclassification adjustment to eliminate the realised gain from the computation of comprehensive income in 20XX.

An entity may display reclassification adjustments on the face of the financial statement in which it reports comprehensive income or disclose them in the notes to the financial statements. The IASB's view is that separate presentation of reclassification adjustments is essential to inform users clearly of those amounts that are included as income and expenses in two different periods—as income or expenses in other comprehensive income in previous periods and as income or expenses in profit or loss (net income) in the current period.

Statement of Changes in Equity

Equity (owners', partners' or shareholders') represents the interest of the owners in the net assets of an entity and shows the cumulative net results of past transactions and other events affecting the entity since its inception. The statement of changes in equity reflects the increases and decreases in the net assets of an entity during the period. In accordance with IAS 1, all changes in equity from transactions with owners are to be presented separately from non-owner changes in equity.

IAS 1 requires an entity to present a statement of changes in equity including the following components on the face of the statement:

  1. Total comprehensive income for the period, segregating amounts attributable to owners and to non-controlling interest;
  2. The effects of retrospective application or retrospective restatement in accordance with IAS 8, separately for each component of equity;
  3. Contributions from and distributions to owners; and
  4. A reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing each change, for each component of equity.

The amount of dividends recognised as distributions to equity holders during the period and the related amount per share should be presented either on the face of the statement of changes in equity or in the notes.

According to IAS 1, except for changes resulting from transactions with owners (such as equity contributions, reacquisitions of the entity's own equity instruments, dividends and costs related to these transactions with owners), the change in equity during the period represents the total amount of income and expense (including gains and losses) arising from activities other than those with owners.

The following should be disclosed, either in the statement of financial position or the statement of changes in equity, or in the notes:

  1. For each class of share capital:
    • Number of shares authorised;
    • Number of shares issued and fully paid, and issued but not fully paid;
    • Par value per share, or that the shares have no par value;
    • Recognition of the number of shares outstanding at the beginning and at the end of the periods;
    • Any rights, preferences and restrictions attached;
    • Shares in the entity held by the entity or its subsidiaries; and
    • Shares reserved for issue under options and contracts for the sale of shares, including terms and amounts.
  2. A description of the nature and purpose of each reserve within equity.

US GAAP Comparison

US GAAP encourages but does not require comparative statements. The SEC requires income statements for three years.

SEC registrants are generally required to present expenses based on function, but there is no such requirement within US GAAP. The US GAAP income statement is presented in basically the same order as IFRS income statements, but differences in presentation and captions result in some differences. Previously, US GAAP included an income statement caption entitled “Extraordinary Items” for items both infrequent and unusual. In 2015, the concept of extraordinary item was removed, making US GAAP more in line with IFRS, which does not allow for any extraordinary items. There are no GAAP requirements that address specific performance measures, such as operating profit. However, the SEC requires the presentation of certain headings and subtotals. Also, public companies cannot disclose non-GAAP measures in the financial statements or accompanying notes.

Discontinued operations under US GAAP are components held for sale or disposed of, for which there will be no significant continuing cash flows or involvement with the disposed component.

In the measurement of gains or losses from derecognition of non-financial assets, US GAAP (as amended by ASU 2017-05) has the concept of an in substance non-financial asset, which is a financial asset including a contract of assets disposal where the fair value of non-financial assets represents substantially all of the fair value of the assets disposed of.

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